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Seeking Alpha Interview

By: Jason Whitby

By: Jason Whitby, MBA, CFA®, CFP®, AIFA®

Seeking Alpha’s Jason Aycock recently interviewed Jason Whitby about what Jason would own (or short) if he could choose just one stock or ETF to own. The interview raised some very important and thought provoking points which we wanted to share with you.

Which single asset class are you most bullish (or bearish) about in the coming year? What ETF position would you choose to best capture that?

If I could own just one stock or ETF, then it would have to be Vanguard’s Total World Stock Index ETF (VT). Perhaps I’m taking the question a little too literally or perhaps I just lack the necessary convictions in my (or anyone’s) market predictions to choose anything more focused. VT is the most diversified ETF capturing the largest percentage of the world stock market capitalization.

I don’t know why I would accept anything less, unless I could tell the future – which I can’t do, no matter how hard I try! Therefore I’ll go with the ETF that gives me the highest probability of achieving a fair return: VT.

How does this ETF fit into your overall investment approach?

Investor Solutions has some straightforward investing biases. First, we believe that capital markets and capitalism work. Therefore ownership should produce a fair return for assuming ownership (equity) risk.

Secondly, we believe that capital markets are efficient. Efficient doesn’t mean perfect or 100% correct. Efficient simply means that market prices are the best estimates of value and that future stock prices are unpredictable. Therefore it makes little sense to try and outguess the market. You can try, but the data show that you will probably fail and the act of “trying” will cost you in fees, taxes and underperformance. These two points lead me to select a broad equity ETF. It is best to accept market risk for market returns and to reduce risk by removing as much systematic risk as possible.

Next, Investor Solutions believes that the market should be described as the most diversified global portfolio using public securities. In our firm, we usually target 15 different investment areas using various institutional mutual funds and ETFs to capture the world market capitalization, tilting the portfolio to capture more value and small-cap risk premium. VT is the closest option though it is heavily weighted to large/mega caps, and has no value tilt. Still, VT is the closest option available with 46% in North America, 15% emerging markets and 34% in developed foreign.

Finally, VT offers this global diversification in one simple ETF at the lovely low price of 0.3%, and tax-friendly to boot. So, 100% equity, the most globally diversified, lowest cost, tax-efficient ETF is the clear winner. Many investors would be well advised to give up their sector plays and just build a portfolio solely of VT.

Some readers will be expecting a sector pick in Just One ETF, but as you note, it’s about matching return with risk. So my question is: Why settle for market returns? Do you consider yourself highly risk-averse?

I’m certainly not risk-averse nor should anyone mistake VT as a low-risk investment for the risk-averse. After all, VT was down about 40% at the worst of it. So I’m absolutely a risk-taker, though an important distinction should be made as to which risk. I see no reason to take uncompensated risk or unsystematic risk. Sure, you can get lucky with sector bets, but if I can only own one ETF, I don’t see that as a good strategy for real money.

As far as why you should just settle for market returns, I’d say why shouldn’t you? There is this idea that investors should “try” to do something: Try to beat the market. Try to get out before a crash. Try to jump in before a rally. Try to do better. Try if you will, but the empirical data all show that “trying” just increases costs and taxes as well as leading to drastic underperformance compared to the markets.

So if the market returns are acceptable, then why not just accept them? You actually are increasing your risk and decreasing your expected return by not just accepting market returns. Sometimes it doesn’t pay to get complicated and “try.” Let’s use the analogy of driving in heavy traffic on the interstate.

Some drivers sit in their lane staring only at the car directly in front of them, blind to everything else. This makes no sense. But neither does the strategy of darting in and out, constantly changing lanes, honking, trying to guess which lane is best. This strategy only increases the chances of getting into an accident, decreases mpg and increases the aggravation of getting to where you want to be.

Most experienced drivers reach the point where they realize that the best strategy is to stay in one lane unless there is a clear reason to change. On the freeway, this is usually the left lane, so let’s consider this lane equity. The right is usually the slowest, so this will be a mix of stocks and bonds. Then finally we have the exit, which is all bonds.

So a driver can try jumping across lanes or they can pick the appropriate lane for their needs and objectives. Usually that’s the farthest left lane (accumulation phase) until they get close to their exit (death) at which time they move to the right lane (distribution phase) and then finally exiting (to the great unknown). Few rational prudent drivers stay to the far left lane and then quickly swerve to the exit. This type of jumping back and forth only increases the chances of a wreck in driving as well as investing.

What about fixed income? Do you expect record-low yields for bonds to have any effect on the global equities that you’re counting on for a steady return?

I never said anything about a steady return. Quite the opposite, I think you should count on unsteady returns from global equities moving forward just as there has always been. There is a real misconception today that markets used to be stable, which is completely ridiculous. Secondly, record-low yields are not the same as record-real yields. But I’m guessing your question is geared to the idea that low bond yields are an incentive for investors to take more risk in stocks.

Obviously, there is some effect here but we could see low yields for a long time. But remember, low yields in the U.S. is different from low global yields. VT is a global investment. The developed markets have low real yields, but VT has about 15% in emerging markets which still have relatively high yields. Trying to use a yield ratio to time equity is a mistake. Better to own the appropriate amount of bonds according to your desire, need and capability to handle investment risk.

Tell us more about global equities, and what makes that asset class your top pick.

