The History of Indexing

[GeoffF100]

Mkt cap based trackers reinforcer the "popularity" element of this by allocating new capital to the largest company irrespective of any of its financial fundamentals.

A market cap weighted tracker of an index of all the available stocks buys new companies when they enter the index. Companies are usually small and never particularly large when they do that. After that, it just holds them until they are taken over or go bust.

Sometimes the market gets it wrong and companies grow too large. That is not a problem. Those companies then move down the batting order and other companies move up.

The cheapest trackers beat 80-90% of managed funds. There is no way of picking winning managed funds that has a better than chance rate of success.

[Dod101]

The cheapest trackers beat 80-90% of managed funds. There is no way of picking winning managed funds that has a better than chance rate of success.

I think a better way of looking at it would be to say that 80-90% of managed funds fail to beat the cheapest trackers. The trackers are the measure, not the other way round and that is only true if indeed the 80-90% is correct.

Of course if the market were only trackers it would collapse because there would be no market and thus nothing for the trackers to track so be grateful that there are active fund managers where I and plenty of others are happy to be.

Mind you questioning the merits of trackers is a bit like arguing about the drawbacks of a HYP!

Dod

[Bubblesofearth]

If untouched all portfolios tend towards becoming scruffy mkt cap weighted portfolios. Which means it doesn't matter how you start.

Equal weighting has no logic behing it other than that of stamp collecting. Why would you have the same investment in Greggs as in Shell?

When you invest in a portfolio of shares you have no idea which ones will do well and which ones will fail so it makes no sense to weight them differently. The higher risk associated with smaller companies, your Greggs vs Shell argument, is effectively removed by diversification. The benefit of this can be quantified by looking at correlations.

If anything, the diversification benefit that smaller company investment brings should mean that these companies shares should underperform their larger cousins over time.They are basically a rarer commodity, entry into which should cost. The fact that, historically, the opposite has been the norm (small caps have beaten big caps over long time periods) makes an even stronger case for equal weighting.

BoE

[GeoffF100]

The cheapest trackers beat 80-90% of managed funds. There is no way of picking winning managed funds that has a better than chance rate of success.

I think a better way of looking at it would be to say that 80-90% of managed funds fail to beat the cheapest trackers. The trackers are the measure, not the other way round and that is only true if indeed the 80-90% is correct.

Of course if the market were only trackers it would collapse because there would be no market and thus nothing for the trackers to track so be grateful that there are active fund managers where I and plenty of others are happy to be.

The vast majority of managed funds cannot possibly beat the cheapest tracker because of their costs. There will always be lots of people paying active managers lots of money to try to beat the market. I am happy to be a freeloader.

[GeoffF100]

If untouched all portfolios tend towards becoming scruffy mkt cap weighted portfolios. Which means it doesn't matter how you start.

Equal weighting has no logic behing it other than that of stamp collecting. Why would you have the same investment in Greggs as in Shell?

When you invest in a portfolio of shares you have no idea which ones will do well and which ones will fail so it makes no sense to weight them differently. The higher risk associated with smaller companies, your Greggs vs Shell argument, is effectively removed by diversification. The benefit of this can be quantified by looking at correlations.

If anything, the diversification benefit that smaller company investment brings should mean that these companies shares should underperform their larger cousins over time.They are basically a rarer commodity, entry into which should cost. The fact that, historically, the opposite has been the norm (small caps have beaten big caps over long time periods) makes an even stronger case for equal weighting.

If most of the money that is invested in market weighted trackers (about 50% according to some estimates) were invested in equal weight trackers, other things being equal, the price of large companies would be driven down, and the price of tiny companies would be driven up to ludicrous levels. In reality, active managers would dump the tiny caps and buy the big caps. The equal weighted tracker would respond by furiously buying the tiny caps and selling the big caps. The active managers would be profiting at the expense of the tracker investors. A market weighted tracker, meanwhile, would just do nothing. It would not affect the market pricing at all.

[Dod101]

The cheapest trackers beat 80-90% of managed funds. There is no way of picking winning managed funds that has a better than chance rate of success.

I think a better way of looking at it would be to say that 80-90% of managed funds fail to beat the cheapest trackers. The trackers are the measure, not the other way round and that is only true if indeed the 80-90% is correct.

