Pride cometh before the fall: Indexing edition

August 29, 2014 10:52 AM

Was ‘owning the index’ a good idea in 2000, when ~50% of the S&P 500 was in tech?

Was ‘owning the index’ a good idea in 2008, when 40% of the S&P 500 was in financials? 

No, of course it wasn’t.

I’m not here to defend active fund managers, who notoriously and consistently have underperformed the S&P 500.  

And I”m not here to say that active fund managers are about to go on a big winning streak vs. the index (as the math just doesn’t work, unless active fund management fees suddenly go to ZERO).

What I am here to say is that when “everybody” knows something, it’s usually a good time to head in the opposite direction. And what “everybody” knows now is that the very best, smartest investment you can make is an index fund.

The conventional wisdom around indexing explains why Vanguard now has nearly $3 trillion in assets and the Vanguard Total Return Stock Market Index (VTI) is now the world’s largest mutual fund, tipping the scales at over $343 billion. 

In sum, “active fund management is outmoded, and a lot of stock pickers are going to have to find something else to do for a living,” as WSJ columnist Jason Zweig recently declared.

Zweig also said the debate over active vs. passing investing is “over”, which (again) should make you stop and think about the questions posed at the top of this piece.

It should also make you think again about what happened to Fidelity Contrafund and Pimco Total’s Return fund after they became the largest mutual funds. If VTI suffers the same fate, that would of course mean “the market” will have a rough go ahead, which is exactly what Shiller’s CAPE and other valuation metrics suggest (although CAPE has its flaws and is much better at forecasting long- vs. short-term returns).

I stand behind what I said during a debate on this issue last December: “The pendulum has swung way too far where everyone thinks all you have to do is index and you’re going to do better. When everyone is on the same side as the boat there is a reversion to the mean.”

And what that would mean is a revival of the idea that there’s a place for old-fashioned stock picking vs. passive indexing. 

A parting thought: In the past few weeks, stories have been written about what a $10,000 investment in Apple 10 years ago is worth today ($456,000) or buying Google’s IPO ($139,500)- and those aren’t even the best-performers of the past decade.

For another POV on active vs passive, check out this NYT interview with Bob Olstein, whose namesake fund has outperformed over long period, He says ‘the rise of index funds is part of a trend toward sloppy investing — a willingness to follow the herd’

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