Index Funds launched the S&P 500 Equal Weight (Ticker: INDEX) index mutual fund earlier this month, one of the only instruments of its kind on the market today. Benzinga sat down with Index Funds' Michael Willis to discuss the strategy of the fund, the difference between equal-weight and cap-weighted index funds and how to beat the S&P 500 with...the S&P 500.
Benzinga: Hey Mike, how's it going?
Michael Willis: Good, Nick. Thanks for taking our call.
BZ: The first thing I wanted to talk about was, first and foremost...tell me a little bit about the index. I've done my research, but I want an overview for other people who aren't familiar with mutual funds and ETFs and how the market cap is composed.
MW: The S&P 500 index, of course, is the most widely benchmarked index on the planet. So, even though the Dow Jones is quoted on a daily basis, on the nightly news the S&P really is the one the managers track, and it's the most widely benchmarked, and it's of course the top 500 largest companies in America, but the scope is really global when you look at the companies -- Google Inc (NASDAQ: GOOG) (NASDAQ: GOOGL) and Facebook Inc (NASDAQ: FB) and Apple Inc. (NASDAQ: AAPL), and the rest of them, they're all global in scope except for some of the ones at the back end of the 500.
So, it's a market cap weighting of the S&P 500. That's what most people understand the index - actually, I don't think most people understand the index that way. But the widely held S&P 500 index is a market cap weighted.
So, you have the top 50 largest companies actually comprising more than 50% of the index. I think that's key for what I'm about to tell you. So, what happens there is it's closer to an S&P 300 index, because the bottom 200 of those 500 companies barely show up percentage-wise in the portfolio.
BZ: S&P 300? What?
MW: When we found the S&P 500 index equal weight, we got really excited, because not only was the performance better across the board since its inception, but it's the simple, logical, pure version of the S&P 500. I think, if you ask the average person on the street, it's probably what they thought they owned when they bought the S&P 500, because they got all 500 equally. So, it's the S&P 500, and Apple, Google, is not weighted any different than any of the other 498 companies constituents in the index.
Now, they choose those constituents based on their market cap, so the size does matter. You have to be the biggest 500 companies out there to make it into the model. And it's changing. It's a fluid model. We get updates daily from the S&P on the model. And it's amazing how many changes they make. They just don't make changes quarterly or semi-annual or annual, they're adding them all the time. Companies are dropping out, they're bringing companies in, there's merges and acquisitions, there's consolidations; and so, that index is really a fluid index.
BZ: Do you re-balance quarterly, yearly... how many times do you re-balance for the index fund?
MW: We balance - it is quarterly, and that is set by Standard & Poor's. So, we're now tracking an index. So our job is not to tinker with it. Our job is not to try to influence our own thought process into the model. Our thought process, our objective, has no tracking to the index. We re-balance quarterly, and that is set by Standard & Poor's. All 500 components go back to the same weighting every quarter, and then they free-float in between those periods. As one of the 500 takes off and does quite well, and another does quite poorly, it's gonna obviously be a lower percentage during that interim period, and the one that's doing well will be a higher percentage, and then it re-calibrates three months later on re-balance day.
BZ: Compare yourself to some competitors like Guggenheim, Invesco; I know they have similar equal-weighted products. Stack up yours to those competitors.
MW: Okay, we're identical in that we each track the same index. There is almost no difference with Invesco because it is a mutual fund, I should say -- because, Guggenheim is an ETF. The ticker symbol there is RSP. And Invesco is a 1940 traditional mutual fund which trades once a day. So, the basic difference between Invesco and us is that we strike an NAV (Net Asset Value) once a day.
So you can trade in and out of our funds once a day. Whereas Guggenheim allows you to trade in and out of it all day long. You can short an ETF. There's definite advantages in terms of liquidity with an ETF. However, I think if you saw on Black Monday, RSP fell 43 percent for about 30 minutes at the open there during a period where the underlying 500 constituents were only down 5 and 6 percent. So you've got a problem there. There's some risk that comes with catering your fund to day-traders.
So, the main difference between us and Guggenheim is they cater to day traders, so you can trade it all day long, you can short it. So you're susceptible to high-frequency traders, we call them HFTs. You're susceptible to shorting. And you're susceptible to market volatility. And so, I don't know how much you pulled on Guggenheim yet, but there's about 20 articles that really focused in on why they fell 43 percent on Black Monday three weeks ago, while we experienced only 1/10th of 1 percent deviation from our underlying constituents when we struck our NAV.
We did not experience the volatility that Guggenheim did.
Black Monday 2015 And Risk
MW: ...If I'm sitting there and I'm a foundation -- there was over $10 billion in RSP on that day. It fell $4 billion there briefly. And it bounced right back, to be fair. But if I'm sitting there and I have $10 billion in the market, and all of the sudden I have $6 billion, that's a problem, especially when the underlying were only down 5.6 percent at their worst point during that morning, when the market gapped down 1,000 points.
