Monday, 17 September 2007

Book Review: The New Investment Frontier III by Howard Atkinson

This is the 3rd edition of Howard Atkinson's book on Exchange Traded Funds. The fact that a 3rd edition was published in 2005, following so quickly on the first edition of 2001 and the second in 2003, reflects the enormous growth and success of ETFs as a new investment vehicle. There's a good reason for that success and Atkinson, with writing assistance from financial journalist Donna Green, explains the what, who, why and how of ETFs with much practical detail, balance and thoroughness. This book is a detailed compendium of ETFs, tailored for Canadians through the inclusion of a great deal of pertinent and useful Canadian tax information, probably everything an individual investor could need or want to know.

The thorough treatment is accorded not just to the tax implications. The same completeness characterizes the rest of the book. The book begins with a brief explanation of what ETFs are and why index investing makes sense, why passive index ETFs offer better returns than actively managed mutual funds and even index mutual funds. It does a lot of comparison to mutual funds, especially useful since that is the alternative for most investors, and shows how ETFs are more tax efficient and lower cost than mutual funds. He demonstrates the tremendous negative effects that higher costs have on an investor's net return returns over the long run. The balance I mentioned above is evident in this section since Atkinson lists such advantages as mutual funds do have over ETFs - namely ability to invest small amounts on a regular basis, automatic dividend reinvestment, no trading commissions on purchases or sales (the term commissions excludes the onerous and pernicious deferred sales charges on many mutual funds) and the availability to obtain certificates to be able to use the fund holding as collateral. There is lots of explanation and discussion of the merits of different indexes that many ETFs track, very handy for making informed decisions about one's asset allocation choices.

Atkinson throughout the book names products, ticker symbols and companies, giving references and copious weblinks; it's a very practical book. Probably, it would be possible to amass through the Internet all the same information that's in this book. However, it would take a huge amount of time and effort. Some of the more arcane detail in the book - things like the effect of trading by institutional investors - comes from Atkinson's position as an industry insider. He works for, or did at the time of publication at least, Barclays Global Investors Canada, which offers many of the leading ETF products. However, it is worth saying that the book does not read like an infomercial for Barclays - all the competing ETFs and companies with their various flavours are reviewed in a factual manner.

One area in which I find Atkinson goes a bit over the top is the discussion of how ETFs are perfect for doing tilts, style weightings, sector rotations in a portfolio termed the Core and Satellite (pages 93 to 122) and then how ETFs can support those who like to do technical analysis (page 123). I think Atkinson knows better since he includes a note of caution that says those tactics really amount to market timing and he has put forth the evidence right at the beginning of the book of the book that market timing doesn't work. Just because ETFs can be (mis)used that way doesn't mean he should tell everyone how to misuse them. He even quotes John Bogle, founder of Vanguard Group, saying that ETFs are like giving investors a loaded shotgun. Yes, indeed! This part of the book is the explanation of how the shotgun can be used, instead of for hunting geese, ducks, or partridge, as it was designed to do, for blowing off your own financial foot. Effectiveness isn't always the test of whether you should be doing something. Atkinson isn't completely wrong - there are two tilts, justified by proper peer-reviewed financial research, that produce greater risk-adjusted returns. These are small capitalization and value (as defined by price/book value only) companies/equities, known as the Fama and French Three Factor Model (see this Wikipedia entry for a brief explanation and link to the scholarly research article). There may other tilts and it is possible that they are beneficial but they remain to be proven so the average investor is best to stay away.

The chapter on using ETFs with a financial advisor provides an excellent introduction to the alternative types of fee arrangements that are possible. It shows how ETFs enable a convergence of interests of the advisor who charges fees (instead of collecting commissions and trailer fees from fund companies) and of the investor. The fee-based relationship with ETF investments can save the investor money compared to mutual funds and provide more comprehensive advice to boot. This happy result is illustrated and explained with real examples of advisers citing hard numbers. Atkinson, however, says forthrightly that for total holdings of under $100,000 the investor is better off with a DIY approach or simply the famous Couch Potato Portfolio.

  • ''... some active managers do beat the market, sometimes even after costs, but the trick is to find them before they do it.'' before, not after, is indeed the key; manager out-performance does not typically last so you cannot reliably use the past good performance to pick the future winners
  • ''The more you pay in management fees and expenses, the less you get in returns. Period. Always scrutinize MERs.''
  • ''The capital gains distribution and consolidation confuses many investors and advisors.'' investors, ok, but advisers too? ... a good example arguing for mandatory formal training for advisers, n'est-ce pas?

The biggest negative of this book results from the passage of time and the inevitable hazard that information has become dated. The explosion of ETFs and similar new products such as Exchange Traded Notes (ETNs) has continued unabated. Of particular note to Canadian investors are:
My thanks to Mike at the publisher Insomniac Press for providing a free copy of the book to review.

I look forward to version four of this very useful book. Four and a half out of five stars.

You can buy it at

1 comment:

Unknown said...

again, helpful review...just picked this one up a few days again and enjoying working my way through.

also, just wanted to mention...i posted a comment/question from your blog "A Starter Diversified Index Portfolio for Canadians"...not sure if you see these commnets on the older posts, but if you do get a chance would greatly appreciate your opinion.

again, thanks very much for your valuable information...a great help to a new invesor like myself


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