Professor Jeremy Siegal can often be seen in ads promoting Wisdom Tree’s Modern Alpha approach to investing, but how well does his funds deliver on this?
Wisdom Tree got into exchange traded funds in 2006, promoting them as “modern alpha” funds. In investing, alpha is the tendency towards price growth, where high alpha investments have higher returns. Every investment has an alpha number, it’s rate of growth, and just calling an investment alpha means nothing in itself, although it does tend to suggest that better alpha is the focus since it’s right there in the name.
Wisdom Tree gets full marks for its brand names, starting with the idea that the company itself is driven by wisdom. They have presumably eaten the apple from the wisdom tree and they are ready to share the wisdom that they have consumed with investors like ourselves. That’s a great looking storefront, but if you are suggesting such a thing in your company name, you need to be ready to deliver on this promise, or at least deliver results that even could be confused with a wise approach.
We will take them to task on this, to see how wise they really are, to see how potent their apple of wisdom may be, to see how prominent a role alpha plays in their investment strategies and how modern it may be, where modern here is defined as adapting to the modern investing environment.
We need to define what wise investing might look like as well as what a modern alpha-focused approach would be seeking before we can judge how well Wisdom Tree has done to fulfill this promise. We might think that all investing approaches seek to be guided by wisdom, where we would use wisdom to direct us toward our goals of growing our money, but we can’t just assume this is the case with a given approach.
Wise investing isn’t just achieving a good return, as a good return is only good compared to other options. The wise person looks at what they are achieving and compares this to alternate courses of actions which might be better. If it takes you an hour to travel to a destination, if there is a different route that will get you there in a half hour, that would be the wiser choice, and the wisdom of choices are always measured by how they compare with other options that can be chosen.
There is a great need for more wisdom in investing. Our mission here is to direct investors toward wisdom, and there is much to do here, given that wisdom really isn’t much of a focus when it comes to people choosing investments and investment strategies. We could even say that the investing world is on the whole quite bereft of wisdom and is a culture based far more on caprice, where you see Professor Siegal on TV telling you he has found a better way, and just jump on board without thinking very much beyond the message in the ad, to invest with them.
We’re not so easily convinced, and we shudder that a great many are. Wisdom Tree does a nice business, with about $46 billion in assets under management these days in these modern alpha ETFs. Perhaps this is reflective of their actually finding a way to improve on the process of investing, or even that their approach isn’t that remarkable but has delivered good enough results that investing with them could be considered wise, but we will need to have a look first.
Wisdom always involves comparison, so even though funds like this dislike these things, because they so often come out with the short end of the stick, we can’t just skip this step or look to do our best to minimize it. That’s not wise, and is the opposite of wise in fact.
Evaluating the performance of investment funds is not a matter of opinion. Professor Siegel can tell us that he is of the opinion that focusing on fundamentals is the right way to invest, something that we completely disagree with, but neither of our opinions in themselves matter, as the only way to see how various approaches perform is to look at how they perform.
Performance with an investment doesn’t just involve seeking the highest potential for returns, for alpha, as we also need to account for risk, for what is termed beta. While just looking at beta calculations with investors is not such a great idea, as this just really measures static drawdown risk and fails to measure this dynamically, beta is at least meaningful for comparison purposes, to at least see how much static downside risk there may be.
Tesla is a good example of a stock with high beta, 1.6 right now, and everyone is aware of how volatile this stock is. How much Tesla can fall during a move compared to the S&P 500 is the static version of looking at risk, where a dynamic view would involve us looking at the net changes over time of this risk potential, where we not only look at downside moves but how it affects net positions. If one investment goes up 5 and loses 2, its dynamic risk would be less than something that goes up 2 and only loses 1 later.
Alpha and Beta Tell a Big and Important Story
We’ll just use normal beta in this discussion though since Wisdom Tree claims that it is superior with it. They don’t tell us what their beta numbers are superior to, and investments have various beta numbers, but this always starts at measuring an investment’s downside potential to the S&P 500, the benchmark of beta.
While so many choose the S&P 500 as their benchmark, we’re not that impressed with this index and want to try to be a little wiser and pick a stronger opponent, another ETF called the QQQ. This is an index ETF that tracks the Nasdaq 100, and if your performance overall is inferior to this ETF, the question of why you should be in your fund rather than QQQ is not successfully answered. We’re going to look at both though for comparative purposes.
