It’s official: The ETF industry has finally gone too far.
IndexUniverse.com reported this morning that a firm called LocalShares is on the verge of launching the Nashville Area ETF, which will likely trade under the ticker NASH. As its name suggests, the ETF will invest entirely in companies located in the Nashville area … the 25th-largest city in the United States.
This news item raises several questions, although none of them is likely to be, “How long do I have to wait for ETFs invested in cities 1-24?” Instead, investors will undoubtedly wonder what companies the fund will target for potential investment. Fortunately, we have Wikipedia to provide us with the answer. As investors will quickly glean from looking at the list, the pickings are slim, and many of these companies are private entities, including (regrettably) Total Nonstop Action Wrestling.
This backdrop highlights the inevitable problem with such a fund: By its very nature it will lack diversification, meaning that investors will be buying a fund with higher risk than a more broadly based portfolio, but with a 50-50 shot, at best, of outperformance relative to the broader market. Perhaps the fund’s launch is a unique way to promote its subadvisor, the Nashville-based firm Decker Wealth Management. Either way, the question isn’t if this fund will eventually be shuttered, but when.
NASH Highlights the Trouble with ETFs
The Nashville ETF is a sign of a larger issue for individual investors: there are now so many ETFs — 1,486, to be exact –that people of all skill levels have access to small areas of the market. This glut has encouraged individuals to dabble in the practice that in the hedge-fund world has become known as “macro tourism.” Barry Ritholtz sums this up as being managers who deviate from “a core competency (Value, Activist, Arbitrage, etc.) and [jump] into the global Macro style of investing, despite a lack of experience and expertise in that arena.”
Unfortunately, hedge fund managers aren’t the only investors who can deviate from their core objectives to chase performance in odd areas of the market. Today, individuals have any number of ways to make ill-advised bets with their savings. Whether it’s Australian small-caps, stocks in Central Asia and Mongolia, or funds that include the words “Alternator,” “Anti-Beta,” “Tail Hedge,” or — perhaps most inscrutably — “Dynamic Magniquant,” there’s an ETF for that.
In most cases, however, very few individuals have the “budget” within their savings to devote to exotic investments, and those who do generally meet with limited success. A telling sign comes from the ad Interactive Brokers Group (IBKR) has been running in Barron’s of late. It highlights the fact that its clients have the highest percentage of profitable currency-trading accounts in the business. But even though Interactive’s traders came in first, their success rate was still only 43.3%. Of the nine other currency brokers cited, six had success rates of less than 33%.
What does this tell us? For most people, the best approach is to avoid unnecessary complexity by buying a few key funds, stashing them for the long term, and rebalancing when appropriate. Why slice and dice your equity exposure when Vanguard Total World Stock ETF (VT) covers all the equity bases in a single basket?
The Bottom Line
The Nashville ETF, while perhaps the most absurd product to hit the market, is just one of many funds that doesn’t deserve a place in individual investors’ portfolios. Ultimately, the best strategy is also the easiest one — keep it simple.
At the time of this writing Daniel Putnam owned shares of VT.