When index investing shines (and when it doesn’t)

Interesting article

When index investing shines (and when it doesn’t)

Indexing is the most thoroughly researched, best-supported method yet devised for ensuring good investing results over the long term.

But don’t just take my word for it.

A long list of Nobel Prize winners and academic researchers – including William F. Sharpe, Eugene Fama, and Burton Malkiel, to name a few – will be happy to tell you about its virtues.

But evidence is one thing and feelings are another.

Index investors still have to deal with their own emotions.

From elation to despair and back again, indexers are just as exposed as anyone else to the market’s surges and swoops.

The stress that goes along with these inevitable highs and lows is the single biggest reason why people sabotage themselves by jumping out of an indexed portfolio at just the wrong time.

Fortunately, you can improve your odds of investing success – not to mention your digestion – by being prepared for the three stages of an index investor’s life.

Let me explain....continues on link

 

All this index, psychology and superannuation talk makes me believe that most people, unless they can prove otherwise, should be forced into a low fee balanced index portfolio for superannuation.

Forced savings over the long term with an inability to sell will guarantee the best returns possible for 80% of the population. Solves the pension problem to some degree and ends the crooked "super mafia" who add no value.

I see major issues for SMSF for any but the most knowledgeable investors. Relatively high fees, particularly for low balance investors, with no controls to stop the selection of high risk portfolios. Who benefits from this, lawyers, accountants, portfolio managers and the government with their audit charges.

Follow the KISS not KILL principle.

This is advice to the policy makers.

 

I disagree with that statement.

My belief is that a value investor can outperform the index over the long-term. This is a long read but the Superinvestors of Graham-and-Dodsville still holds true today IMO - The Superinvestors of Graham-and-Doddsville

 

While it’s true that some can and will do better. It’s far from certain, and does not disprove the statement that indexing is likely the best method for ‘ensuring good investing results over the long term’.

This is true for the majority of people which I think that’s what the statement meant.

Everyone can’t be a value investor and outperform. The maths don’t work like that. So it can’t be the best method for the masses.

 

I'm not trying to imply I'll outperform the market, but I don't think it's that hard to find people with a good track record of beating the index who are likely to continue to do in the future.

In my opinion, investing money with value-focused managers who have a track record of outperforming the market is the best way to ensure good results over the long-term.

 

It would be good to see the list over the past 25 years when looking at the same variables on which fund managers that have beaten the index..
All one would have to do is look at the stock price of the ASX top 50,and the way prices can change very quickly below a company face value for a simple media spill and a number of other illogical reasons-that why short-term investors go belly up they use short-term price changes to link or unlink their success or mostly failure of their investment approach..

 

@pwnitat0r

Had a quick look at Portfolio Visualizer

From 1994 to 2018 the Vanguard 500 Index (1) outperformed the Vanguard Value Index Fund (2)

According to Portfolio Visualizer if $10,000 were invested in the Vanguard S&P 500 Index in 1994, it would have grown to $95,338 by 2018. If it were invested in Vanguard’s Value Index, it would have only grown to $87,483

A CAGR of 9.61% as opposed to 9.22%


Time frames and market moods are important though, simply resetting to a year earlier (1993) and it looks like this :

• Vanguard S&P 500 Index $104,769 CAGR 9.62%

• Vanguard’s Value Index $103,448 CAGR 9.56%

There are other times where value stocks outperformed, they make likely do so again - I've got no idea so have stuck with a basic portfolio

Mark Hulbert seems to think value stocks are cheap

These stocks haven’t been so cheap since 2000

Value stocks are now cheaper than ever — with only one exception.

That exception came at the top of the internet bubble in early 2000. Few investors remember that in the subsequent bear market, in which the S&P 500SPX, +0.46% lost 49%, many value stocks actually rose in price.

Value stocks, of course, are those that are most out-of-favor among investors, as indicated by a low price-to-book ratio. They are the opposite of growth stocks — those that trade with the highest such ratios.

 

I don't think you can consider Vangard Value Index fund a proxy for being invested with a value-focused fund manager. As soon as it's an index of some sort, it's the complete opposite of what a value-focused manager does - buy fractional pieces of a company when it is under valued.

Indexing is not without its faults. Personally I don't know how you could be comfortable buying an index of the ASX 200 and having circa 20% of your money with the big 4 banks, BHP. No thanks, not for me.

And there's owning the crap withijnthe ASX200 too, why not weed out the poor companies?

 

I believe that a value value investor can outperform the index.

I also believe that only half of all value investors can outperform the index before fees.

It is quite hard for more than half of the people to be above average.

 

How about zero management fees? Only a performance fees for outperformance against the relevant benchmark?

Page 7 under the "zero fee manifesto" -
https://egpcapital.com.au/wp-content/uploads/2018/07/PerformanceLetterFY2018_Final.pdf

 

If they could throw in money back for underperformance I would be all in on that.

 

That's pure fantasy. It's an extremely generous model when you consider most funds will charge 1-1.5% regardless of how they perform.

I can't understand why index fund advocates aren't intrigued by zero management fees and only paying performance fees for outperformance. The MER is better than index funds, as is your chance of outperforming the index. It seems a no brainer to me.

In 10-15 years this time, I think this model will be the new index funds.

 

@pwnitat0r I am keen to know if you can list the downsides of the performance fee only model?

 

Even if the MER is zero, the average active return still equals passive return.
Passive Option: 1 Million invested; return = 10%; MER .014
Return $100,000, cost $1,400


Active option: 1 Million invested. 0% Management +20% performance.
Having no unique ability to foretell a manager’s future outcomes I diversify managers.

$500,000 is invested with managers who out perform and return 14%. My return is $70,000 and I pay 4%*$500,000*20% = $4,000

The other $500,000 is invested with managers that balance the active on average = Passive equation. They earn 6% return and I earn $30,000 and pay no management fee. (chances are they will soon enough go out of business with no fee income and I will eventually be forced to incur capital gains on the $30,000 and re-allocate to a new manager)


In total I have made the same with both passive and active 0% management - $100,000, but active has cost me $4,000 in fees and passive $1,400. Passive has a reliable income source to run their efficient funds. Actives have a non-reliable source of income to run their high input funds.

edit
oops sorry @Falcon - didn't see your post to @pwnitat0r prior to posting.​

 

Are you saying buy LIC's or individual stocks instead of VAS/STW?

AFI is still 25% banks
ARG - 20%
MLT - 29%
WHF - 30%

 

I would be petrified about the risk I would be taking on (personally).

If you managed a portfolio of 100m with only an outperformance fee as remuneration I would split the portfolio into 10 components and then take stupid bets knowing that one of my ten will pay off.

If the other 9 go belly up I would not care. I get paid for outperformance for my one.

Maybe I am inherently evil.

 

There is the possibility it under performs and you end up with less than average returns.

For all the talk of indexing, I haven't seen any cons discussed... only the pros.

 

Anyone can make up numbers to fit their agenda... I could just as easily make up numbers showing outperformance. What is your point?

 

Would you do the same thing if your net worth was invested in that too?

 

Neither. Those bank weightings are very scary IMO. I would not be comfortable with that at all.

I have invested my money with value-focused investment managers who charge performance fees.