Thank You to Roger Nusbaum, Melissa Lee, Eugenio Moreno March 17, 2010, David Kotok, Chairman & Chief Investment Officer
“If you are familiar with Kotok and have read his stuff you know he is no lightweight, so I am not sure why he of all people is ETF-only.” Roger Nusbaum, www.benziga.com, March 14, 2010. For Roger Nusbaum’s full report see: http://www.benzinga.com/171952/the-big-picture-for-the-week-of-march-14-2010 .
We thank Roger for the compliment (grin) about our weight, which is an ongoing problem and not fully revealed on TV. And we would also like to furnish him with an answer. There are many reasons to like ETFs. One of them is the issue of informational advantage, and, Roger, the issue you raised in your comments about consumer discretionary stocks and two ETFs can demonstrate it.
First the viewpoint: simply, there is no LEGAL informational advantage with a single stock. There may be an illegal advantage. For example, you can learn about a new drug before the news is public, and successfully profit on a trade. You will have become an insider and broken the law. But you may also get away with it. So you profited illegally. If you get caught you may go to jail. That is the risk of using an illegal informational advantage. In our firm we have very severe rules against this activity, and anyone caught may be terminated at once for cause.
So if you, as an investor, do not have an illegal informational advantage on a single stock, what do you have? Either you are totally current all of the time on every item concerning a company, in which case you have informational neutrality, or you are missing something for some reason that others have not missed and you are at an informational disadvantage. Note I am talking about disclosed facts and not opinions. Analysts render opinions. Sometimes they get surprised, but the opinion is based on knowledge and examination of the industry and gaining an understanding of the company’s operations within that industry. It may not be based on illegal information. Note how analysts specialize in industries for that reason.
ETFs start with the industry. They acknowledge the lack of a legal informational advantage. To stay with the drug company example, a large pharma-oriented ETF position captures all or most of the industry group. It suggests that the investor has to draw inferences about the entire group and not try to outguess the other guy on a specific company. If pharma does well, the investor will do well. He doesn’t need to choose between Merck and Pfizer; he has both. Roger, that is one of the reasons we like ETFs. It is only one of many, but it is the one that applies to your column concerning my discussion with Melissa Lee.
There were two consumer discretionary ETFs under discussion. The first is VCR, a Vanguard-sponsored group of 381 stocks. The largest weight is McDonald’s at 5.5%, number two is Disney at 4.6%, and Home Depot is number three at 4%. Wal-Mart is not a component of this ETF.
The other ETF is IYC. It is comprised of the Dow Jones US Consumer Service industry grouping. It contains 194 stocks. McDonald’s is 5%, Disney is 4.2%, and Home Depot is 3.9% of the weight. But the big guy in IYC is Wal-Mart at 8.2%.
Clearly Wal-Mart has a powerful influence on one of these ETFs and is not part of the performance of the other one. Both ETFs are at new recovery highs since the first of the year. Until two days ago the ETF with Wal-Mart had underperformed the ETF without it. Wal-Mart was the reason for the performance difference. Melissa Lee pointed that out in our off-camera conversation, and she called it “dead money”. If you have seen Melissa as anchor on CNBC’s Fast Money you know she is sharp and quick and economizes on time and words. She was correct. Wal-Mart has been dead money.
She asked me why the two ETFs instead of one. What TV time limitations didn’t allow us to explain is that we wanted an overweight position in consumer discretionary sector in order to capture the recovery for a while, given the stimulus coming and the fact that the economy was in recovery. We liked the VCR position and its very broad array of stocks. But we worried about how one could be taking a positive position for the consumer recovery but ignore the largest vendor to the US consumer. Actually, we should say, the world’s consumers. So we needed to have some Wal-Mart in the weight. But we didn’t want to be too heavy in Wal-Mart, so we compromised with two positions. That kept us in some Wal-Mart but it allowed a lower weight than if we put all the eggs in one ETF basket.
