By John Lunt, Lunt Capital
“There are eighty-eight keys on a piano and within that, an entire universe.” ― James Rhodes
I do not play the piano, but I certainly appreciate those who do! A skilled pianist uses all the 88 piano keys in various combinations and tempos to create beautiful music. It would be difficult to compose a great song if certain piano keys were missing or broken. Likewise, it would be impossible to play attractive music with only one piano key.
Some attempt to play investment music on the ETF piano by repeatedly pounding one key—the “Fee” key. Without question, the Fee key is one of the most important and most beautiful keys on the ETF piano. In many cases, past investment music was lacking because the Fee key had been neglected, so we can understand the temptation to repeatedly pound it now! The continual hammering of the Fee key has the potential to drown out some of the other ETF piano keys that can be used in combination with the Fee key to produce beautiful, enduring investment music. Great ETF investment music would include the Index, Liquidity, Strategy, and Asset Class keys.
The “Index” ETF investment key might be compared to “Middle C” on the piano. The Index key is a critical part of the ETF investment music—it defines the investment universe, the rules used to select securities from the universe, and a schedule for how and when the index rebalances. The “Liquidity” key is often played in a chord with the “Fee” key, as liquidity can materially impact the true cost of buying or selling an ETF. Using the Liquidity key correctly requires an understanding that the liquidity of the underlying securities is more important than the daily trading volume of the ETF.
The are several “Strategy” keys on the ETF Investment piano, including an “Active” key, a “Rotation” key, and a “Hedge” key to name just a few. Don’t forget some of our favorite “Factor” keys including Momentum, Quality, Value, and Volatility. Vital “Asset Class” keys might include U.S. equities, International equities, fixed income, real estate, and natural resources in all of their varieties, sub-categories, and sectors. Just as the Fee key alone fails to produce great music, repeatedly pounding any other individual key will fail to produce the desired investment outcome.
“There’s nothing remarkable about it. All one has to do is hit the right keys at the right time and the instrument plays itself.” – Johann Sebastian Bach
All of the piano keys are equally available to any person that sits at a piano. However, access doesn’t automatically result in great music! Creating and playing beautiful piano songs requires practice, discipline, grit, skill, and patience. Composing and playing a great piano song does not happen overnight. The common quote used by piano teachers is “You only need to practice on the days that you eat.” Excellent investment music results from years of diligent practice by advisors and investors. Trained musical composers and performers combine the piano keys using different tempos and levels of loudness. Skilled ETF composers and performers can play faster and louder (more aggressive) or play slower and quieter (more conservative). The greatest investment songs might have sections of fast, medium, and slow music.
Occasionally, pianos need tuning in order for the keys to play the notes as expected. In a similar fashion, our ETF investment pianos need an occasional tuning of our assumptions to a proper historical context so we can remember what the notes really sound like.
We can learn to play investment songs written by great investment composers of the past. However, the best investment sounds come from creating new investment songs for a specific individual, family, or institution. Some of the greatest investment songs have yet to be written! We would slightly modify the quote from musician Tom Lehrer: “Life [Investing] is like a piano. What you get out of it depends on how you play it.”