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ETF Investment Strategy: The Value Line Paradox

Value Line — a purveyor of market-timing and stock-picking advice — not only offers advice on picking ETFs as well as stocks, but also they had their own ETF until recently — the Value Line Timeliness Selection ETF — that actually mirrored the advice given by the famed Value Line newsletter. The fund was administered by PowerShares, which pulled the plug on it after four years of lackluster returns.

Some things — Robert E. Lee’s march into Pennsylvania, the Titanic — look fabulous on paper but, when translated into reality, reveal some rather tremendous flaws.

Paper versus practice

Using a proprietary system more secretly guarded than the recipe for Coke, the Value Line newsletter’s performance track record has been nothing short of eye-popping. On paper, at least. From the Value Line website:

Value Line’s exclusive Timeliness™ ranking system—an “at-a-glance” prognosticator of 6-12 month relative price performance for approximately 1,700 actively traded U.S. stocks, ranging from 1 (highest) to 5 (lowest). Since 1965, higher-ranked stocks that have repeatedly outperformed market indices.

Each and every year, check the website and, lo and behold, Value Line’s picks are kicking serious butt. The banner headlines read something like this,

The 2010 Results Are Clear. . . Value Line’s #1 Ranked Stocks: 29.7% . . . S&P 500: 12.8%.

It’s unclear what timeframe they are talking about, but the message is certainly clear that if you buy Value Line’s picks, you’ll get rich by “repeatedly outperform[ing] market indices.” Hmm. Possibly. On paper. But what about in the real world, where real dollars would be invested in those picks?

Ah, there’s the rub.

The company, you see, offers not only a newsletter but a few mutual fundsergo, real investors in the real world. The flagship Value Line mutual fund (VLIFX), which, according to its prospectus, taps into the very same wisdom that guides the newsletter, has not exactly set the world on fire.

The fund, which has a Morningstar rating of one star, calls itself a “mid-cap growth fund.” According to Morningstar Principia, the fund’s ten-year annual return as of June 30, 2011 was –0.07, compared to 5.52 for the Russell Midcap Growth Index and 2.72 for the S&P 500.

Going back 15 years, the fund’s annual return averaged 2.97 percent compared to 7.73 percent for the Midcap Growth Index and 6.5 percent for the S&P 500. Not only would you have earned terrible returns, but VLIFX’s volatility was substantially greater than that of the S&P 500!

The lesson to be learned

How can a mutual fund that tracks the allegedly super-successful newsletter be such a flaming dud? There are a number of possible explanations. One is that the return numbers given by Value Line are a bit, um, off. (In fact, independent research has come up with far, far lower return figures.)

Or perhaps the managers of the mutual fund were unable to follow the advice given in their own newsletter. Perhaps trading costs ate up all profits — and then some. Whatever the explanation, investors lost money.

But the point in sharing the Value Line paradox isn’t so much to steer you away from any single mutual fund or ETF. The point is to steer you away from thinking that you — or anyone else — can trade in and out of ETFs, stocks, bonds, or anything else successfully. It’s not nearly as easy as many people (such as the Value Line editors) make it seem.

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