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The Growing Peril of Index Funds: Too Much Tech

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Re: The Growing Peril of Index Funds: Too Much Tech

#51

Post by whack »

avar wrote: post #50
dbecker wrote: post #49

Earlier quoted context omitted.

This article is talking about diversification to reduce risk, which is unrelated to "timing the market" and which can be consistent with passive investing.

Some investors described in the article moved from market cap weighted indexes to ones that were disproportionately weighted to disfavor tech stocks, they believe that they're overvalued and that they can get out earlier than everyone else. That's trying to time the market. The firms mentioned in the article will be happy to charge you much higher fees than Vanguard for questionable longer term returns. It's basicall…

Even if the average returns and risk are identical for each security individually, you can minimise your portfolio risk by investing equally across many different industries. If a downturn were to occur, different securities in a single industry will be much more correlated, as compared to different securities across different industries.

Re: The Growing Peril of Index Funds: Too Much Tech

#52

Post by avar »

whack wrote: post #51
avar wrote: post #50

Earlier quoted context omitted.

Some investors described in the article moved from market cap weighted indexes to ones that were disproportionately weighted to disfavor tech stocks, they believe that they're overvalued and that they can get out earlier than everyone else. That's trying to time the market. The firms mentioned in the article will be happy to charge you much higher fees than Vanguard for questionable longer term returns. It's basicall…

Even if the average returns and risk are identical for each security individually, you can minimise your portfolio risk by investing equally across many different industries. If a downturn were to occur, different securities in a single industry will be much more correlated, as compared to different securities across different industries.

Yes, that makes sense. But that's entirely unrelated to what I'm pointing out here.

(Some of) the article is making the argument that investors should decide for themselves how over- or undervalued certain segments of the economy are.

So on one hand you'd have a diverse market cap weighted index where you buy into stocks representing the proportional to their portion of the economy.

On the other hand you might think you have special knowledge to layer on top of that. Are banks undervalued? By how much? Let's say 10%. Then let's sell something else to buy 10% more banks, now what's 10% overvalued? Tech?

I've yet to see any sort of compelling data that this sort of managed investing is a good idea, and that's what it is.

Just because you're not buying TSLA and instead just disproportionately buying "car stuff", or not selling AAPL but just selling "tech stuff" you're still trying to pick stocks and trying to beat other stockpickers doing the same thing. You're just picking subsets of the economy instead of individual stocks.

Re: The Growing Peril of Index Funds: Too Much Tech

#53

Post by perl4ever »

avar wrote: post #52
whack wrote: post #51

Earlier quoted context omitted.

Even if the average returns and risk are identical for each security individually, you can minimise your portfolio risk by investing equally across many different industries. If a downturn were to occur, different securities in a single industry will be much more correlated, as compared to different securities across different industries.

Yes, that makes sense. But that's entirely unrelated to what I'm pointing out here. (Some of) the article is making the argument that investors should decide for themselves how over- or undervalued certain segments of the economy are. So on one hand you'd have a diverse market cap weighted index where you buy into stocks representing the proportional to their portion of the economy. On the other hand you might think…

I don't think it's a good idea to guess what's over/undervalued. But equal weighting different industries is not quite the same thing. No matter how you weight things (by capitalization, by company, by industry, whatever) you are making assumptions about correlations. No dogma can tell you which is right a priori, because correlations change, especially in crises when it matters most.

Also...the total market, cap weighted, may be the optimal way to invest the whole world's capital - but that doesn't mean that it's the optimal way to invest, say, $50K. If you have $100B, say, you can't put it in a stock that's currently valued at $1B. But if you have $1000, you don't have that constraint.

Regardless of how the optimal portfolio may differ, when you're investing a relatively minute amount compared to the entire market, it's hard to imagine the optimum is not going to be different.

...You don't pilot your car under all the same constraints as an 18-wheeler, just because that's optimum for shipping large quantities.

Re: The Growing Peril of Index Funds: Too Much Tech

#54

Post by perl4ever »

pedrocr wrote: post #41
brndnmtthws wrote: post #9

This is an inherent property of all market cap weighted indexes. An alternative approach is equal weighted indexes, which have historically outperformed market cap weighted indexes. There's no free lunch though: this is a case of your typical risk/reward tradeoff. Equal weighted funds are more risky (volatile), but have higher historic returns than market cap weighted funds. Some of them feature equal weighting acros…

>Equal weighted funds are more risky (volatile), but have higher historic returns than market cap weighted funds. But do they outperform after risk adjustment? I doubt it and if not you're better off just leveraging a bit to your desired level of risk. The point of passive investing isn't that the trading strategy can be automated, the point is to say "I want to grab exactly the average return of the market every yea…

I don't think it makes sense to equate risk with volatility. Say I have $1M. If I buy a cap weighted S&P 500 fund, I have about $40,000 in Apple, because it's about 4%. If I then switch to an equal weighted S&P 500, that $40K will be split up between 20 stocks with about $2K each. That is clearly more diversified with respect to company specific risk. It may or may not be worth it given increased fees, but you can't just dogmatically say it's equivalent to cap-weighted plus leverage. It's qualitatively different.

Re: The Growing Peril of Index Funds: Too Much Tech

#55

Post by perl4ever »

pedrocr wrote: post #43
brndnmtthws wrote: post #10

Earlier quoted context omitted.

This is not quite correct. There are other weighting methods (specifically, equal weighting) which would prevent this situation, whilst still remaining passive.