So, we're actually very happy to cater to investors who don't want to day-trade. And really, there's 15 trillion of them, because there's $15 trillion of assets in our space, and though ETFs are the fastest growing space. But there's still only $2 trillion over there for the people that want to day-trade and short their ETFs and do some of that other fancy stuff.
BZ: It seems like your index also has better fees in terms of those competitors. I was looking that up. Like you said with the ETF, you're suspect to more market risk on a daily basis. It's a little bit scary for those of us who are not quite in the know of the workings of day trading and the psychology of it. It seems like INDEX is meant for 1, 3, 5, 10 years down the road. Am I right? Is that the timeline you're looking at?
MW: That's exactly right. And we love the 401K plans, IRAs...We cater to the longer-term hold investor. And frankly, what this came down to is, we spent 20 years trying to beat the S&P 500 and we couldn't. So, we get excited about that fact -- because, we think we're not alone.
Warren Buffett And Beating The S&P
MW:Look at Warren Buffett. Two years ago, he announces that when he dies, he's gonna tell his heirs just to put 90 percent in the lowest cost S&P 500 and 10 percent in cash, and that's all he's gonna tell them to do, because frankly, Buffett's been having difficulty beating the S&P 500, and I don't know how much you paid attention to the dialogue, but, every year during his annual report, we all watch it because he's arguably the best trader on the planet.
And he's said in the past that if he can't beat the S&P, he needs to be fired. And so, every year, they show his trading five years against the S&P 500, and every year, he's had a better trailing 5 than the S&P up until 2014. We were all wondering what he was going to do, because in 2014, we really got soundly beat in 2013 in our portfolios, and so did Buffett. And it was such a trouncing that it ruined his trailing 5-year number. I think he no longer beat the S&P during that period, so they put a trailing 6-year number in the annual report, I believe.
So, I think a lot of money managers out there like me, like Buffett, are just finding it hard to beat the S&P. And so, we got an opportunity to use our ticker symbol, INDEX, to pick the best index on the planet...Our goal, though, is to be the low-cost provider. So we're sticking our neck out here and saying we think we found the best-kept secret on Wall Street in terms of indexes. And we've got an easy ticker for everybody to remember. We're gonna be the low-cost provider, and we think that's our winning ticket.
The Memorable Ticker
BZ: How did you guys luck into having INDEX as your ticker? It's really identifiable. It seems like it'd be an easy thing to sell, right?
MW: You know, to be honest with you, I think that's a $20 million gift right there. That's a gift from God. I'm not gonna take any credit for that. But in my mind, from a marketing standpoint, it's worth -- to the right company, and hopefully that's us -- it's worth $20 million. I love John Bogle. I think he was right from the beginning. They laughed at him when he first rolled out the S&P 500 index. And they said, "Why would we want to ever own something that only got market returns? We're managers, we're paid to beat the market," and it just didn't make sense to them. And now, look.
Over $1 trillion, the largest mutual fund company in the world, and John Bogle was proven right. I would think he would love that ticker, but they prefer all their tickers to start with VF for Vanguard Funds. We're just happy we were able to land it, and excited that we can move it forward and hopefully make it easy for people to tell other people...And really, we could only beat the S&P with the S&P. And that's the fun part of this. We didn't have to go outside of the S&P 500 to beat it.
The Proof Is In The Pudding
Beating the S&P 500 with the S&P 500.
BZ: There was a notable financial blogger, Michael Batnick...he brought up the fact that while he does like your INDEX product, you could possibly get pretty similar returns with the S&P mid cap 400 that Vanguard has indexed as a fund based off of that index, and it has pretty similar correlation, except the BPS -- they charge 15 basis points less than your current fund. How would you counter this claim?
MW: What you miss there though is at least the top 100. As much as we say we want the equal weight throughout the portfolio, we would hate to give up Apple and Google and Facebook. To get that 400, you're gonna be giving up a lot of most of the well-known names of the S&P 500. And that's a space we don't want to pull ourselves out of.
BZ: How much are you looking to have in terms of assets under management? What's your goal?
MW: Yeah. We think there's about $15 billion in the equal weight space right this minute, between RSP and Invesco. But, depending on the numbers you look at, there's well over $100 billion in the S&P 500 market cap portfolios out there. So, our real competitor is SPDR S&P 500 ETF Trust (NYSE: SPY), which is the S&P 500, the largest ETF in the world, and some of these other S&P 500 index funds that are in our space. If you have $500 billion over there, and well over a trillion when you include separate account managers who utilize S&P 500 strategies.
We think they're gonna start to see that the equal weight really smooths out some of the returns and the performance, and justifies a second look by those spaces. And if we even had 5 percent to 10 percent of that space...we love Guggenheim, we love Invesco, we think there's plenty of room for all of us. We see a day where we're all gonna have around $10 billion and up. And that's not even a lot. If we each had $10 billion, that would be $30 billion, and that's not even close to what the S&P 500 market cap weight market is.
