American Investment Services, Inc.

Disciplined, Diversified, & Cost Effective

Apr. 2006 – Stuck in the Middle

No good product goes unabused by Wall Street. Such is the case with exchange-traded funds (ETFs).

Our readers will recognize that we recommend several ETFs. These allow investors to take a stake in several of our recommended asset class indexes at an extremely low cost. However, ETFs have grown exponentially in a very short period and have been seized by savvy marketers hawking ETFs based on various “groupings.” These are intuitively appealing to investors, but have no place in a portfolio based on rational, asset class investing. Some are bizarre, such as ETFs based on initial public offerings, while others are more conventional, including ETFs based on specific industries and commodities. With the exception of REIT and gold-based ETFs there are no funds based on industries or commodities that represent legitimate asset classes. So-called mid-cap ETFs have proven popular, but we tend to think Jim Hightower, the famous Texas politician, had it right when he quipped that the only thing in the middle of the road is a yellow stripe and dead armadillos.

Our parent, the American Institute for Economic Research, closely examined the returns on the middle three quintiles of U.S. common stocks ranked by market capitalization. They concluded that while small and large-cap stocks have unique and therefore desirable risk and return characteristics, mid-cap stocks do not.

During the years 1926-2005, the median difference between the returns on the largest quintile and the smallest quintile was more than 13 percentage points. During 8 out of 10 12-month spans during those years, the returns on the middle quintiles were somewhere between those of the largest and small quintiles. The other 20 percent of the time (when the returns on the middle three quintiles were outside the range between the first and fifth quintile) the median difference from the closer of the two remaining quintiles was only about two percentage points.

This suggests that there is little point in holding a “mid-cap” fund, especially when the portfolio contains funds that hold companies further down the list of companies ranked by size. Asset class investing takes advantage of dissimilar price movements, and in this respect, investment vehicles based on mid-cap stocks offer little value.

Also in This Issue:

Structured Asset Management: Walking the Walk, Part 2
Quarterly Review of Investment Policy
The High-Yield Dow Investment Strategy
Recent Market Statistics
The Dow-Jones Industrials Ranked by Yield
Asset Class Investment Vehicles