Letters to the Editor
To the Editors:
I just finished reading “Recipe for Picking Winners: Add Time to a Pinch of the Past,” by Mark Hulbert in the June 2007 issue of the AAII Journal. I always appreciate Mr. Hulbert’s analyses. However, I thought the conclusion reached regarding risk adjustment did not agree with the data—specifically, the conclusion he reaches is that risk adjustment only helps over the short term. Looking at the data presented in Figure 1 of the article, risk adjustment never improves the results—except with the 15-year prior record and only there for the contrarian view (trying to predict based on the results from the worst performers over the past 15 years). This is probably statistically insignificant, anyway.
Even for short-term historical predictions, including risk adjustment resulted in poorer performance. It simply degraded the contrarian performance more than the top performers in the short term. The message should be: Don’t include risk adjustment when trying to predict future newsletter performance. If you must look at the short term, use the worst performers from the recent past. These will produce a higher likelihood of success (although still worse than no newsletter at all!).
On the other hand, maybe a combination of short-term negative correlation (taking the worst performers from the past year) and long-term positive correlation (taking the best performers for the past 10 years) might produce something even better. But there may not be any newsletters that match both conditions.
To the Editors:
John Markese’s article “Face-Off: Mutual Funds vs. ETFs” in the June 2007 AAII Journal provides an interesting comparison; however, it doesn’t seem to answer one question: What distinguishes exchange-traded funds (ETFs) in risk from other closed-end investment companies?
Dr. Markese states unequivocally that ETFs are not inherently different in risk from mutual funds, with risk differences “explained by portfolio composition differences.” While that may be true as to the market value of the underlying holdings, I don’t understand how that is true for the market value of the shares. Dr. Markese confirms the important difference that mutual funds offer shareholder redemption at current net asset value, while ETF shares are bought and sold at market prices. Unless the market prices are somehow stabilized in a way not discussed, the prices may be at a discount or premium to the value of the underlying holdings. Accordingly, there would seem to be the same risk as historically applied for closed-end investment companies, which usually sell at a discount to value of underlying holdings.
Unless I’m missing something in Dr. Markese’s analysis, the possibility of such a discount would seem to make for a substantial difference in risk between ETFs and mutual funds.
Donald T. Elliott
Closed-end funds issue a limited number of shares while ETFs can continuously buy and redeem shares to authorized institutional traders, a mechanism that helps keep ETF share prices close to their net asset value (NAV). For more on how this works, see the discussion on page 13 of this issue’s special report on ETFs.
To the Editors:
Just about every interpretation of the P/E, the price-earnings ratio, is contained in “Will the Real P/E Please Stand Up?” in the August 2007 AAII Journal [The Investor Professor column]. Yet may I add one that isn’t?
The P/E indicates how many years it will take for the earnings per share to add up to the price of a share, given that earnings remain constant. A P/E of 20 means that in 20 years the price will be earned. A P/E of 11.6 means that in a little under a dozen years the price will be earned. Of course, earnings don’t remain constant. A P/E of 39 means you will have to wait 39 years to cover the price if the earnings never change. Therefore, a P/E of 39 cannot be a bargain unless earnings increase in the future. In any event, I like to own stocks with stable earnings and low P/E ratios of around 12. I like the expectation that in a dozen years I will probably have recovered my purchase price, making the shares seem as if they were free. P/E ratios help me think of stock investments in terms