Regarding the Pensions & Investments special report on exchange-traded funds and concern about an ETF meltdown: I don't believe it is the plumbing, as professor James Angel claims. It is some of the rogue plumbers with their highly leveraged brainless algorithms that are ruining a marvelous tool for investors; and that is not going to be solved with some mechanical trading scheme to halt trading. This is just portfolio insurance on steroids. Remember the crash of 1987?
Louis Aguilar, commissioner, Securities and Exchange Commission, should look to see these off-board speculators played in past market failures. I am all in favor of arbitrage trading recommended by Mr. Angel, but we found evidence that arbitrage trading is not working well.
At the top of the market last February, the Pension Research Institute started a new research project — investing 100% in ETFs — called “portfolio navigation.” The purpose of this research project is to see if we can come up with a better strategy than the programs we decry. It is being conducted in real time so everyone can watch it evolve without covering up faults we find, which is the standard practice.
Evidence to support our claim against high-speed trading was reported on our blog www.pmpt.me on May 15. We compared the probability distribution of an all-ETF portfolio with a portfolio that combined active managers with passive indexes using our new optimizer. We were surprised to see the all-ETF portfolio had much more volatility, more downside risk, and lower upside potential ratios. The opposite was true in all previous years of our research. This resulted in reducing equity exposure on May 15, prior to the August fiasco. It is too soon to make any claims about results, but in the spirit of full disclosure, the PRI portfolio dropped 1.9% on Aug. 24, far less than any market indexes, and was down 2.91% as of Nov. 25.
One possible solution to the problem addressed in the P&I article would be to develop a new set of ETFs that would trade on a platform available only to long-term investors like retirement plans and endowments. Let the brainless schemes play their computer games in the current gambling casino they have created and stop harassing investors who have planning horizons in terms of years, not milliseconds.
FRANK A. SORTINO
Director, Pension Research Institute LLC
Menlo Park, Calif.
