About the Editor
Samuel Lee is an ETF strategist for Morningstar and editor of Morningstar ETFInvestor, a monthly investment newsletter. Prior to becoming editor, Lee was a fund analyst on Morningstar's passive funds research team, where he covered alternative, dividend, and actively managed ETFs and performed quantitative modeling of ETF strategies.

Lee joined Morningstar in 2008 as a data analyst, where he evaluated ways to measure and improve the firm's data quality.

Lee holds a bachelor's degree in economics, with honors, from Grinnell College.


Investment Strategy
Morningstar ETFInvestor scans the globe for value and improving fundamentals across virtually all asset classes. Editor Samuel Lee draws upon academic and practitioner research — including Morningstar's sizeable bench of stock, bond and fund analysts — to find reliable drivers of outperformance.

Morningstar ETFInvestor features two real-money portfolios.

The ETF Income Portfolio assembles a high-quality collection of income-generating ETFs with the goal of earning 5% in excess of the 30-day T-bill rate over a full business cycle. The portfolio adheres to a benchmark-agnostic strategy in its search for absolute returns.

The ETF Global Asset Allocation Portfolio, on the other hand, is more benchmark sensitive. It seeks undervalued asset classes with improving fundamentals. The strategy seeks to beat the 60/40 MSCI ACWI/Barclays US Aggregate benchmark over a full business cycle, with the least risk possible.

 
 
May 30, 2015
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Samuel Lee,
Editor, Morningstar ETFInvestor
Samuel Lee is an ETF strategist for Morningstar and editor of Morningstar ETFInvestor, a monthly investment newsletter. Prior to becoming editor, Lee was a fund analyst on Morningstar's
Featured Posts
ETFInvestor Weekly Update - May 29, 2015

The Scripps Howard National Spelling Bee and the Pursuit of Alpha


After I started (and finished) reading “The Incredible Shrinking Alpha”* last night, I tuned into ESPN to watch SportsCenter’s coverage of...the Scripps National Howard Spelling Bee. Having been primed by what I had just read, I was struck by how neatly the evolution of this Super Bowl of spelling seemed to align with the concepts put forth by Michael Mauboussin and co-author Dan Callahan in “Alpha and the Paradox of Skill”. In this paper, the authors, state that:

In many competitive interactions it is the relative level of skill that matters, not the absolute level of skill. In many fields, including investing, the dispersion of skill is shrinking, which leaves more to luck.

They go on to frame this concept using a familiar example from the world of sports:

The late Stephen Jay Gould, an evolutionary biologist at Harvard University, wrote about this to explain why no hitter in Major League Baseball has had a batting average over .400 since Ted Williams hit .406 in 1941.He showed that the coefficient of variation (standard deviation divided by the mean) declined steadily over the past century, which is consistent with a declining variance in skill and stable variance in luck. Gould concluded that the skill of modern players is better than ever but that the spread of skill has narrowed. Follow-up studies in baseball support this hypothesis.

The same phenomenon seems to be affecting the world of competitive spelling. Based on my admittedly un-scientific research, the absolute level of skill of SCRIPS spellers has increased with time. In 1925, Frank Neuhauser took home the trophy. His final word? “gladiolus” (from Latin). This year’s co-winners, Gokul Venkatachalam and Vanya Shivashankar split the top prize after outlasting the remaining 283 competitors and successfully spelling their final words “scherenschnitte” and “nunatak”, respectively. (a complete list of former champions and winning words can be found here). Knowing one’s flowers doesn’t cut it anymore, as today’s spellers are clearly more skilled than their predecessors.

It is also interesting that this is the second consecutive year that there have been two winners to emerge from the field. The reason? The event’s organizers ran out of words for the contestants to spell. Is this evidence that the relative level (i.e. standard deviation) of spellers’ skill has narrowed with time? Again, this is an un-scientific thought experiment on my part, but it seems that this might be the case.

What does all of this mean in the context of the pursuit of alpha? According to Mauboussin and Callahan:

These analyses introduce the possibility that the aggregate amount of available alpha—a measure of risk-adjusted excess returns—has been shrinking over time as investors have become more skillful. Investing is a zero-sum game in the sense that one investor’s outperformance of a benchmark must match another investor’s underperformance. Add in the fact that in aggregate investors earn a rate of return less than that of the market as a consequence of fees, and the challenge for active managers becomes clear.

The supply of available alpha is shrinking, getting more difficult to come by each day. Though this is not because active managers are bad at their jobs, it’s because, in aggregate, they are more skilled than ever before--on an absolute basis. Meanwhile, their relative skill level has narrowed. The net result is a fiercely competitive field fighting over a diminishing prize. This phenomenon is by no means unique. These days, being able to spell an obscure German word on national television will only get you half a trophy.

Best,

Ben

*The book is a quick read--more of a pamphlet, really--that threads together a wealth of very good research. It gives you the gist and puts things in chronological order, but the meat of it is contained in the pages of all the works referenced at the end.

 



From Morningstar.com

Fund Managers Who Spit Out There Own Cooking – A look at why you should be skeptical of a skinny chef.

Your 401(k) Has Probably Gotten Better - Sore spots remain, but you cannot discount massive improvements in  plan availability, employee participation, deferral rates, and (in many cases but not all) investment options.

Elsewhere…

Mary Meeker's 2015 Internet Presentation – The 20th edition of an epic slide deck from the influential analyst turned venture capitalist.  Slides 4-7 provide great historical context. It is incredible how quickly technology has evolved and fundamentally changed almost everything we do.


Sources of Edge – Taken from the Legg Mason archives. Bill Miller discusses three sources of edge: informational, analytical, and behavioral. The last, in my opinion, is far and away the most enduring of the three.

Portfolio Holdings
Income Portfolio
ETF
YTD Ret %
Price $
1.0
108.3
CASH$
N/A
1.0
6.1
60.1
9.8
67.7
0.6
11.5
0.7
20.7
-2.7
29.9
0.2
39.9
-0.5
24.6
Global Asset Allocation Portfolio
ETF
YTD Ret %
Price $
1.0
108.3
CASH$
N/A
1.0
6.1
60.1
0.3
20.7
-2.7
29.9
0.2
39.9
9.2
41.4
-0.1
81.1
-0.5
24.6
Most Popular ETFs
ETF Name
YTD Rtn %
3 Yr Rtn %
Trading Vol.
NASDAQ 100 Trust Shares
-10.76
1.45
125,000,944
SPDRs
-3.64
2.68
87,466,496
Semiconductor HOLDRs
-6.23
-11.66
26,838,700
iShares MSCI Japan Index
-6.59
7.18
17,256,500
iShares Russell 2000 Index
-7.46
6.43
16,210,700
Energy Select Sector SPDR
15.88
15.50
14,900,000
Financial Select Sector SPDR
-8.42
2.61
11,612,800
DIAMONDS Trust, Series 1
-3.75
2.21
7,350,600
Utilities Select Sector SPDR
6.84
6.82
3,848,200
Materials Select Sector SPDR
-4.31
8.50
2,179,300
 
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