Explaining the High/Low Style of Investing

Before the 1980s fashion magazines took a strictly orthodox approach to styling: each model wore one designer label, head-to-toe. Mixing was a fashion no-no. This was both for reasons of decorum (imagine arch enemies Elsa Schiaparelli and Coco Chanel forced to cohabit a single look), as well as to avoid the wrath of advertisers. When ELLE launched in America the magazine’s pages were a cacophonous mix of luxury designers and accessories. It took another decade before the fashion industry dared mix high- and low-end labels in a single outfit.

Today, of course, this is old hat. H&M, Zara, and Uniqlo have figured out that the same customer who buys her cashmere scarf from Brunello Cuccinelli and her handbag from Bottega Veneta will pop into COS (owned by H&M) in Paris or London for her fast-fashion fix. In 1983 Halston was vilified and his reputation ruined for partnering with J.C. Penney, whereas recently Karl Lagerfeld, Stella McCartney, and Sonia Rykiel were championed for collaborating with H&M. High/low style is now a part of the lexicon; it’s in our wardrobes, homes, and restaurants. Not surprisingly, it’s also in our investment portfolios.

The highs of ETFs

Low-cost index exchange-traded funds have become hugely popular investment products. As of June 2015 the Canadian-listed ETF market was valued at $84.7 billion. ETFs have several attractive features:

  1. They provide cost-effective diversification by industry, geography and asset class;
  2. They have price transparency since they are valued by market demand like stocks;
  3. Most are highly liquid and can be bought or sold throughout the trading day;
  4. They can be borrowed and sold-short like equities;
  5. Specialty ETF can provide access to markets that would otherwise be prohibitive for retail investors, e.g. frontier markets or certain commodities;
  6. They can be more tax-efficient than mutual funds.

Given their list of attributes it’s not surprising that investors swear by index-ETFs finding them superior to any other investment style. Staunch proponents of passive investing, such as Eugene Fama, a finance professor at the University of Chicago Booth School of Business, who developed the “efficient market theory” calls active management a “zero-sum game”. Fama believes that all stock prices reflect all publicly available information and investor expectations. Why waste your money on active management or hedge fund fees, he asks.

Managing the downside

According to Larry Berman, chief investment officer at ETF Capital Management, “there is no downside to investing in a low-cost ETF. You can buy a Vanguard ETF that covers the North American stock market for around 20 basis points (0.20 per cent). That’s incredible. Over the long term, equities are still the best performing asset class but there may be periods when the market is crashing and your portfolio could lose 20 per cent. Not too many people are comfortable with that.”

To minimize the downside, some advisors actively manage a portion of the portfolio to take advantage of market inefficiencies. When some asset classes, industries or geographic areas come under selling pressure they may become “mispriced” by the market. A value-oriented tactical portfolio manager is able to “tilt” the portfolio to take advantage of these situations. This hybrid approach, where some proportion of the portfolio is in low-cost index EFTs, while other portions are more actively managed is sometimes referred to as a “core and explore” style.

Over time, value managers have out-performed their benchmarks by tilting their portfolios toward these “mispriced” investments. These strategies can help the investor wring a higher return than could be achieved by passive investing alone while reducing overall management fees. “Part of the value proposition in having a professionally managed portfolio is to get advice and to help you stay on track to meet your investment goals,” says Berman.

Defining your (investment) style

A savvy fashion buyer knows that the t-shirts from J. Crew will serve her just as well as the ones from Gucci. But if she invests a little more, the Gucci handbag will give her a bigger “fashion return” than the one from J. Crew. Likewise, a savvy investor should put aside the orthodoxy of an all-active or all-passive portfolio. There is value in both—if you (or your advisor) know where to look.

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