I'd argue an equal weighted index is no longer passive. You're actively making a bet that smaller companies will outperform bigger companies. Someone else will be taking the other side of that bet. Me with my cap weighted index will get the average of the two and be actually passive.

But many investors are going to take the side of big companies, not because they are choosing the optimal approach, but because they have to, because they have too much capital to invest in small companies. So it's not logical to assume their returns must be equal on average.

Re: The Growing Peril of Index Funds: Too Much Tech

#56

Post by pedrocr »

perl4ever wrote: post #55
pedrocr wrote: post #43

Earlier quoted context omitted.

I'd argue an equal weighted index is no longer passive. You're actively making a bet that smaller companies will outperform bigger companies. Someone else will be taking the other side of that bet. Me with my cap weighted index will get the average of the two and be actually passive.

But many investors are going to take the side of big companies, not because they are choosing the optimal approach, but because they have to, because they have too much capital to invest in small companies. So it's not logical to assume their returns must be equal on average.

I didn't say their returns would be equal, I said my returns will always be equal to the average of the market exactly because I'm a passive investor. The sum of all bets is what I'll be making. The standard text on that:

https://web.stanford.edu/~wfsharpe/art/active/active.htm

As for there not being enough of the small companies available to do the equal weighted S&P500, the smallest companies in the index have 3.5B$ in market cap. So there's almost 2T$ of that mix available and there would be much more if that amount of capital suddenly decided to implement that strategy as the market caps of the bottom of the S&P500 index would certainly rise significantly.

Re: The Growing Peril of Index Funds: Too Much Tech

#57

Post by pedrocr »

perl4ever wrote: post #54
pedrocr wrote: post #41

Earlier quoted context omitted.

>Equal weighted funds are more risky (volatile), but have higher historic returns than market cap weighted funds. But do they outperform after risk adjustment? I doubt it and if not you're better off just leveraging a bit to your desired level of risk. The point of passive investing isn't that the trading strategy can be automated, the point is to say "I want to grab exactly the average return of the market every yea…

I don't think it makes sense to equate risk with volatility. Say I have $1M. If I buy a cap weighted S&P 500 fund, I have about $40,000 in Apple, because it's about 4%. If I then switch to an equal weighted S&P 500, that $40K will be split up between 20 stocks with about $2K each. That is clearly more diversified with respect to company specific risk. It may or may not be worth it given increased fees, but you can't…

>you can't just dogmatically say it's equivalent to cap-weighted plus leverage

I'm saying it's strictly better to do cap-weighted plus leverage. That's what financial theory tells us anyway, that the best portfolio is whatever mix between risk free cash and the same mix as all the assets in the world. Deviating from that brings you farther away from the efficiency frontier. Now for this to hold EMH must hold and we know it's not true in the stronger forms which was why I was asking for a risk adjusted benchmark.

Re: The Growing Peril of Index Funds: Too Much Tech

#58

Post by pedrocr »

perl4ever wrote: post #53
avar wrote: post #52

Earlier quoted context omitted.

Yes, that makes sense. But that's entirely unrelated to what I'm pointing out here. (Some of) the article is making the argument that investors should decide for themselves how over- or undervalued certain segments of the economy are. So on one hand you'd have a diverse market cap weighted index where you buy into stocks representing the proportional to their portion of the economy. On the other hand you might think…

I don't think it's a good idea to guess what's over/undervalued. But equal weighting different industries is not quite the same thing. No matter how you weight things (by capitalization, by company, by industry, whatever) you are making assumptions about correlations. No dogma can tell you which is right a priori, because correlations change, especially in crises when it matters most. Also...the total market, cap wei…

>If you have $100B, say, you can't put it in a stock that's currently valued at $1B. But if you have $1000, you don't have that constraint.

Your argument is that there is a mispriced security somewhere that can be bought at a low price. There is currently only 1B$ of it available and so the professional manager with 100B$ to spend just doesn't bother to pick up that money. But you with just 1000$ can do it instead. What makes the professional manager pass up on that opportunity? He has at least as much money as you, why doesn't he invest at least that amount?

In reality that opportunity doesn't exist. Companies can't be consistently mispriced lower because there is too much demand for their stock. That's not how markets work for anything.

Re: The Growing Peril of Index Funds: Too Much Tech

#59

Post by Analemma_ »

zitterbewegung wrote: post #33

This looks like a PR piece to make people afraid of investing in the S&P. Some people have suggested thought that since investing in index funds makes the companies that are apart of the index fund to not compete with each other due to their shareholders. I'm not sure if the previous statement is even valid or real.

There have a lot of hit jobs on index funds in the last few years, often published in the Wall Street Journal. Active fund managers are getting really scared that money continues pouring out of them and into Vanguard as it becomes common knowledge that actively managed funds almost never beat index funds net of fees.

https://news.ycombinator.com/item?id=12368136#12368902 <- I said this a year ago and it's going to continue

Re: The Growing Peril of Index Funds: Too Much Tech

#60

Post by ataturk »

avar wrote: post #5

The second edition of Jack Bogle's "Little Book of Common Sense Investing" came out this last October. It goes into detail in evaluating active investment such as what's being recommended in this article v.s. passive investment. Plainly put, I've yet to see any compelling evidence that the supposed experts being quoted in this article can time the market as they're suggesting with their suggestion of getting out of t…

How many years, exactly do you think? I need to know so I can get to cash just ahead of that time period.

What if these "crashes" happen only once a liftetime and we just had a major correction in 2008/9?

Seriously, follow Bogle's advice and sleep better at night.

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