June 05, 2010

Is One ETF Really All You Need?

Referring to a post on Seeking Alpha, a recently established exchange traded fund promises to be the one and only ETF investors need to get an overall exposure in the stock market.  Paul Hrabal, President of U.S. One (ONEF) explains:

Our firm wants to give small investors (under $100K in investable assets) access to the same professional portfolio management that high net-worth investors receive from their dedicated advisors, but at a fraction of the cost, packaged in a way that is easy to understand and buy and which follows the time tested approach of passive index investing. ONEF would be suitable for someone looking for an all- in-one buy-and-hold stock fund that handles the asset allocation and securities selection for them. This single fund gives exposure to nearly the entire investable global equity market. It's geared towards the 30-50 crowd - people that are still far from retirement – and most in need of long-term growth through stocks. Obviously anyone who buys this fund is still on their own for fixed-income exposure. U.S. One hopes to also launch similar 'one-and-done' bond and balanced ETFs to provide a full range of investment solutions to small investors.

The concept is certainly worth considering.  It is true that, on average and over time, the vast majority of investors do NOT outperform the major market indices, something we have also concluded on numerous occasions.  That is why, on average, it makes more sense to invest in a low-cost index fund that is simply matching the performance of the market at minimal expense to the investor.  This strategy is typically a better choice than stock picking, certainly for smaller and unsophisticated investors. 

It also beats owning mutual funds on average because the majority of Mutual Fund managers do NOT outperform the benchmark over time either.  On top of that, management fees and fees in various forms, typically 1% or higher will eat into returns further.  Hence, the idea of a single product with a balanced exposure of the entire stock market exposure sounds appealing.

There are still a number of caveats with U.S. One however.  To begin with, you're entrusting your money with a fund manager that has never managed a fund before.  Ron Rowland of AllStarInvestor.com notes:

“The Advisor has no prior experience managing, or administering, an investment company. One Fund also has no prior experience with assets under management and no track record. The portfolio manager currently does not manage any other accounts. When buying an actively managed fund, most investors base part of their decision on the manager’s experience. In the case of ONEF, there does not appear to be any."

And Paul Hrabal plainly admits:

Ron is right. This is my first foray into the portfolio management industry. That being said, my methods are time-tested and supported by long-term data analysis in terms of being a buy-and-hold follower of passive indexing, with minimal portfolio activity. People can go see for themselves how the underlying components have performed. I'm not trying to be the best stock picker out there. My aim here is simply to track the global equity market as cheaply as possible. Having a single fund which limits the commissions you'd pay to own each of the underlying components separately and then to have to rebalance annually, we are offering a very compelling value proposition to small scale investors.

In the increasingly competitive arena of Exchange Traded Funds where a large number of funds have a hard time getting off the ground (some of them have been closed due to lack of investor demand), a newbie is facing an uphill struggle.  That shows in the minute value of the fund which has been conveniently omitted from the fund’s website (they only display the value of shares outstanding).  At the close of this week, ONEF was worth just $2,371,200, a value so low that it would normally not allow covering the fund’s own administrative expenses at a reasonable ratio, certainly not at the proposed 0.51% expense ratio to investors.

That said, there are other reasons to be cautious.  While smaller investors these days are better served than ever in terms of being able to get a broad market exposure with a number of ETFs at lower cost than Mutual Funds, one must still question: what is the point of paying someone to select just 5 ETFs and come up with a relatively simple weighting and annual rebalancing?  U.S. One has the following holdings as of 3 June 2010:


Then there is that old question of diversification.  What is the best asset allocation, what weightings should be employed and how often and how much should the portfolio be rebalanced.  As the past few years since the financial crisis showed, diversification does not always work and certainly within just the equity side, it remains questionable whether it really makes much of a difference for the smaller investor.  As Doug Short of www.dshort.com puts it:  Diversification works until it doesn’t...


As the chart above implies, perhaps a John Bogle approach (John Bogle was the founder of the Vanguard Fund family) which is a simple aged based asset allocation strategy, wherein the fixed income component matches an investor’s age is probably the best way to create an easy and relatively safe way to balance a portfolio.  Any investor should be able to achieve that without having to pay a fund manager.

In closing, Ron Rowland who maintains the ETF Deathwatch List has the following comments:

ONEF has huge obstacles to overcome. The sponsor has entered an extremely competitive ring, yet appears unprepared for the battle ahead. I predict ONEF will be near the top of my ETF Deathwatch when it becomes eligible in December 2010.

Given the investor mood these days, it is questionable whether ONEF can stick around that long...

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