RETAIL REPORT: Three Investment Strategies to Fear

Traders Magazine Online News, October 30, 2018

John D'Antona Jr.

Trick or treat.

As the end of October rapidly approaches, investors can choose an investment trick or treat when it comes to investing ahead of the new year or holidays. Gerry Frigon, Chief Investment Officer at Taylor Frigon Capital Management shared with Traders Magazine some of his thoughts on three investment strategies to fear.

Robo Advisors

• We believe that the single most important factor of successful investing involves having a consistent investment philosophy which informs your selection of companies whose stock you will own. 
• This is the opposite of what algorithm-based strategies usually do - because those algorithms are frequently changed to try to capture "what's working now."
• We have pointed out before that backwards-looking, mathematics-driven investment strategies, such as the "quant" or "black box" strategies of the computer age or the "various systems" of market prediction that T. Rowe Price wrote about all the way back in the 1930s, usually fail (in the words of Rowe Price) "at crucial turning points in the market."
• It's great to have a sophisticated investment strategy that "beats the pros" if you can manage to only use it during "periods chosen for their lack of unusual stock market activity." This is exactly why so many quant strategies were wiped out by the "unusual activity" of 2008 - 2009.
• The problem is that no mathematical model can predict the next entrepreneurial development that will create new markets and drive economic activity in a completely different direction.
• It is these unexpected innovations, and the companies which develop them or take advantage of them, which create real wealth and growth.

ETFs

• We believe that ETFs pose a potential threat to investors and to the efficiency of the market mechanism, and ultimately to true price discovery.
• They replace an investor’s ownership of securities issued by a business with a synthetic vehicle linked to securities by a process of financial engineering.
• This distancing of the investor from the portfolio of securities that the ETF is supposed to be tracking lowers the perceived need to scrutinize the securities in the underlying portfolio: in other words, it breeds complacency on the part of the typical investor in the ETF.
• Even an unsophisticated and relatively uninformed investor in an individual stock, for instance, acknowledges that someone should be performing careful analysis on that stock: with an ETF, many investors seem to believe (mistakenly, in our opinion) that careful ongoing analysis of the underlying securities and the companies that issue those securities is less necessary, or even entirely irrelevant.
• There have been attempts to create “active ETFs” which track a portfolio of securities selected by a manager rather than an index or market segment – but even after several years these have less than 1% of all ETF assets, and the majority of them own securities other than stocks.
• We suspect that many active managers would prefer to manage portfolios in which the trading is not driven primarily by arbitrage activities.
• Because arbitrage by its very nature requires liquidity (in more ways than one), a temporary liquidity shortage could lead to the price of the ETF decoupling from the portfolio of securities it is supposed to be tracking. 

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