Of course if the market were only trackers it would collapse because there would be no market and thus nothing for the trackers to track so be grateful that there are active fund managers where I and plenty of others are happy to be.

The vast majority of managed funds cannot possibly beat the cheapest tracker because of their costs. There will always be lots of people paying active managers lots of money to try to beat the market. I am happy to be a freeloader.

Your way of course guarantees that you will not beat your index which is fine if you are happy with that. Depends I guess on why you are investing.

Dod

[OhNoNotimAgain]

I think a better way of looking at it would be to say that 80-90% of managed funds fail to beat the cheapest trackers. The trackers are the measure, not the other way round and that is only true if indeed the 80-90% is correct.

Of course if the market were only trackers it would collapse because there would be no market and thus nothing for the trackers to track so be grateful that there are active fund managers where I and plenty of others are happy to be.

The vast majority of managed funds cannot possibly beat the cheapest tracker because of their costs. There will always be lots of people paying active managers lots of money to try to beat the market. I am happy to be a freeloader.

Your way of course guarantees that you will not beat your index which is fine if you are happy with that. Depends I guess on why you are investing.

Dod

The way active funds beat the index is not by being smarter at stock picking inside the index but by investing outside the index. The reason Woodford did so well, and then blew up, was because he was investing in unlisted companies. Most UK active funds have large overseas holdings, typically in the US.
I have never come across a UK active fund that has beaten its index by investing only within the index. It may have happened but it is never been demonstrated to my knowledge.

[GeoffF100]

I think a better way of looking at it would be to say that 80-90% of managed funds fail to beat the cheapest trackers. The trackers are the measure, not the other way round and that is only true if indeed the 80-90% is correct.

Of course if the market were only trackers it would collapse because there would be no market and thus nothing for the trackers to track so be grateful that there are active fund managers where I and plenty of others are happy to be.

The vast majority of managed funds cannot possibly beat the cheapest tracker because of their costs. There will always be lots of people paying active managers lots of money to try to beat the market. I am happy to be a freeloader.

Your way of course guarantees that you will not beat your index which is fine if you are happy with that. Depends I guess on why you are investing.

To make money. If you are investing for entertainment, I would not recommend a global tracker.

[GeoffF100]

If untouched all portfolios tend towards becoming scruffy mkt cap weighted portfolios. Which means it doesn't matter how you start.

Equal weighting has no logic behing it other than that of stamp collecting. Why would you have the same investment in Greggs as in Shell?

When you invest in a portfolio of shares you have no idea which ones will do well and which ones will fail so it makes no sense to weight them differently. The higher risk associated with smaller companies, your Greggs vs Shell argument, is effectively removed by diversification. The benefit of this can be quantified by looking at correlations.

If anything, the diversification benefit that smaller company investment brings should mean that these companies shares should underperform their larger cousins over time.They are basically a rarer commodity, entry into which should cost. The fact that, historically, the opposite has been the norm (small caps have beaten big caps over long time periods) makes an even stronger case for equal weighting.

If most of the money that is invested in market weighted trackers (about 50% according to some estimates) were invested in equal weight trackers, other things being equal, the price of large companies would be driven down, and the price of tiny companies would be driven up to ludicrous levels. In reality, active managers would dump the tiny caps and buy the big caps. The equal weighted tracker would respond by furiously buying the tiny caps and selling the big caps. The active managers would be profiting at the expense of the tracker investors. A market weighted tracker, meanwhile, would just do nothing. It would not affect the market pricing at all.

The best way to make money in that world would be to float a worthless company. The equal weighted tracker would have to gobble up the shares, pushing the price up to a ridiculous level. You could sell and sell, and the equal weighted tracker would be forced to buy all that you sold. That process would go on until you bankrupted the equal weighted tracker. You cannot do that with a market weighted tracker. (The only equal weighted tracker that I know tracks the S&P 500, where a committee would not admit the worthless company to the index, provided that they are doing their job properly that is.)

If people invest small amounts of money in an equally weighted tracker they depress the price of the large stocks a little, and inflate the price of the small stocks by rather more. If too much money goes into equal weighted trackers, the investors will inevitably lose out. Buying a market weighted tracker does not distort the market prices.

