[b]Under the Hood Index Series[b]
Under the Hood: The Indexation That Is, Versus The Indexation That Should Be
April 3, 2017
Most modern investors cannot beat an index consistently. This much is apparent. Most people cannot find a good manager and, even if they do, they will eventually dismiss that manager at the first sign of material underperformance. Therefore, it follows that, if possible, most people should be invested in a broadly diversified index like the S&P 500, or perhaps the Wilshire 5000.
Unfortunately, indexation as presented and advised at the current time is not to buy and hold broadly based indexes. It is asset-gathering, marketing, and fee enhancement at its finest. It bears much more similarity to consumer marketing than to investing. In fact, it is more or less what the active managers were doing when they had the upper hand.
The studies of managers proceed from the incorrect assumption that the active manager of the past was a well-intentioned **** Economicus trying to find the best investment. Rather, though, **** Economicus was trying to raise the maximum amount of assets and, ultimately, this impacted the stock selection decision. That led to the underperformance. The index manager of today is behaving precisely like the active manager of the past, and will soon exhibit the same outcome.
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Under the Hood: What’s in Your Index? The Value of Cash
September 27, 2016
For the first time since the late 1940s, stock and bond yields have essentially converged. Once upon a time – say for the prior 80 years – investors demanded higher yields from stocks since the risk was greater. So what does this mean? If nothing else, caution is in order, and investors should be very thoughtful, perhaps more than at any other time in their careers, about where capital is being put at risk and why.
Which brings us to cash and public companies. Cash earns effectively no income, and can lower various valuation metrics, which are surely also important to executive compensation and performance benchmarking. As a result, many investors wish for the cash on the balance sheet to be deployed — a nice word for “spent” – through share repurchases, dividends, or acquisitions. But this is only a productive use of cash if the transactions are done at attractive valuations, and without taking on more leverage than appropriate. As is usually the case, well, take a look.
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Under the Hood: 5000 Years of Interest Rates (Part II)
September 2, 2016
We’ve heard a lot about the historically low interest rates. But what does this mean? First, by historic, we mean in recorded history, so we’re already, in a sense, footnotes in a future economics textbook. Second, we really don’t want to be footnotes in a future financial markets textbook, as casualties of the greatest interest rate risk in history. But it appears that the potential impact from rising rates is underappreciated. The search for yield in all the ordinary places – long-term bond funds, REIT and utility funds, the ‘dividend aristocrats’ – is not diversification and it’s not safe. They’re at historic high valuations and it all hinges on interest rates. One must escape them, which means to step outside the indexation/ETF vortex.
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Under the Hood: 5000 Years of Interest Rates (Part I)
August 9, 2016