Today marks the one month anniversary of trading for the Powershares ValueLine 100 Index Fund (PIV). It’s rare that I am enticed by the siren wale of the fund industry’s product machination machine but even the strictest dieters fall to temptation once in a while. (I bought a few shares recently.) I see several issues worth exploring before deciding to aggressively purchase this new ETF.
- The Value Line index will be more dynamic than the more traditional indices used to model ETFs. Does a capital gain issue exist?
- Value Line has a great record of selling research to individual investors and retail stockbrokers but a rather poor record of managing money. It is also unproven that this new Best of Breed top fifty picks of the Value Line list will enhance investor returns.
- There is a closed end fund alternative to PIV in FVL that trades at a substantial discount to its Net Asset Value with a poor track record.
- Cost……Is always and everywhere an issue in this business.
Exchange Traded Funds treat index changes differently than one might assume. ETF’s actually exchange shares of the stock being removed from the index for shares of the stock being added to the index in a tax free exchange. The question I have pondered without finding a definitive answer is, “At what price is the tax free exchange achieved?” Certainly, the party that facilitates the exchange, does so in order to make a reasonable profit, and one could only assume that a deft trading operation could possibly achieve superior prices for both the buy and the sell of the shares entering and exiting the index. For taxable shareholders there is clearly a benefit to the tax free exchange which I suspect outweighs the perceived costs. For the tax exempt shareholder the cost benefit analyses may look entirely different.
Admittedly, I have always been suspicious of the Value Line research ranking track record and the so called Value Line Effect. I guess it’s just my nature, I have always felt that running money is a whole lot more involved than picking stocks and using a seemingly arbitrary method of identifying your entry and exit price points. My suspicion was confirmed when Value Line flamed out miserably with their own open end mutual funds.
The other attempt at mimicking the Value Line effect is the closed end First Trust Value Line 100 Fund (FVL) which carries a .95% expense ratio and trades at just less than a 9% discount to its NAV. This beast of a fund has grossly underperformed the S&P500 since its inception in June of 2003. In summary, FVL has underperformed the S&P 500, trades at a discount of 8.77%, costs a fortune and has had massive taxable distributions. Last month’s distribution of $2.40 was about 14% of the share price…..all taxable.
With the FVL track record one must ask if Powershares CEO, Bruce Bond really thinks he can build a better Value Line Mouse Trap or if he simply did what the fund industry always does; put a wet finger in the wind and say “I can raise $500 million in that.”
That being said, PIV is clearly a better product than FVL. For starters it’s an ETF which by definition is technologically superior to a Closed End Fund. There is virtually no chance that PIV can trade at a substantial discount for any relevant period of time. It’s nearly certain that there won’t be any capital gains distributions to worry about. There are other differences as well in how PIV will attempt to achieve alpha. PIV will only hold fifty stocks that it deems to be the Best of Breed from the Value Line list. These nifty fifty names are chosen based upon a safety screen and an undisclosed number of technical indicators. At .60 bps we will see if PIV makes it longer term with the indexing community.
Maybe the FVL shareholders will encourage their board to approach the PIV board about another type of tax free exchange, PIV shares for FVL shares. Maybe the board of FVL will wake up to their fiduciary duty and make that inquiry on their own…..uh not likely.
In the mutual fund business you raise lots of money in one of two ways. You either have stellar raw performance numbers or you are the low cost index provider. The ETF world hasn’t quite sorted itself out yet in this regard. Vanguard has gone the low cost route. Barclays and State Street have feet in both ponds, and Powershares is clearly looking to generate performance. The risk in the Powershares business model is clear. If their unconventional index products create risk adjusted performance sufficient to cover their substantially higher fee structure, they will go down in history as having created a paradigm shift in the mutual fund business. From where I sit, PIV has made a very large bet on the Value Line methodology where First Trust and even Value Line itself have failed.
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