[Bubblesofearth]

If most of the money that is invested in market weighted trackers (about 50% according to some estimates) were invested in equal weight trackers, other things being equal, the price of large companies would be driven down, and the price of tiny companies would be driven up to ludicrous levels. In reality, active managers would dump the tiny caps and buy the big caps. The equal weighted tracker would respond by furiously buying the tiny caps and selling the big caps. The active managers would be profiting at the expense of the tracker investors. A market weighted tracker, meanwhile, would just do nothing. It would not affect the market pricing at all.

But that's not the World we live in.

BoE

[Dod101]

The vast majority of managed funds cannot possibly beat the cheapest tracker because of their costs. There will always be lots of people paying active managers lots of money to try to beat the market. I am happy to be a freeloader.

Your way of course guarantees that you will not beat your index which is fine if you are happy with that. Depends I guess on why you are investing.

To make money. If you are investing for entertainment, I would not recommend a global tracker.

With respect that is a glib and rather meaningless comment. People will invest for instance to produce a good 'natural' income with the emphasis on dividends or for all out capital growth or a mixture. I rank my share portfolio in accord with what I regard as the desirability of the shares. For instance, I am happy to hold my top eight holdings, Scottish Mortgage, Unilever, Alliance Trust, Legal & General, Segro, Caledonia, Shell, 3i Infrastructure in that order. Most have reached there themselves through growth of the share price. They give me a good mixture of income and capital growth. I cannot do that with an index fund and will have to hold all the dross as well as the decent stuff.

I hold only 31 shares all told with a similar mix of income producers and growth.

Anyway if you have not read the book, I too can recommend it.

Dod

[GeoffF100]

Your way of course guarantees that you will not beat your index which is fine if you are happy with that. Depends I guess on why you are investing.

To make money. If you are investing for entertainment, I would not recommend a global tracker.

I cannot do that with an index fund and will have to hold all the dross as well as the decent stuff.

The problem is that nobody knows what is dross and what is decent - not with a more than luck success rate anyway.

[Dod101]

To make money. If you are investing for entertainment, I would not recommend a global tracker.

I cannot do that with an index fund and will have to hold all the dross as well as the decent stuff.

The problem is that nobody knows what is dross and what is decent - not with a more than luck success rate anyway.

Nobody knows. That is true but it will not stop me, at least, trying.

Dod

[OhNoNotimAgain]

I cannot do that with an index fund and will have to hold all the dross as well as the decent stuff.

The problem is that nobody knows what is dross and what is decent - not with a more than luck success rate anyway.

Nobody knows. That is true but it will not stop me, at least, trying.

Dod

Excellent work. So glad you people like you sacrifice your returns to keep the market efficient.

Moderator Message:
Please moderate your tone, Rob. Sarcasm like this isn't appreciated. -- MDW1954

[Dod101]

The problem is that nobody knows what is dross and what is decent - not with a more than luck success rate anyway.

Nobody knows. That is true but it will not stop me, at least, trying.

Dod

Excellent work. So glad you people like you sacrifice your returns to keep the market efficient.

Well I try to know (what is dross) but I am not a Warren Buffett and I believe that I can do a least as well as an index fund and hopefully better otherwise there would be no point would there? And unlike many/most active managers I do not feel I have to add a lot of stuff in order to provide diversification.

Dod

[Lootman]

Nobody knows. That is true but it will not stop me, at least, trying.

Excellent work. So glad you people like you sacrifice your returns to keep the market efficient.

Well I try to know (what is dross) but I am not a Warren Buffett and I believe that I can do a least as well as an index fund and hopefully better otherwise there would be no point would there? And unlike many/most active managers I do not feel I have to add a lot of stuff in order to provide diversification.

Yeah, when I started out investing my idea was that I would beat the market and become rich quickly that way. My style was all about out-performance. But then back then I didn't have a lot and I was in a rush to have a lot.

Now that I have a lot, as I feel sure you also do, my objectives are very different. I am perfectly happy to collect the 8% a year that on average the market gives me just for being in it passively. That is still a doubling every 9 years. And I also do not want to risk losing my pile because of speculation on a few fast names.

In any event the last time I looked at the performance of Ohno's fund it was in the third quartile and had an expense ratio of over 1% per annum. No thanks.

[Dod101]

Excellent work. So glad you people like you sacrifice your returns to keep the market efficient.

