Trying to Answer

I had this question come in I’m not entirely sure I follow it but I will give it my best shot. It was in response to my saying I would not evaluate ETFs as described in this post.

Essentially what would be the way you would do things? I looked through your archives in search of a more clear analysis methodology -- all I could find was the "Big Picture" post on August 15, 2005. What you talk about in this post could be used towards ETF analysis, however, is not directly correlary with traditional quant methods, more qualitative. What comes to mind regarding this more textbook analysis approach towards ETF analysis in your mind?

I think the reader wants to know how I do evaluate them. Evaluating a particular ETF comes late in the process. I start much bigger with asset allocation. Then I evaluate each of the ten sectors in the S+P 500 to decide whether I want more or less exposure than what is in the market. For example I want more energy than the 10% or so in the market and I want less exposure to financials than the 20% or so in the S+P 500.

I make these decisions based on current events and historical precedent. Hopefully the two can be woven together to create a reasonable forward-looking analysis. This is how themes start to come together. Behind this is the foundation of having studied supply and demand for all sorts of things, understanding various cycles and figuring out what the market might be afraid or what is already priced in. This process needs to repeat for various countries and I need to understand the role in the global economy of those other countries.

It is in the last two paragraphs where I get most calls right or wrong.

Once I have figured this out (or think I have), I then try to assess what the best tools are to capture all the effects I want to capture. This has to be done in conjunction with client needs. For various reasons owning Norway through a common stock may not be possible for every single client. Given the totality of each client situation I have to figure out the best thing or things to capture the market. If I think the best way to capture financials is with five different stocks, those five may not be right for every client. For example, some clients own a bank stock from Chile. A Chilean stock is not right for everyone so not every client owns it.

Very rarely do I think an ETF the single best way to capture something. Where I do think an ETF is the best way to go, that is what I buy. Some clients have more ETFs than other as a function of tolerance for volatility or because of account size.

The shorter answer is I don’t really evaluate ETFs in a way that the reader is asking about. I decide on the sector or the country and then find the tool. I can say that I want to be sure that the ETF adequately captures its intended effect..