Markets are rising, but experts are divided over whether an exchange traded fund (ETF) that tracks an index may is the best way to invest in highly imbalanced markets.

The latest warning comes from US cannabis investor and news service New Cannabis Ventures, which said over the weekend that buying the sector isn’t the best way to take advantage of the improving North American marijuana story.

It suggested marijuana ETFs that track the North American market are too heavily weighted to the largest companies, which are based in Canada, and companies with tangential exposure to cannabis.

“The largest licensed producers, all of which are generating operating losses and are valued substantially higher relative to revenue or EBITDA than the largest multistate operators [which operate in the US as well], have been lagging them in the market, a trend we expect to continue,” the company said.

“The five largest LPs have returned an average of -28.5 per cent year-to-date, while the four largest multistate operators in terms of market cap… have returned an average of -5.1 per cent.”

Nine columnist Stephen Bartholomeusz pointed out in early May that passive investing via an index tracking ETF may not be the best way to play a pandemic as individual stocks rose and fell based on their exposure to COVID-19, levelling out gains or losses from each.

Individual companies such as Woolworths (ASX:WOW) surged as investors noted the panic buying of February and March just as they sold off travel stocks such as Flight Centre (ASX:FLC), which have themselves started to get interesting again.

Investors urged to pick a team

Buying the index has been a popular route for amateur investors since the instruments boomed following the global financial crisis.

Most ETFs available offer exposure to a particular industry, such as energy or financial stocks. The broadest Australian investment available is via an ASX300 ETF.

But today stock picking, an art that even most active fund managers fail to consistently do well, is the theme du jour amongst financial commentators.

“In my opinion, you should spend less time worrying about which sector to invest in and spend more time looking for good stocks, because smart investing is about buying what goes up and selling what goes down,” said Wealth Within chief analyst Dale Gillham.

“[In over diversified portfolios] it is very common to find that one third of the portfolio is rising while the remaining stocks are going down or sideways… a portfolio that is over diversified is exposed almost exclusively to market risk, which is why many investors end up achieving very mediocre returns.”

But markets are rising

And yet markets around the world, for now at least, are rising.

The ASX All Ordinaries fell 37 per cent from a high in February to its March 23 nadir and has since put back more than half of its losses, after central bank and government stimulus “lobotomised” cash as an investment and forced savers further into equities.

Gillham believes the rise is no longer “just a suckers rally” but could continue through June.

Richard Montgomery, a manager at ETF specialist BetaShares, says the central bank and government support should “lift all boats” and pitched the diversification angle, saying picking winners can be difficult in a market like this — a point supported by corporate cop ASIC which released data showing how bad amateur investors are at timing the market. 

“There have been concerns in the past that ETFs, and the ability for investors to buy or sell when they wish, have not been tested in extremely volatile markets. However, in the most challenging conditions, ETFs have delivered liquidity and efficiency, putting these doubts to rest,” Montgomery told Stockhead.

“The key is to get your asset allocation right, and hold quality investments. We’d suggest investors build a core using ETFs that provide broad exposure to asset classes such as Australian equities, international equities and fixed income. Then if you’re looking to take a position on particular sectors or regions, you can express those investment views using more specialised ETFs.”

Everything good is bad

Others, such as EY partner Duncan Hogg in the AFR last week, believe the disconnect between what is actually happening in economies and therefore to company profits and losses, and market, means another downward spiral is likely.

“The full impact of COVID-19, which will only become apparent in August and our view is it will probably be worse than the optimism out there reflects,” he told the newspaper.

A disconnect between the state of the Australian economy and the ASX was a frequent complaint towards the end of 2019 and the start of 2020. Equities were looking expensive compared to the revenue companies were generating, and experts were widely expecting an economic slowdown or even a recession this year.

Emphasising the level of confusion among investors now is the “bankruptcy play”, as money is thrown at companies in bankruptcy as well as those planning for their own demise.