Thursday, September 16, 2010

So, This Professor...

Over the weekend, The Wall Street Journal had an interesting piece on new exchange-traded fund (ETF) offerings based on the theories and academic research of university professors and other academics. The article cites University of Pennsylvania's Jeremy Siegel as being a co-founder of Wisdom Tree Investments in 2006 which issued ETFs focusing on dividend paying stocks. Another example given was SummerHaven Investment Management LLC which last month started a commodity ETF driven by the research of Yale University's Geert Rouwenhorst.

When I saw this article, my interest was piqued because I had heard of WisdomTree but hadn't looked into their offerings much. After reading on their website that the LargeCap Dividend ETF follows their own fundamentally weighted index, I began to understand the problem with their lackluster returns. Besides their heavy weighting in financial stocks during the crisis, the use of the term "index" with the word fundamental preceding it scares me off. After all, the purpose of an index is to include a broad-based representation of a large group of assets without any bias towards fundamentals. In this case, including an entire universe of dividend-paying stocks, rather than those that simply meet a pre-determined fundamental threshold may have been more appropriate.The slippery slope towards a manager taking an active role in stock selection under the guise of indexing is possible.

I greatly respect Professor Siegel and his work. His focus on dividends is one that I can agree with completely. After all, dividends are ultimately what drive returns on stocks. However, I'm quick to shy away from any ETF or index fund offering that has too flashy of a personality behind it (yes, Siegel even publishes a newsletter) or invests according to a fundamentally-weighted index. Index fund and ETF investing should be boring and the goal is to invest in both to capture the returns of an entire universe of securities, not an "index" of cherry-picked securities.

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