The underestimated risks of ETFs and passive investing

Anyone thinking about investing money today will sooner or later come into contact with ETFs – Exchange Traded Funds. In most cases, these are exchange-traded funds that imitate a stock index such as the DAX or S&P 500. A whopping 5.5 trillion US dollars have now flowed into this form of investment worldwide, and the trend is rising. What is it that makes this form of investment so attractive?

The most powerful argument for ETFs is their low fees. As this form of investment merely replicates an existing index, it does not require a fund manager to invest selectively in individual equities or other securities. This saves the cost of its work.

In addition, ETFs also allow smaller investors to invest in a wide range of equities at a stroke. This means, as the saying goes, that the investor does not have to “put all his eggs in one basket” and diversifies his portfolio.

In principle, ETFs are a plausible way of investing as cheaply as possible in different companies and markets in order to achieve market-conform (i.e. average) performance. On average means nothing bad per se – in a good stock market year, solid returns are possible. But since ETFs merely track other indices, they will never perform better than these – if fees are included, performance even falls below average.

Since no fund manager actively pulls the strings in the background, but also in this scenario the corresponding index is still rigidly represented due to the business model, no loss limitation takes place in ETFs.

The passivity of ETFs also creates an unpleasant side effect that could harm the economy in the long term.

ETFs are shareholders in the companies in which they invest. Of course, this also means that they have voting rights at the annual general meetings of these companies. These events are an important vehicle for public companies to vote on issues such as management remuneration, bonus packages or improvements in corporate governance.

A study has shown that ETFs are as passive in exercising their voting rights as they are in their investments, and in the vast majority of cases agree to proposals of the company management. Why should they want to make big changes? The fact that ETFs only track one index and do not need to outperform it means that there is no incentive to ensure that companies evolve.

Considering that more equities are now held by passive funds than by active funds, this passivity could have a long-term negative impact on the relevant companies. And even if not every active fund manager makes direct use of his voting rights, he does so every day in a different way – by letting companies know how he classifies them through purchases and sales.

We don’t want to badmouth ETFs. For many investors, this form of investment can make sense. However, it is important to note that there are a number of companies in an index that are not doing very well. Either they are companies that are hardly growing any more and are completely overvalued (due to the steady passive acquisitions of ETFs), or perhaps even companies that are already out of money and will be in a very bad position in the near future.

As long as investors blindly buy everything with ETFs, these companies will continue to be “supported” in their valuations. Particularly in the extreme times of ultra-easy monetary policy, this will encourage this situation to inflate – until a major setback occurs and investors withdraw their money all at once.

Healthy companies that are growing and earning a lot of money are being dragged into the depths. But as soon as the situation calms down, the active managers see their chance to get extremely cheap access to the good companies. The overpriced or ailing companies (which are now at best normally priced) are not bought – except by the ETFs. To find out how this can turn out for an ETF buyer, read the short article “Good is not good enough for us“.

We are convinced that with our strategy of value investing, we can achieve above-average returns over the long term and thus outperform comparable indices. This is precisely where our portfolio managers are world-class – in the careful selection of undervalued and strong companies. They prove this year after year.

The basic principle of value investing is simple: we buy shares of companies whose current or expected price is lower than their value. According to Warren Buffet’s motto: “The price is what you pay. The value is what you get.” In the long run, we assume that the price (= share price) adjusts to the actual value of the company, and the price rises (details on our value investing strategy can be found here).

Thanks to the low minimum investment of € 35,000, we are for the first time also enabling relatively smaller investors to benefit from our sustainably successful investment strategy.

Ultimately, you have the choice. If you are satisfied with an average return, ETFs with their low fees are a legitimate option. Or you can rely on the skills of our portfolio managers, who use our proven value investing strategy to achieve above-average performance through selective stock selection. Fees have also fallen sharply as a result of modern technology. For just 1.20% fixed fees plus 10% performance fee of the earned performance, you not only receive excellent asset management, but also your own custody account including all costs.

How do you decide?

Estably is the first Liechtenstein-based digital asset management firm to offer world-class asset management through a blend of technology and human investment expertise. Thanks to the portfolio managers’ many years of experience in the field of value investing, the aim is to achieve above-average returns – starting at an investment sum of € 35,000. The aim is to make professional asset management, which was previously possible exclusively for major investors, accessible to everyone – in a convenient, transparent and profitable way.

Everything about our service can be found in our whitepaper.