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Simple Index Funds May Be Complicating The Markets
I was about to submit the same reference when I discovered you were many hours ahead of me. That's always the case. I should have anticipated this action from the master Linkster.
Jason Zweig is an excellent financial columnist, and this article is especially insightful. The current piece is data dense, and serves a meaningful warning of possible dangers caused by the extensive use of Index products by institutional elites.
The article is chock full of takeaway investing wisdom and hints. Everyone, please take a peek at Ted's Link; I think it will be worth your time.
A decade ago, Index operations only cornered 16 % of the marketplace; today the commitment is more like 33 %. There is logic propelling that trend.
The amazing part of that statistic is that institutional agencies have become frontline buyers and quick trigger finger traders of Index products. When they trade, they trade in large, almost coordinated, volume; they are market movers. The overarching market wide impact is increased volatility.
I find it interesting that the smartest guys in the investing universe (most education, most experience, full time research staff, unlimited resources) have become large Index participants. There is a lesson here.
The article cites a research study that reports only 17 % of mutual funds investing in US equities beat their benchmarks in 2011. That’s sad, but consistent with a plethora of earlier studies that often report a similar statistic that hovers around the 30 % mark. So 2011 was a particularly miserable year for active mutual fund management.
An active fund manager’s life is a daunting challenge, especially when tasked to overcome the funds expense ratio hurdle. Standard and Poor’s will release its SPIVA Active versus Passive fund manager performance comparison study in a few weeks. My guess is that it will reinforce the finding that Zweig summarized. SPIVA will add further detail that will reveal where active management did outshine its benchmarks.
The institutional world often analyzes alike, shares common goals, is lemming-like in behavior (you escape blame if you follow the crowd), and invests in lockstep. This predictable behavioral pattern not only enhances volatility, it also is a contributing factor in shrinking the benefits of diversification.
Because of these activities, investment category correlation coefficients have been moving toward a value of unity, One, perfect lockstep.
Don’t despair. If you believe in broad portfolio diversification to reduce overall portfolio volatility and risk (I do), the simple solution is that a much broader diversification is needed as a compensation mechanism to battle the correlation coefficient trendline. Investment class correlations are never perfect and are never static. They change over time as categories become more and less popular with the investing cohort. And don’t overlook fixed income positions when constructing your personal portfolio holdings.
Just review the checkerboard mix of performance results that the Periodic Table of Investment Returns matrices display on an annual schedule from sources such as Callan Associates and Allianz Global Investors. I have referenced and Linked these sources in past postings. They visually demonstrate the significance and benefits of worldwide category diversification.
Enjoy Zweig’s weekend WSJ article titled “Simple Index Funds May Be Complicating the Markets”. That may be true, but, overall I still believe they simplify my portfolio, and still represent a meaningful percentage (not all) of it.
Comments
I was about to submit the same reference when I discovered you were many hours ahead of me. That's always the case. I should have anticipated this action from the master Linkster.
Jason Zweig is an excellent financial columnist, and this article is especially insightful. The current piece is data dense, and serves a meaningful warning of possible dangers caused by the extensive use of Index products by institutional elites.
The article is chock full of takeaway investing wisdom and hints. Everyone, please take a peek at Ted's Link; I think it will be worth your time.
A decade ago, Index operations only cornered 16 % of the marketplace; today the commitment is more like 33 %. There is logic propelling that trend.
The amazing part of that statistic is that institutional agencies have become frontline buyers and quick trigger finger traders of Index products. When they trade, they trade in large, almost coordinated, volume; they are market movers. The overarching market wide impact is increased volatility.
I find it interesting that the smartest guys in the investing universe (most education, most experience, full time research staff, unlimited resources) have become large Index participants. There is a lesson here.
The article cites a research study that reports only 17 % of mutual funds investing in US equities beat their benchmarks in 2011. That’s sad, but consistent with a plethora of earlier studies that often report a similar statistic that hovers around the 30 % mark. So 2011 was a particularly miserable year for active mutual fund management.
An active fund manager’s life is a daunting challenge, especially when tasked to overcome the funds expense ratio hurdle. Standard and Poor’s will release its SPIVA Active versus Passive fund manager performance comparison study in a few weeks. My guess is that it will reinforce the finding that Zweig summarized. SPIVA will add further detail that will reveal where active management did outshine its benchmarks.
The institutional world often analyzes alike, shares common goals, is lemming-like in behavior (you escape blame if you follow the crowd), and invests in lockstep. This predictable behavioral pattern not only enhances volatility, it also is a contributing factor in shrinking the benefits of diversification.
Because of these activities, investment category correlation coefficients have been moving toward a value of unity, One, perfect lockstep.
Don’t despair. If you believe in broad portfolio diversification to reduce overall portfolio volatility and risk (I do), the simple solution is that a much broader diversification is needed as a compensation mechanism to battle the correlation coefficient trendline. Investment class correlations are never perfect and are never static. They change over time as categories become more and less popular with the investing cohort. And don’t overlook fixed income positions when constructing your personal portfolio holdings.
Just review the checkerboard mix of performance results that the Periodic Table of Investment Returns matrices display on an annual schedule from sources such as Callan Associates and Allianz Global Investors. I have referenced and Linked these sources in past postings. They visually demonstrate the significance and benefits of worldwide category diversification.
Enjoy Zweig’s weekend WSJ article titled “Simple Index Funds May Be Complicating the Markets”. That may be true, but, overall I still believe they simplify my portfolio, and still represent a meaningful percentage (not all) of it.
Best Regards.