Well I try to know (what is dross) but I am not a Warren Buffett and I believe that I can do a least as well as an index fund and hopefully better otherwise there would be no point would there? And unlike many/most active managers I do not feel I have to add a lot of stuff in order to provide diversification.

Yeah, when I started out investing my idea was that I would beat the market and become rich quickly that way. My style was all about out-performance. But then back then I didn't have a lot and I was in a rush to have a lot.

Now that I have a lot, as I feel sure you also do, my objectives are very different. I am perfectly happy to collect the 8% a year that on average the market gives me just for being in it passively. That is still a doubling every 9 years. And I also do not want to risk losing my pile because of speculation on a few fast names.

In any event the last time I looked at the performance of Ohno's fund it was in the third quartile and had an expense ratio of over 1% per annum. No thanks.

Well 'a lot' is very subjective but yes what you have said pretty well sums up my attitude nowadays. I can do what I want when I want and that is good enough for me.

Dod

[OhNoNotimAgain]

Well I try to know (what is dross) but I am not a Warren Buffett and I believe that I can do a least as well as an index fund and hopefully better otherwise there would be no point would there? And unlike many/most active managers I do not feel I have to add a lot of stuff in order to provide diversification.

Yeah, when I started out investing my idea was that I would beat the market and become rich quickly that way. My style was all about out-performance. But then back then I didn't have a lot and I was in a rush to have a lot.

Now that I have a lot, as I feel sure you also do, my objectives are very different. I am perfectly happy to collect the 8% a year that on average the market gives me just for being in it passively. That is still a doubling every 9 years. And I also do not want to risk losing my pile because of speculation on a few fast names.

In any event the last time I looked at the performance of Ohno's fund it was in the third quartile and had an expense ratio of over 1% per annum. No thanks.

Well 'a lot' is very subjective but yes what you have said pretty well sums up my attitude nowadays. I can do what I want when I want and that is good enough for me.

Dod

The illusion of control is why we feel safer driving our own car rather than in an aeroplane flown by a professional. Yet the statistics tell a very different story. Evidence based investing has still a long way to go.

[dealtn]

Yeah, when I started out investing my idea was that I would beat the market and become rich quickly that way. My style was all about out-performance. But then back then I didn't have a lot and I was in a rush to have a lot.

Now that I have a lot, as I feel sure you also do, my objectives are very different. I am perfectly happy to collect the 8% a year that on average the market gives me just for being in it passively. That is still a doubling every 9 years. And I also do not want to risk losing my pile because of speculation on a few fast names.

In any event the last time I looked at the performance of Ohno's fund it was in the third quartile and had an expense ratio of over 1% per annum. No thanks.

Well 'a lot' is very subjective but yes what you have said pretty well sums up my attitude nowadays. I can do what I want when I want and that is good enough for me.

Dod

The illusion of control is why we feel safer driving our own car rather than in an aeroplane flown by a professional. Yet the statistics tell a very different story. Evidence based investing has still a long way to go.

I think the evidence is pretty clear that the average person is a worse flyer than a trained pilot.

I think the evidence is also pretty convincing that on average managed funds provide lower returns than an index (especially after fees)

Can you explain your analogy please? (Feel free to use evidence and statistics as that appears to be the base of your argument)

[hiriskpaul]

I think the evidence is also pretty convincing that on average managed funds provide lower returns than an index (especially after fees)

The performance drag seems to be mostly because of fees, but not solely. Lack of diversification is a problem as well:

https://www.vanguardinvestments.se/docu ... eturns.pdf

The less diversified a portfolio, the less likely it is to hold the small percentage of stocks that account for most of the market’s long-term return. Concentration can increase the odds of earning high margins of outperformance, but the probability of missing that return target increases more quickly than the probability of reaching it.

Another detractor from performance will be the the presence of algos, high frequency traders and other arbitrageurs. If these guys make money, and they seem to, then there is even less to go around for actively managed funds. They make little out of tracker funds as there is next to no trading going on in cap weighted trackers, so they must be creaming off the active investors.

It would be perfectly possible for funds available to retail investors to beat the index on average if there was a source of return elsewhere. eg less skilled managers of hedge funds, pension funds, sovereign wealth funds, etc. or low-skilled private investors, day traders, etc. In practice though it doesn't happen and retail funds underperform. The bigger the timespan, the bigger the average underperformance and the fewer outperforming funds there are.