Investing in VT is the lowest risk to my future, meaning the lowest risk of not achieving my return objective. The lowest risk of missing the market returns. The highest probability of success. Let’s say you decide to place all your capital in a commodity producer ETF or a Gold ETF – what happens if this very narrow slice of the market does nothing? What if it isn’t its time to shine?

I hate to use a gambling analogy, but let’s take roulette. Picking one gold stock is like placing all your chips on the number 13. Picking one gold ETF is like picking 4 numbers. Picking an S&P 500 ETF is like picking red. Some people think VT is essentially placing your chips on all the roulette options, but it isn’t, not even close.

Buying the total global stock market, VT in our example, and not trying to jump in and out, is like owning the roulette table. The casino might not win every time, but over time, the casino is the only winner in Vegas. And that is what we are trying to accomplish in the capital markets. We are trying to extract a premium over the risk-free rate on our investment by accepting ownership risk.

Are there alternative ETFs that could be used to capture the same theme? What makes VT your first choice?

The only other global ETF is iShares MSCI ACWI Index Fund (ACWI). If I couldn’t choose VT, I’d be happy with ACWI. For all practical purposes the difference is marginal and both would achieve my goal if utilized prudently. With that said, VT has a lower fee and a slightly more diversified index, and Vanguard is well known as a master at managing index funds.

How does your view differ from the consensus sentiment?

Investors today have too much data- er, I mean noise. One day the experts are predicting the second depression while simultaneously other experts are predicting deflation or inflation or something catastrophic. Most people don’t understand that the media is in the ad business. Extreme sells. Polarization of opinions gets air time, not level-headed common sense strategies.

So what is the sentiment in the industry about VT? VT is boring. It is hard for anyone in the investment industry to make a living talking about VT. It is easier to talk about some sexy sector selling the hopes of something new and improved. A vote for VT is a vote for common sense.

If you could only have one investment, a lot of people in the financial services industry would pick VT, but they wouldn’t tell you. Their salary is often dependent on creating an aura of mystique, of being an expert, of knowing something no one else does. Essentially what they promote at work isn’t necessarily the same thing they do with their own investment portfolios.

Do you still believe in the efficient market and modern portfolio theory? Some say that both failed in 2008?

How did the efficient market hypothesis (EMH) fail in 2008? EMH basically states that current market values are the best estimates and that future market price are unpredictable. EMH does not state that the market prices are correct.
I’m not sure why some people feel EMH or modern portfolio theory (MPT) failed in 2008. No one should infer that the validity or application of EMH & MPT will insure positive returns. Rather, the application increases the probability of a positive return. There is a difference between possibilities and probabilities. EMH and MPT help increase the desired probability but cannot remove the possibility of a negative outcome.
The alternative would be market timing and there simply is no empirical data that supports market timing. Are there successful money managers timing the market? And, will these same money managers successfully time the markets moving forward? All the data would lead any rational, prudent investor to abandon market timing

What catalysts, near-term or long-term, could move the sector significantly?

I’m sorry, but it seems like a futile exercise and detrimental to investor performance to try and guess. A simple question: Do you believe in a return on equity ownership and are you willing to accept the risk of equity ownership? If yes to both, just buy the appropriate amount of the global markets, in this case using VT. If you can’t answer yes to both, then don’t get involved.

What could go wrong with your pick?

By wrong, I’m guessing you mean a negative return. But that’s a mistake. The real thing that could go wrong in my mind would be that VT produces a significant tracking error to the FTSE All-World Index. Given the breadth and liquidity of the index, as well as Vanguard’s management experience, I’m not worried.

Fair enough, but another global stock pullback would be considered “wrong” for those who would rather be taking even low bond yields (and of course, that kind of “going wrong” is “going right” for those on the other trade, shorting the broader equity market). What do you think the odds are of a big macro event hurting global equities, like the eurozone debt crisis?

Of course we would rather be in low-yielding bonds or short stocks right before another global stock pullback and then move long global stocks right before another global stock rally, but the chances of getting both right are pretty slim to none. Even being more or less “right” in your timing still wouldn’t mean a better return than just sticking to your investment plan.

When we consider what can go wrong, investors essentially should be trying to gauge how much downside they can handle. You ask about the odds of another big macro event hurting global equities and I’d say you should expect it to happen. The questions are really when and how bad, and the answer to both are just guesses and speculation. As an investor, you should expect there will be years with negative returns and you should not expect anyone to be able to successfully get you out right before. Try as they might, the net result is usually worse than just staying the course.

Also, let’s put this in perspective. You reference the eurozone debt crisis. I’d like to point out that last year everyone loved Europe and the euro. The broader European stock markets were up about 35% in 2009, compared to about 25% for the broader American stock markets. So how did investors in VT do? They enjoyed a return of about 30%. Now in 2010, the eurozone debt crisis has punished the euro and European markets. Yet for all of the concern, the VT is about flat for the year after being down at worst 10% in June. For most investors, the investing experience generates a far worse mental account than the actual return.

This is exactly why I would pick VT if I could only own one security. You can expect big macro events, both positive and negative, to occur at some time, yet still be confident that you will be OK. If you aren’t comfortable with that, you should either hold less VT or just be happy with cash or low bond yields.

Thanks, Jason, for sharing your choice with us.