As we move forward to the New Year, I can’t shake the feeling that for private traders, like us, 2019 has proven to be a magical year, a year that finally, throughout the brokerage industry, has removed from us the shackles of commissions from our trading. Many of the new things I’ve attempted in the past months has been help me understand the opportunities opened up by a commission-free world.
One thing it means is that I can build my own equivalent of an exchange-traded fund, free of the expense ratio built to the price. Sure, it’s generally quite small — 0.09% in the case of SPY, for example. But it adds up, and as a trader, I’m reluctant to give up even a penny of potential profit.
That small expense payment compensates the fund for the cost of its management — buying and selling shares to maintain various balances. But I know how to trade. And I live in Portland, Oregon, where do-it-yourself is strongly held ideal. I don’t need to pay someone to trade for me when I can easily build my own DIY ETF.
When I hear people singing the praises of index funds, I can’t help think that they’ve forgotten what a fund is. It’s stocks, bundled together, but still separate, with separate earnings and market risks and dividends and management smarts. A third advantage of having no commissions to pay is that I can pick and choose from among a fund’s holdings and buy only the best, using whatever rating system I prefer. (I use Zacks premium, paying for it with the money saved with commissions.)
When I first set up the Genetics Portfolio a short while back, I was testing the idea that I could show good returns if I were to pick only the stocks ranked “buy” by Zacks from the entirety of an exchange-traded funds holdings. By being selective, I should be able to improve on the fund’s performance.
So how good are the stocks that funds hold? Are the managers carefully picking the best of the best?
There were, I found, surprisingly few stocks with “buy” rankings (ranks 1 or 2). In the 37 ARKG holdings, only one symbol is ranked 1, and eight ranked 2. That means 74% of the fund’s stocks have a Zacks rank of hold or sell or, as is the case with three symbols, have no analyst following and so no Zacks rank.
Intrigued, I took a look at some other ETFs, to see how they stacked up. DJI, which tracks the Dow Jones Industrial Average, has 30 stocks, only seven of which are ranked “buy”.
I looked at several sector ETFs, the sort that do well in the late stage of the business cycle and continue to outperform during the recession. XLP, the consumer staples sector fund, has four stocks ranked “buy” out of a total of 33 in the fund’s holdings. XLV, the health care sector fund, has has 16 “buys” out of 61 holdings. XLU, the utilities sector fund, has four ranked “buy” out of 28 holdings.
There’s a fourth advantage to building our own funds. The big ETFs own a lot of shares, and that means they aren’t very nimble, because it takes time to find buyers or sellers of such large lots. Private traders can get an instant fill. So rather than being forced by the logistics to hold on to underperforming symbols, we can trade in and out, commission-free, whenever we think it’s best for performance.
And indeed, we aren’t limited to subsets of the big funds. We can create our own, by whatever criteria we like. I’m partial to stock symbols that begin with “Z”, so my 10-symbol Zombie Portfolio can begin with ZEN, work trough ZUMZ and then reach completion with ZYNE.
An odd criterion? Yes. Worth experimenting with? It’s on my to-do list, perhaps as one of the wonders 2020 will bring.
By Tim Bovee, Portland, Oregon, December 26, 2019
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