But, to answer your question specifically, we need a billion dollars in the next 18 months to show the world that we have something competitive and that we have something exciting, and we think we can hit that number.
BZ: Are there any specific sectors you like, coming to the year end?
MW: Look, I think the better play is this -- think about it. The market's just pulled back. If I showed you a better index than the one you already own, why not harvest tax losses here? The market's been really volatile. The deck is being re-shuffled, so to speak. We just had nearly a billion dollars in assets come out of Guggenheim S&P 500 Equal Weight ETF (NYSE: RSP). And if you look at SPY, it's a whole lot more than that. So a lot of people have gone to cash here. They've been spooked about the September-October part of the year.
We're hoping that when they re-look at their portfolios and come back into this, that we're gonna be in the mix. You can harvest those tax losses, come out of the indexes that you're in and come into our index on the way up. We think that's the better play, because the Santa Claus rally is typically something we see. So, even though the next month or so might be really challenging on the market, those investors that go to cash, we think they'd have a good position to come back in and we want to be in on it.
As far as specific sectors, we don't do that anymore. That was, my prior life was, trying to beat the S&P. And what I found was I had years where I beat it and I had years that I didn't. Over the course of 20 years, what I realized is it was a waste of time to try to beat the S & P 500 index. Very few managers do it. 86 percent don't, according to a Standard & Poor's report. But on a wider level, if you look at the S&P 500 equal weight, I don't know what those numbers would look like, but I'd love to see, if it's 86 percent don't beat the S & P 500 market cap, I'm just guessing, but I'm guessing it's above 90 percent don't beat the S&P 500 equal weight returns.
If that's the case, why kill yourself and risk your hard-earned savings and time to try to get into that 10 percent category when you have a 90 percent option that's sitting right there?
BZ: The numbers make sense to me. For the day-traders that go on Benzinga, are there any individual names you like? I know you mentioned some of the big large caps in the S&P 500, you mentioned you like some of those names. Is there anything you see specifically with companies?
MW: There's one in particular...ticker symbol INDEX. That looks really good right now.
BZ: I had to give it a try. I had to try to get a little something on the day-trader side. But hey, I love the index, it seems like it'd be a great product. Who knows, maybe I'll be a potential customer soon. But hey, I really appreciate you taking some time out of your day and talking this over with me. As a Millennial myself, I know there's people like me that want to know a way to invest in long term. So, really great stuff.
MW: What it could be, the core portfolio holding for the person who wants, let's say, just a core holding, let's say 50 percent of their portfolio. And then they can use the other 50 percent to have some fun, so to speak, if they really want to try to beat the market. Buy a Chipotle Mexican Grill, Inc. (NYSE: CMG). Chipotle has a great restaurant model, high margins, they're hard to beat right now. There's a reason McDonald's Corporation (NYSE: MCD) went out there and tried to buy them.
They can look for those gems and try to find them, but we really believe the core portfolio should be built around some of those higher-percentage return plays like the S&P 500 index. Beyond that, if they wanted to try to beat the market with a certain percentage of their portfolio, at least they're not risking [everything].
Don't Overlook It, Millennials
BZ: If you were my age -- I'm 24 -- are you investing in the index? What's the advantage for me?
MW: Here's what I would say. I can save you 20 years of my pain. I went through what you're talking about. I day-traded through college and my grad school, when I was getting my MBA. I bought a, it was cutting edge at the time, a satellite system, real time data feed, I studied volume, all the underlying companies that I purchased, I watched flows, I literally was watching trading tick by tick, and had some amazing months. I think the best month I ever had, I was up 4500 percent. But those returns aren't sustainable.
So when you read these emails that come across, and they go, "Hey, earn 500%!" Or, "Earn 50%!" Over time, you are better off using compounding of interest over time in your favor. You can just see what happens is, you're gonna have some great returns, but then you're gonna have a year that you get cut in half or something, you just get wiped out.
And the compounding of interest over time won't work to your favor. Where, if you're 24, you've got a good 30, 40 years of compounding that you can start to work right this minute just by dropping a couple thousand dollars a year into saving - I would just say, if you can save 10-20 percent a month, you're gonna be so far ahead of anybody. And then, if you can limit your speculation to maybe 10 percent of your portfolio, to try to find that next Apple or next Google. But limit it to 10 percent of your portfolio so that if you lose that part of the portfolio, it's not gonna materially affect you.
That would be my biggest recommendation, is to say, consistently use the time value of your money to your advantage. You're young. And, start saving now, and you're gonna see that. The first 7 years are like staring at a boiling pot. You feel like it's not getting anywhere. But after year 7, the numbers really start to compound, and you're gonna look -- you'll look a lot better than your peers if you can start right now at 24. That's a great age.
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