We wouldn’t think that beating QQQ’s performance with an actively managed fund should be all that challenging. After all, QQQ isn’t managed actively, it’s just a collection of 100 different stocks and they are stuck with them through thick and thin, where active management can both choose and hold stocks specifically based upon their strength. All you need to do to beat QQQ is to weed out the weaker performers in the index, and you’ve done it.
As it turns out, doing this isn’t just a challenge for active fund managers, it’s a huge one. We’ve compared the performance of various active funds against QQQ and it’s rare that they don’t get trounced by it. If you can find a fund that even comes close, you’ve really got something, a real outlier, a real rarity.
If it doesn’t compete, we need to ask ourselves why we would prefer inferior performance, although we generally don’t mind. We just happily invest along with these funds and don’t try to look around too much, just like they want it, and especially are directed away from strong competitors such as QQQ. That’s not how we do it here though, and always prefer seeking the wise thing to do rather than be content with relative degrees of ignorance.
We’re not even sure why people just aren’t interested in doing any sort of due diligence when it comes to choosing their investments, and conduct themselves like they are brainwashed. Some do a bit of homework, but in a way that they are directed, comparing a bad fund with another than looking at what else they may accomplish. There are plenty of influencers out there to do their thinking for them, much like barkers at a cheap carnival, and the question of this being a better place to hang out just doesn’t come up.
Wisdom Tree does an ad with the professor telling us that they have figured out some sort of better way without really telling us too much, other than he is seeking modern alpha through using fundamental analysis. People don’t know how much of a challenge this would be, as it is possible in theory perhaps but fundamentals and alpha are two very distinct things.
The fundamentals look at the company and the alpha part has to do with the stocks themselves, which are very different, and trying to drive alpha by looking at fundamentals just doesn’t work very well and will have you behind even the mediocre S&P 500 overall, even though you may get lucky and beat this index once in a while.
Not beating the S&P 500 consistently deserves a spot in the hall of shame, although if there were one, it would have to be a very large hall and would consist of the great majority of funds since so few of them even beat this index. The ones that seek to understand the movement of stock prices by measuring business fundamentals, especially those who give extra weighting to “value,” have already set themselves up for failure before they get started, and persist in this failure proudly.
Wisdom Tree does try to present a case for using valuation, where they tell us that if we go back to 1957, there is a correlation between lower price to earnings ratios and stock performance. That might be true, but the fact that they have to go back 63 years to make this work shows us how hideously outdated this strategy has become.
Wisdom Tree’s Approach Isn’t Modern and Shiny, it is Old and Rusted
Unfortunately for them, this is a relic of the ticker tape days, and since then, we’ve moved more and more away from this idea. In the old days, a lower price to earnings ratio actually stimulated demand for stocks, and people would jump on laggards and bid them up. Now, we’ve moved to the point where there is a strong inverse correlation with this, where in the 21st century you could just do the opposite of what Wisdom Tree is trying to do, to go with the highest ratios, and be on the right side of things overall.
Doing what might have worked in the 1950’s and 1960’s but no longer works now is not going to produce very good results, and this will tend to underperform a random basket of stocks like a major index. Wisdom Tree doesn’t rely exclusively on this, as a pure “value” fund would, so we would expect that their results would outperform value funds which get kicked around by even the S&P 500, but having some of this factored in there will still serve to diminish their results.
Actual modern alpha is based upon momentum, where we look at how well stocks are performing and want to be in the ones that are performing well and out of the ones that are not. Alpha means performance, and the modern part just involves setting aside decaying ideas such as how stocks performed many decades ago and look to what works today, in this century.
If you are seeking alpha though as Wisdom Tree tells us they are, all we have to do is to look at their alpha score to see how they are doing with this. This will actually tell us everything we need to know about how Wisdom Tree’s funds stack up against each other as well as our reference, QQQ, because the other side of the coin, their beta score, are very similar.
Before we look at alpha though, we’ll get the beta comparisons out of the way, to show that this is a wash pretty much with their large cap fund. We’ll look at their 3 Domestic Core Equity ETFs, small, medium, and large, and this will also give people an idea of how these different types of ETFs compare with one another.
We’ll start with their U.S. Earnings 500 Fund (EPS), which has a beta of 1.04. Their U.S. MidCap Earnings Fund (EZM) comes in at 1.4, and the U.S. SmallCap Earnings Fund has a beta of 1.58. SPY, the ETF that tracks the S&P 500, has a beta of 1, and our reference, QQQ, has a beta of 1.02, slightly higher than SPY.
