The Fallacy of Benchmark Investing
The endless argument between active versus passive investment management styles appears to be one with no end in sight. Exchange-traded funds, for all of their great features and benefits fall well within the passive management camp. ETFs are designed to track an index by holding all the components of the index. This creates another rhetorical question. “If the benchmark delivers mediocre returns does outperforming this benchmark indicate a sign of superior investment management?”
An example of this behavior is the iShares Global Energy Sector Index Fund (NYSEMKT: IXC). This ETF was brought into existence on Nov 12, 2001 and has a long enough history to examine this concept. Below is a snapshot of the returns of iShares Global Energy Sector Index Fund and what the actual index has done. In 6 of 9 measuring periods iShares Global Energy Sector Index Fund has outperformed. This is good news on a relative scale. On an absolute scale, it appears that this very large ETF with over $1 Billion of assets under management is not generating significant returns in a sector that is crucial to the world economy. The price chart below seems to confirm this.
The iShares Global Energy Sector Index Fund holdings are stocks that compete in the energy sector on a global basis. The number one holding by weighting as of Apr 25, 2013 is Exxon Mobil Corp (NYSE: XOM). The holding is reported at 14.547% and out of the 91 total holdings this one stock can influence the fund value like no other. Take a look at the charts for Exxon Mobil Corp, Crude Oil, and RBOB Gasoline below. As consumers of energy, it seems there is disconnect between what we see at the pump everyday and what these energy market contributors reflect. As huge as Exxon Mobil Corp is, I do not see any significant growth or investment return potentials. Regardless of how widely held this stock is, opening a position may lead to lackluster returns.
The second position of iShares Global Energy Sector Index Fund is Chevron Corp (NYSE: CVX), with a weighting of 8.497%. See the price chart below. Chevron Corp share price shows a better past return than iShares Global Energy Sector Index Fund does. Chevron Corp also posts a five-year dividend growth rate of 9.18%. In relation to the top four stocks of iShares Global Energy Sector Index Fund, Chevron Corp appears to be best on a stand-alone basis.
Third spot of iShares Global Energy Sector Index Fund goes to BP (NYSE: BP) an ADR. BP holdings equal 4.97% at this time. BP is mired in the Gulf Oil spill of 2010 and the ongoing legal battle seems to have no end in sight. In my opinion, an active fund manager would have sold all positions in BP. Due to the fact that it remains in the passive index iShares Global Energy Sector Index Fund must continue to hold this stock. See chart below.
Rounding out the top four of the iShares Global Energy Sector Index Fund bring attention to Royal Dutch Shell (NYSE: RDS.A) an ADR. Royal Dutch Shell has a 4.622% allocation to this ETF. This is another company that is contracting in the energy industry. While its circumstances are not as dire as BPs, it appears that Royal Dutch Shell can look to improve financial performance while living up to the desire to maintain a high dividend rate. See the chart below.
In my opinion, one of the downsides of passively managed investments is the reliance on the underlying benchmark. Fund managers the deliver mediocre returns to the shareholders can too easily say; “ that is what the benchmark returned and we followed it.” This argument that is for actively managed funds is a driver for the new and upcoming variation of ETFs, the actively managed ones. In time we shall all see which side may be right more often.