Pragmatic Capitalism

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Nicholas P. Cheer: “Don’t buy Index Funds”

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Would be glad to hear more opinions on this topics:

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Posted by Kirill Gankin
Posted on 03/15/2017 3:28 PM
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What parts do you question exactly? There’s a lot there. Some right and some very wrong.

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Cullen Roche Posted by Cullen Roche
Answered on 03/16/2017 12:06 AM
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    Alright, I took a closer look here. Here are my thoughts on each point:

    1. Index funds are NOT passive

    Yeah, I’ve expressed the same point several times. All funds are active funds. Index funds are typically less active.

    However, he cherry picks a few high flyers to say that Index funds underperform. This is rear view asset picking. The average comparable active fund underperforms its correlated index.

    2. Index funds are GUARANTEED to underperform the index

    Yes, index funds generate a total return that is post-tax and post-fee. No one generates the actual index return.

    3. Index funds have failed to vote in investors interests

    I’ve never much understood the infatuation with shareholder voting rights. If you think the direction of a company is significantly impacted by the average shareholder then you’re dreaming. Most companies are controlled by their executives and a select few board members. The fact that index funds don’t vote in favor of what most shareholders want is a relatively moot point.

    4. Index funds Ignore the laws of investing

    The author seems to be saying that factors are “laws”. Factors are just ex-post performance drivers. Most of DFA’s big funds underperform a simple market cap weighted index. Tilting to factors does not necessarily generate better returns because it’s really damn hard for a factor fund to identify the companies that will match that factor IN THE FUTURE. Factor investing is higher fee active investing by a different name.

    5. Index funds Do Not Make Sense

    This statement makes no sense. You can buy lots of different asset classes through index funds. They don’t all become “more expensive” at the same time. For instance, a 60/40 index holds components that are getting expensive (stocks) while others (bonds) are offsetting this increasing risk.

    My Countercyclical Indexing strategy goes even further by rebalancing to reduce the exact risk the author is talking about. And I use nothing but index funds.

    6. Index funds assume perfect efficiency

    No, indexing has nothing to do with market efficiency and everything to do with fees.

    As I’ve described many times, the idea that the stock market is “efficient” is simply wrong. The Efficient Market Hypothesis is one of the most useless concepts ever created.

    7. Index funds Ignore the Allocation of Capital that is at the core of Capitalism

    He’s confusing secondary markets and primary markets. Having index funds in existence does not mean primary markets don’t get funded. In fact, private equity investing and venture capital have grown tremendously during the rise of indexing so the data doesn’t support this idea at all.

    8. Index funds FAIL investors at the worst times

    Again, bonds don’t fail investors at the worst times. A bond index fund offsets stock losses when stocks are having their “worst times”.

    9. Index funds Ignore Academic Research

    There are lots of factors based index funds. There are lots of smart beta index funds. There are lots of market cap weighted index funds. These funds are all based on theoretically sound academic research. Again, the author seems to be generalizing about market cap weighted index funds like an @P 500 index fund. But even that index is based on a simple CAPM style academic research that was first laid out 75 years ago….

    10. Index funds will fail investors again

    See 8. This is just wrong.

    I don’t see a lot of sound understanding in this article. The author seems to misunderstand some fairly basic points about portfolio construction, diversification and general market understanding.

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    Cullen Roche Posted by Cullen Roche
    Answered on 03/16/2017 1:18 PM
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