Apple, for comparison, has a beta of 1.28, definitely a high beta stock that moves a lot. Wisdom Tree’s big cap ETF (EPS) is lower than this, but is not even as low as QQQ, and while QQQ is a bit more volatile than SPY, EPS is two bits more volatile. Being even more volatile than QQQ puts an end to any discussion about how EPS is less risky, even though Wisdom Tree tells us that their funds enjoy “reduced portfolio volatility and risk.”
We’re not sure what this is supposed to be lower than, but it’s certainly not the Nasdaq, and oddly enough, just putting all of our money in QQQ would probably be exactly the sort of thing they are assuming their funds are less risky than. EPS’ beta of 1.04 is not an issue, but it sure isn’t lower than 1.02. The other two funds have a lot higher betas than Apple and you’d be considerably safer putting all of your money in Apple stock than these other two, not to mention that Apple has the performance of a thoroughbred where these two are plug horses.
We would not want to exclude the mid and small cap funds just because they have such a high beta, but if your beta is this high, you had better have the performance to make up for it. This is where the alpha number comes in, and it turns out that the alpha of these two are simply terrible. The mid cap fund has an alpha of -14 and the small cap has an alpha of -15.9. SPY comes in at 0, the reference, and QQQ has an alpha of 10.42. For those who are familiar with how much QQQ outperforms SPY, these two funds underperform SPY by an even greater amount than this. We know enough already to declare these two funds to be hideous, without even looking at the returns, but when we see such ugliness with 3 year alpha and beta numbers, the stench of this is more than enough to decide.
Whatever modern alpha means to Wisdom Tree, it can’t mean good alpha given that these two are claimed to be based upon modern alpha. Perhaps their large cap fund actually has a modern alpha instead of a dreadful alpha, but it’s -2.67 isn’t very good either. It’s a tad riskier than both SPY and QQQ, not by an amount that should concern us, but its underperformance is very noteworthy. The red that they use with negative alphas need to be heeded and this alone is enough of a reason to stay away.
Since these numbers are over the last 3 years, we’ll look at their 3 year returns to see how this does carry over to returns. QQQ wins this race handily with an average annual return of 22.63%, SPY comes in second place with 10.57% per year, with EPS, the Wisdom Tree’s star performer, bringing up the rear with 8.19%. That’s not a lot off SPY, but funds that underperform SPY like this do not have a reason to exist, and a modern alpha approach would have all of our money in QQQ and enjoying over twice the returns with similar risk.
We already knew that the returns from the mid and small cap funds will be plenty ugly, and the mid-cap averaging -1.62% per year with the small cap losing even more at -3.31% per year does not disappoint. These funds are so bad that Wisdom Tree, in their pursuit of modern alpha, actually figured out a way to lose money during a bull market where the S&P 500 averaged over 10%, a year. We need a special section in the hall of shame for these two, in the back room where they keep the other assorted oddities of nature.
There is a strong correlation with the size of the market cap in a fund and the wisdom involved in selecting them, where small caps require a smaller measure, mid caps a little more but still very little, and big caps ending up being the only wise choice. We do not have to even get into the reasons why, but we certainly wonder how anyone would have such a lack of wisdom to want to actually invest in either of these smaller funds of Wisdom Tree’s, or a lot of other things that they offer. Even though their large cap fund may not be that shiny of a car but it still runs, instead of being old wrecks that you used to find in people’s back yards in the 1960’s, where this strategy of theirs has been suspended in time.
They have some other goodies at this circus, such as their U.S. Total Dividend Fund (-5.39 alpha, 4.82% return), and their U.S. Multifactor fund (-2.43 alpha, 7.91% return), as well as fixed income, where you’re guaranteeing yourself very inferior returns by virtue of the nature of these investments. Wisdom Tree’s ads and their website promise much, but instead of good, better, and best, they deliver bad, worse, and even worse.
You would think that their eating from the Tree of Wisdom would have them deciding more wisely than this. As the story goes, Adam and Eve became aware of the existence of sin after they ate the fruit from this tree, but the apples from Wisdom Tree’s wisdom tree still has them blind to sin, the sin of people investing in any of this stuff of theirs. There are a lot of sinners out there in the investment world though it seems.