Who wouldn't want to invest like Warren Buffett? Advisors can give clients an opportunity to do so with ETFs that emulate the tactics of successful billionaire investors.
Some ETFs attempt to clone the funds of high profile investors by mirroring the investments listed in their 13F filings with the SEC, says Justin Carbonneau, a partner at Validea Capital Management in West Hartford, Conn., the investment advisor to the Validea Market Legends ETF (VALX).
However, 13Fs can be dated. While some successful investors outperform by holding stocks for the long term, many managers and hedge funds don’t, he says.
Consequently, by the time their 13Fs come out, a fund may have trimmed or completely eliminated its stake in a company.
Moreover, managers of cloning ETFs may not understand the rationale behind why successful investors buy and hold certain stocks. This could pose problems, Carbonneau says.
“For example, some cloning ETFs bought Valeant before all of the news about drug price gouging, and its stock got crushed,” he says.
For its ETF, Validea builds different models based on different investors' fundamental strategies and then picks stocks using computer-simulated models, Carbonneau says.
Validea has studied the stock selection strategies of successful investors: Those whose portfolios have outperformed over time or whom have written books or tested strategies in academic papers. The firm’s models include approaches based on Buffett, Ben Graham, Peter Lynch and other very successful investors.
“The better the understanding a financial professional has about an investment strategy, such as the various cloning methodologies, the better they will be able to help clients make it through the enviable ups and downs all strategies go through,” Carbonneau says.
Like any investment, the buyer should understand the ETF’s characteristics, costs and how it has performed, says Claudia Mott, a planner at Epona Financial Solutions in Basking Ridge, N.J.
Just because a popular hedge fund or well-known investor is willing to take a big bet on a stock or a sector doesn’t mean that same strategy is right for everyone.
“Providing individual investors with the opportunity to own a portfolio that mimics those of some well-known investors certainly seems appealing. Who doesn’t want to be Warren Buffett?” Mott says.
“But because of the risks in these ETFs, they should not be considered a core holding in a portfolio but rather a supplemental position that may or may not add value to the overall performance,” she says.
Katie Kuehner-Hebert is a freelance writer in Running Springs, Calif. She has contributed to American Banker, Risk & Insurance and Human Resource Executive.
This story is part of a 30-30 series on smart ETF strategies.