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Lead the Herd

Peter Katevatis - Mar 08, 2017
There have been many discussions regarding low fee Exchange Traded Funds (ETFs) and how investors don’t need to beat the market.  With the SPDR S&P500 ETF Trust (SPY) generating a 22.31% return in the past year, being average definitely helps you rea

There have been many discussions regarding low fee Exchange Traded Funds (ETFs) and how investors don’t need to beat the market.  With the SPDR S&P500 ETF Trust (SPY) generating a 22.31% return in the past year, being average definitely helps you reach your goals.  However, there are some very interesting trends developing that could become disturbing.

 

As with most successful historical strategies, the money will always follow it.  One of the top ETF companies, which happens to be my favourite, is Vanguard Group.  In February 2017, the Wall Street Journal reported that Vanguard’s assets under management just topped US$4 trillion.  That’s $4,000,000,000,000... an awful lot of zeros!

 

KWM - Lead the Herd

 

My concern is that individual investors and even some institutions often don’t realize the exact mechanics of what occurs when they buy an ETF in the market.  Continuing with our example of SPY that was named above, if you buy $10,000 worth of shares in the market you now own a small piece of 500 companies that constitute the S&P 500 Index.  The top 3 companies are Apple (3.19%), Microsoft (2.50%), and Alphabet (2.43%).  So just looking at these 3 of 500 pieces… your purchase of $10,000 in the ETF will create a subsequent purchase of $319 Apple, $250 Microsoft, and $243 Alphabet.

 

As we start to add multiple zeros to each of these index ETF purchases you can see that more and more of the public’s investment funds are funnelling into less and less companies.  This process will eventually lead to a valuation gap between the top indexed companies and those companies on the outside looking in.

 

Since I am always looking for the best opportunities for clients to benefit I see a wonderful valuation lift potentially present when a company grows large enough to join the index.  If you can own a growing smaller company that joins an index you should get a boost in price when the herd of ETFs start buying.

 

Great idea, but how do you execute something so obscure?  This is where professional management steps in as “stock junkie” types scour the shadows of the market.  Having been an advisor for a while I know several of these folks and I’m happy to share some thoughts. 

 

It would not be ethical (or legal) for me to publically share investment ideas but don’t hesitate to contact me to discuss it further.