I hate alternative investments, which is really a fancy term for over-priced financial products. The Globe and Mail is featuring a special report on such investments covering topics like iUnits ETFs, principal-protected notes, private equity, hedge funds, art and commodities. In my opinion, none of these products (apart from ETFs) are suitable for average investors. In the 2005 Berkshire Hathaway annual report, Warren Buffett warned us about the effects of frictional costs on investment returns:
The Gotrocks, now supporting three classes of expensive Helpers, find that their results get worse, and they sink into despair. But just as hope seems lost, a fourth group – we’ll call them the hyper-Helpers – appears. These friendly folk explain to the Gotrocks that their unsatisfactory results are occurring because the existing Helpers – brokers, managers, consultants – are not sufficiently motivated and are simply going through the motions. “What,” the new Helpers ask, “can you expect from such a bunch of zombies?”
The new arrivals offer a breathtakingly simple solution: Pay more money. Brimming with selfconfidence, the hyper-Helpers assert that huge contingent payments – in addition to stiff fixed fees – are what each family member must fork over in order to really outmaneuver his relatives.
The more observant members of the family see that some of the hyper-Helpers are really just manager-Helpers wearing new uniforms, bearing sewn-on sexy names like HEDGE FUND or PRIVATE EQUITY. The new Helpers, however, assure the Gotrocks that this change of clothing is all-important, bestowing on its wearers magical powers similar to those acquired by mild-mannered Clark Kent when he changed into his Superman costume. Calmed by this explanation, the family decides to pay up.
And that’s where we are today: A record portion of the earnings that would go in their entirety to owners – if they all just stayed in their rocking chairs – is now going to a swelling army of Helpers. Particularly expensive is the recent pandemic of profit arrangements under which Helpers receive large portions of the winnings when they are smart or lucky, and leave family members with all of the losses – and large fixed fees to boot – when the Helpers are dumb or unlucky (or occasionally crooked).
Personally, I am just going to avoid all the fancy alternative stuff (actually I have a venture capital fund to get rid off), and stay in my investing rocking chair.
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12 responses so far ↓
1 Investorial // Apr 4, 2006 at 9:26 pm
I agree with you in most part. It’s evident in my various writings that I’m not a fan of instruments such as principal-protected notes, and hedge funds. Quite a few of those opinions were share on my blog previous.
In terms of hedge funds, I like the idea of using more advanced option-trading to help one’s portfolio (which contradicts a bit of my own value investing philosophy). Which could be another post for you, are there any value investors who recommend shorting or options in general?
IMHO, art should be bought for appreciation, not for “appreciation”. Sorry about the double-entendres. Private equity is simply that, non-accredited investors should not venture there unless you’re joining to be an owner, not an investor (ie: buying the coffee shop down the corner)
I’m unconvinced about ETFs yet due to my lack of exposure. I’m well aware of what they are but have not conducted further research beyond that. I don’t like to be the first to board the titanic! =D
2 Canadian Capitalist // Apr 5, 2006 at 5:16 am
I have never shorted stocks or used options. I can see how writing covered calls might generate extra income but beyond that I have never bothered to learn more about options.
I don’t know why you would call ETFs “the titanic”. Most ETFs simply track an underlying index. I like ETFs because they are simple and provide exposure to a diversified asset class.
3 Investorial // Apr 5, 2006 at 6:54 am
I use titanic to describe new, buzzy things that are hailed as “the next big thing”, “unsinkable” and have a lot of first-time adopters. Beyond the metaphorical similarities. ETFs are not titanic. =)
My aversion to ETFs arise from the very fact that they are tracking indexes. I’m not too into passive investing, and I haven’t figured out yet why people would a buy a derivative product that hardly seem like they were backed by any real asset (correct me if I’m wrong, please!)
Here’s a link I found
http://www.gold-eagle.com/editorials_05/laird010606.html
I totally agree with writing covered calls, especially if you are a contrarian investor and just sitting on an unloved dividend paying company. =D
4 Are ETFs A Real Asset? » Investments + Editorials: Dissecting the good, the bad, and the ugly of investment / financial media! // Apr 5, 2006 at 7:15 am
[...] Are ETFs A Real Asset? I’ve been participating in a comment thread with Canadian Capitalist about alternative investments. I mentioned an aversion towards ETFs because to what I understand, ETFs are sort of like derivatives? Though I was hard pressed to find such a definition online. [...]
5 Canadian Capitalist // Apr 5, 2006 at 8:54 am
It is true that some ETFs use derivatives. Examples include the old iUnits XSP and XIN.
But most ETFs are real assets. A ETF does have the actual underlying securities backing it. Take the IVV, which tracks the S&P 500. If you have enough shares of IVV, you can exchange it for the underlying stocks that make the S&P 500. In fact that is how the issuer makes sure the ETF tracks the index. If it deviates too much, arbitrageurs will buy the ETF and exchange it for shares and vice-versa.
I read the article you have linked and the author is talking mostly non-sense. Hard-core gold bugs want us to sell everything (they always rant about paper assets) and buy gold bullion and bury it in a hold in our backyard. Gold pays no interest, costs money to store and protect and gives a measure of inflation protection and nothing else.
6 Average Joe // Apr 5, 2006 at 9:52 am
I am a big fan of ETFs. In fact, what I like to do is put money into a mutual fund index. Once that mutual fund index gets big enough (ie. low transaction cost - for me, I would wait til roughly $6,000 so that the trading cost of $30 is .5%), I flip that mutual fund into an ETF so that I can enjoy the much, much lower MERs.
The bulk of my Canadian Equity is in XIU. MER of .17. Not including e-Funds or even Altamira, most mutual fund index funds charge over .7. Some (like BNS) charge over 1%!
I am also looking at buying XBB in the very near future as my bond component. MER of .3 I believe. And with the low bond yields, every little bit helps.
7 Investing Intelligently // Apr 5, 2006 at 11:02 am
“I haven’t figured out yet why people would a buy a derivative product [ETFs] that hardly seem like they were backed by any real asset (correct me if I’m wrong, please!)”
I can’t imagine that any stock index ETF would not be backed by real assets.
8 Investorial // Apr 5, 2006 at 7:35 pm
Well, the education I’m getting out of this has been great. So ETFs can be considered as derivatives? I’ve always had a “to each his own” attitude, if you like PPNs, or ETFs, or run-of-the mill mutual funds, stock-picking, options, currency trading… then all the more power to you, AS LONG AS you understand it.
I’ve exposed my weakness in ETF’s. Thanks guys!
9 Average Joe // Apr 5, 2006 at 8:54 pm
Investorial:
Check out iunits.com. They have an FAQ on how ETFs work. You can also see the holdings in the various ETFs at http://www.iunits.com/english/funds/fund_values.cfm
10 Maryann // Apr 6, 2006 at 5:00 pm
Hi,
How I can contact the admin of this blog as I need to share one important information.
11 Canadian Capitalist // Apr 6, 2006 at 7:15 pm
Maryann: You can contact me at ccapitalist-at-yahoo-dot-ca.
12 Free Money Finance // Apr 7, 2006 at 3:32 am
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