Silly gimmick alert: The Index of Economic Freedom Portfolio

Did the world really need yet another mutual-fund gimmick? The Liberty Investment Group seems to think so: it's launched something called the Index of Economic Freedom Portfolio to no little acclaim. Here's Mark Skousen:

Spath and Kirkscey back-tested the performance of their index and came to a startling conclusion: Over the past 11 years, the Economic Freedom Portfolio has far outperformed world stocks in general. While the MSCI World Stock Index rose 140% during this time, and the Emerging Markets Index climbed 85%, the IEFP rose an astonishing 254%. See the graph below.

I have no idea where this chart came from, but it makes no sense to me. There are two big oddities:

The lines all start at different points. Shouldn't they all start at the same point? (The chart is meant to show returns over 11 years, not over 12 years.)
The horizontal lines look evenly spaced, but the markers on the y-axis are all over the shop, with the 0% line marked as 10%, and the 30% line marked as 130%.

I tried to look at the fund's prospectus for insight as to how this chart was calculated, and came up with nothing. Skousen says that

The Index of Economic Freedom Portfolio (IEFP) is updated each year, according to the Heritage/WSJ annual index.

And Stephen Kirchner goes even futher:

First Trust Portfolios LP has launched a fund that tracks the Heritage Foundation/WSJ Index of Economic Freedom.

Not true. The fund for sale now is the "Index of Economic Freedom Portfolio, 2007 Series" – which means that you buy and hold a bunch of securities from 17 countries which came somewhere near the top of the index in 2007. The Portfolio never gets updated: if a country falls out of the index, its stocks stay in the fund, and if a country makes it into the index, its stocks will never make it into the fund. If you wanted to track the index, you would need to sell the 2007 series when the 2008 series was launched, and so on – paying large up-front fees each time.

And I have no idea what this means, from Skousen:

In 1995, the IEFP consisted of only 6 countries. Now there are 17 countries in the portfolio. Clearly, economic freedom has been expanding around the globe.

There might be 17 countries in the portfolio, but there are no fewer than 30 countries ranked "free or mostly free" by the Heritage Foundation index. And it's not the top 17 countries which make the cut, either. Estonia, for instance, comes in 12th on the index, but isn't in the fund.

So when the fund managers created their pretty chart, did they take returns from the IEFP, which started off with 6 countries and now has 17? Because if they did then they're charting returns from a dynamic portfolio of stocks, which changes according to the freedom index – and it's a bit misleading to then use the returns of that dynamic portfolio to sell a fund which is entirely static and never changes.

On the other hand, did they just take the 17 securities in the 2007 series, and see how they've performed over the past 11 years? That wouldn't be much of an indication of anything, and it's probably not surprising that the fund did well over the past 11 years, since the Finland chunk is invested 100% in Nokia, while the New Zealand chunk is invested 100% in New Zealand Telecom. Amazingly, both stocks have done very well over the past 11 years: what a coincidence!

Hilariously, they've even decided that in order to represent Luxembourg in their fund, they're going to invest 100% in Tenaris, which is really more of an Argentine company than a Luxembourgish one. In any case, Tenaris is a very multinational company, dependent wholly on the oil industry, which has done very well in recent years (of course), but which has almost no connection to economic conditions in Luxembourg.

The Index of Economic Freedom Portfolio is a joke, and I sincerely hope that people don't go piling into it based on misleading information from places like "Investment U". If you really want to bet on the Heritage Foundation index, take the top 7 countries, ranked "free", and buy the five countries where there are ETFs based on their stock markets. I'll even give you the ticker symbols: EWH (Hong Kong), EWS (Singapore), EWA (Australia), SPY (USA), and EWU (UK). New Zealand and Ireland are too small to worry about. There – I've just saved you a 3.95% sales charge.

Posted by Felix at 16:25 EST