It turns out we got a boost since this interview (March 12, 2010; see: CNBC.com). Wal-Mart had several positive announcements on March 15 and was upgraded by analysts. That spiked the stock. It also reversed the relative performance of the ETFs. Both are still higher than last week, but IYC is now outperforming VCR and has done so by a good increment in the last two trading days. We had no illegal informational advantage on Wal-Mart. We did not know that the announcements were coming. We did believe that Wal-Mart needed to be in the representation with some weight but we didn’t want to overweight it. So we blended the two ETFs to manage the risk of too heavy a concentration.
We thank Roger Nusbaum for raising this technical question in his column.
Now let’s segue to an appeal for some assistance to some folks who really need it.
“Please call my mobile” was the message. I responded immediately, and my friend Eugenio Moreno answered the phone in Santiago, Chile. Eugenio and I have traveled together and exchange views about the world. He is a shipping executive for a major company in his country and he is also a community activist and concerned citizen. And he is a member of the Global Interdependence Center and has worked with me on projects involving Chile. I trust him. He described the plight of the poor in Chile in the post-earthquake environment. He told me about a fundraising group that is very legitimate and has a US IRS ID number and is raising funds for assistance. They are also a micro lending group and are doing some fine work that deserves support, in my view. I believe that they are affiliated with the Jesuits.
Eugenio’s email information is below. I am sending a thousand dollars. I will also be traveling to Argentina and Chile starting this coming weekend. I hope to learn a little more about conditions in the region and also take a few days to find a friendly Patagonian trout that is not too shaken by the quake.
Eugenio wrote:
“Dear David,
As you know, on February 27th Chile was struck by one of the most violent earthquakes in history, causing huge damage to the centre and south of the country. The area worst hit by this earthquake – approximately 250 km between the cities of Talca and Concepcion – has seen many buildings, houses, roads, bridges and rail infrastructure destroyed or heavily damaged.
In some places the situation is truly desperate and thousands of families have lost their houses and all their belongings. The scale of the destruction is such that they need as much help as they can possibly get.
I would like to offer our friends at GIC the opportunity to make a donation to Hogar de Cristo, which is a private NGO and a charitable institution founded in 1944 by Saint Alberto Hurtado, SJ. Hogar de Cristo has an annual budget of US$60 million and is focused in assisting poor people all over Chile through different program centers. Several of their centers are damaged or destroyed in their structure, and total cost of damages amounts to an estimated US$6.5 million.
Hogar de Cristo also operates a microcredit foundation, "Fondo Esperanza", similar to the Grameen bank in Bangladesh that works with 39,000 poor families. In the earthquake, 15,000 of the small businesses in the region were seriously damaged. Hogar de Cristo is now working hard to raise US$230 per family, which is about US$3.5 million, to give assistance to these 15,000 families, allowing them to restart their work and business.
Hogar de Cristo therefore needs to raise an estimated total of US$10 million, so if our friends at GIC are willing to help they will be most thankful. I wish to share with you that a close and good friend of our family, Father Agustin Moreira, SJ, has been the general Chaplain at Hogar de Cristo for the last ten years.
You can visit their web page at: www.hogardecristo.cl or www.fondoesperanza.cl for more information.
I am sorry to contact you this way – it is not my intention to put you ‘on the spot’. However I feel that as an individual I must convey to you the scale of this disaster and ask for help on behalf of Hogar de Cristo; any help will be gratefully received.
(I am copying my friend Father Agustin.)
Yours faithfully,
Eugenio Moreno
HOGAR DE CRISTO USA Phone: 954-336 9431 Mailing address: 318 Indian Trace #128 Weston, FL 33326 e-mail: hogardecristousa@bellsouth.net
HOGAR DE CRISTO U.S.A IS A FLORIDA NONPROFIT CORPORATON. IT IS A PUBLIC CHARITY EXEMPT FROM FEDERAL INCOME TAX UNDER SECTION 501 (C) (3) OF INTERNAL REVENUE CODE IRS # 03-0599418
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