Picking stocks can be fun, but for many people, a portfolio consisting of a solid group of exchange traded funds (ETFs) can offer much better performance. According to a study by Morningstar, out of 3,000 active funds tracked, only 47% survived and outperformed their index benchmark. Thus, one of my favorite strategies is to have a balanced portfolio of ETFs with a few carefully selected stocks as the “cherries on top."
Joel Greenblatt (Trades, Portfolio) is a legendary value investor and famed stock picker who has an extremely diversified portfolio of over 1,140 stocks worth $3.2 billion. He is famous for creating the “Magic Formula” method of investing. The Magic Formula uses a systematic approach to stock picking based on return on capital and earnings yield. When the formula was backtested, it had an average return of 33% per year over 16 years, which is astonishingly good, as the S&P 500 returned approximately 10% per year over the same period.
It is interesting to see that despite Greenblatt’s great stock-picking skills, he also has a few ETFs in his portfolio. In fact, his two largest holdings are ETFs, and he was recently buying more shares of both of them in the first quarter of 2022.
1. The Gotham Enhanced S&P 500 ETF
The Gotham Enhanced S&P 500 Index Fund (GSPY, Financial) is a value-focused fund which selects stocks primarily from the S&P 500. As you may have guessed from the name, Gotham Funds is owned by Gotham Asset Management, which is run by none other than Joel Greenblatt (Trades, Portfolio) himself.
Joel Greenblatt (Trades, Portfolio) uses his disciplined value investing approach to weigh the fund's stocks based on his firm's “assessment of value,” which uses both absolute and relative valuation techniques. In his letter to shareholders, Greenblatt provides further detail on his valuation methodology;
“Similar to a Private Equity firm, we examine a company’s cash flow generation and then determine its all-in cost as if we were buying the entire business."
This information is then correlated with the weight of the stock in the S&P 500 index. While it is a passive fund for investors, it is actively managed; the portfolio is rebalanced daily to buy more stocks when trading cheap and sell when expensive. The managers are also careful to not overexpose the fund to a single stock, which helps to reduce the risk and volatility for investors.
This fund is the largest holding of Gotham Asset Management and made up ~7.5% of the 13F portfolio as of the end of the first quarter of 2022. Greenblatt added to the fund in the first quarter of 2022 at an average price of $24 per share, which is 10% higher than where the stock trades at the time of writing.
The fund has generated a fantastic 90.33% return since inception, or a 12.42% annualized return, which slightly edges the S&P 500's 12.05% annualized return. Year to date the fund is down 17%, but this is slightly better than the S&P 500, which is down 19.96%. Despite the close correlation to the S&P 500, it is great to see slightly larger gains and lower drawdowns, which indicates some alpha in the strategy.
A key metric to analyze when assessing ETFs is the expense ratio. In this case, the fund has a 0.5% net expense ratio with a minimum investment of $5,000 for new investors.
2. The S&P 500 ETF Trust
The second largest holding in Joel Greenblatt (Trades, Portfolio)'s investment portfolio is the classic SPDR S&P 500 ETF Trust (SPY, Financial). Founded in 1993, the S&P 500 ETF Trustwas the very first ever ETF listed in the United States.
The fund's holdings consist of the 500 largest and best performing companies which trade on U.S. exchanges. Its top holdings include Apple (AAPL, Financial) at 7.09%, Microsoft (MSFT, Financial) at 5.08%, Amazon (AMZN, Financial) at 3.24% and Alphabet (GOOGL, Financial)(GOOG, Financial) stock at 2.04% and 1.88% respectively. In addition, Warren Buffett (Trades, Portfolio)’s investing conglomerate Berkshire Hathaway (BRK.B, Financial) can be seen in the top holdings at 1.54% and Tesla (TSLA, Financial) at 2.03%.
Warren Buffett (Trades, Portfolio) often states investing into an S&P 500 index fund is a great strategy for the average investor. This makes complete sense as the S&P 500 index fund contains a diverse range of the best performing and most profitable companies and it filters out underperformers naturally.
The S&P 500 ETF Trust has returned a fantastic 12.82% per year over the past 10 years and 9.63% since 1993. However, year to date the S&P 500 is down 19.96%.
This ETF is the second largest position in Joel Greenblatt (Trades, Portfolio)’s portfolio and makes up ~4.4% of the total 13F portfolio value. In addition, Greenblatt was buying more of this ETF in the first quarter of 2022 at an average price of $444 per share, which is ~11% higher than where it trades at the time of writing.
The ETF has an extremely cheap expense ratio of 0.0945%, which is much lower than the 0.5% net expense ratio charged for Greenblatt’s Gotham Enhanced ETF.
Final thoughts
The Gotham Enhanced S&P 500 ETF offers investors the security of the S&P 500, but with the value investing skills of Joel Greenblatt (Trades, Portfolio) as a bonus. It has outperformed the S&P 500 index with a 0.37% greater annualized return since inception. However, once we include the 0.5% net expense ratio, Gotham's ETF gains have been 0.13% less than the S&P 500 benchmark on average.
Both of these are excellent ETFs that demonstrate the value of including some ETFs in a portfolio rather than just relying on picking individual stocks. Even some of the most successful value investors in the world recommend ETFs.
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