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  • - I generally assume that most

  • of you watching these videos are already fully

  • on board with the idea that index investing makes sense.

  • While stock picking

  • and actively managed funds should be avoided

  • like the plague.

  • Most Canadians are apparently not on board with that idea.

  • As at the end of 2018, only 11.5%

  • of Canadian investment fund assets that is mutual fund

  • and ETF assets domiciled in Canada

  • were invested in index funds.

  • Clearly more people in Canada

  • should subscribe to my channel.

  • I'm Ben Felix Portfolio Manager at PWL Capital.

  • In this episode of "Common Sense Investing"

  • I'm going to tell you

  • that there are no good reasons to avoid index funds.

  • (upbeat music)

  • Anecdotally, I can tell you that there are lots

  • of financial advisors out there who genuinely believe

  • that index funds are terrible investments.

  • They have their reasons to believe this.

  • And I'm willing to bet that it's this type of misinformation

  • from supposedly financial professionals that is

  • keeping so many Canadian dollars invested

  • in actively managed funds.

  • Let's start with the classic fallback line for any advocate

  • of active money management.

  • Index funds are risky.

  • The premise of this argument is

  • that when you own the whole entire market, you will get all

  • of the ups and all of the downs that the market delivers.

  • The alternative would of course be investing

  • with an active manager that is able to feel out

  • the market and use their analysis

  • and intuition to protect you from a downturn.

  • The active management story sounds way better

  • than writing out, down markets with index funds.

  • But the story does not hold up

  • when we look at the data.

  • Vanguard did a study in 2018

  • to look at the performance of active managers

  • in bull markets when stocks are doing well,

  • and in bear markets, when stocks are doing poorly.

  • Critics of index funds would suggest

  • that active managers should outperform the index

  • in a bear market.

  • The data show that more than 50%

  • of active managers outperform the index

  • in some historical bear markets, but in other bear markets

  • less than 50% manage to be the index.

  • This should not instill confidence in anyone betting

  • on active management to save them in a downmarket.

  • If active funds do not offer any protection

  • when stocks fall, then there is no basis to say

  • that index funds are a relatively risky investment.

  • Active management also introduces

  • a whole other element of risk.

  • We know that the market as a whole is risky.

  • It goes up and down in value

  • as investors expectations about the future change.

  • For taking on the risk of the market,

  • investors expect a positive return.

  • In other words, the risk of the market is a priced risk.

  • An active manager is still taking on market risk

  • but they're also taking on active risk.

  • The risk that their bets will end up paying off.

  • Active risk is not a priced risk.

  • I would argue that active management is far riskier

  • than index investing because active management

  • introduces an additional level of risk.

  • And it is a type

  • of risk that does not have a positive expected return.

  • Another common reason to avoid index funds is

  • that you get no control over your holdings.

  • You end up buying all of the bad stocks

  • along with the good ones.

  • With the right active manager,

  • you will only get the good stocks

  • while avoiding the bad ones.

  • This is another great story without any data to back it up.

  • The problem with only picking the good stocks is

  • that there is no way to tell what a good stock is.

  • There is a massive difference between the quality

  • of a company and the quality of its stock returns.

  • For example, from 2010 through 2017

  • a time when and Google, Apple, Amazon

  • and a Netflix shares were on a massive growth path.

  • Domino's pizza had stock returns that dominated all

  • of the tech giants.

  • It takes some serious predictive ability to successfully bet

  • on a company like Domino's.

  • This is not a small issue either.

  • My example is descriptive of how stock returns work.

  • Of the roughly 26,000 stocks that appeared

  • in the CRSP database,

  • a comprehensive database of U.S. stocks

  • from 1926 through 2015, only 1000 of them were responsible

  • for all of the market returns in excess of treasury bills

  • over that time period.

  • That was like finding a needle in a haystack.

  • We can think about this issue another way.

  • Global stocks as whole returned 8%

  • per year on average from 1994 through 2017

  • if you missed the top 10% of performers each year

  • your average return drops to 3.6% per year.

  • It is easy for an active manager to say

  • that indexing results and owning all

  • of the good and bad stocks.

  • What they're not able to tell you is which stocks are good

  • and which ones are bad.

  • The reality is that it is a relatively small number

  • of stocks that drive the market's returns.

  • And it is next to impossible to consistently

  • identify those stocks at least ahead of time.

  • When proponents of active management give these reasons

  • for avoiding index funds, it is always

  • on the basis that active management is a superior.

  • This is where the data comes in.

  • The SPIVA Scorecard shows us the percentage

  • of funds in each category that were able to

  • beat their benchmark index over a given time period.

  • The SPIVA Canada mid-year 2018 report shows

  • that the vast majority of actively managed funds

  • were unable to beat their benchmark index

  • over one, three, five, and ten-year periods.

  • Of course, the rebuttal to this data is that

  • but he would invest with any old active manager.

  • Smart investors only invest with skilled active managers.

  • If you can find a skilled manager,

  • index funds don't make sense.

  • Let's dig into that for a moment.

  • The idea that a successful active manager might be skilled

  • needs to be considered alongside the fact

  • that their success may have been due to luck.

  • Even over long periods of time

  • some active managers will beat the market

  • due to luck rather than skill.

  • This makes the process of finding

  • a skilled manager exceptionally challenging.

  • In a 1997 paper

  • Mark Carhartt demonstrated that any persistence

  • in mutual fund outperformance was not due to

  • manager's skill, but due to exposure to the common factors

  • in stock returns, including size value and momentum.

  • The abstract to the paper concludes the results

  • do not support the existence of skilled

  • or informed mutual fund portfolio managers.

  • In 2010 Eugene Fama and Kenneth French,

  • again studied mutual funds

  • in their paper luck versus skill in the cross section

  • of mutual fund returns and found that before costs

  • there are both skilled and unskilled managers

  • but the skilled managers are not skilled enough

  • to cover their own costs.

  • Over the years, there have been many anecdotal examples

  • of superstar fund managers who flamed

  • out hard to finish their career, were they lucky or skilled?

  • If they were skilled, why did their skill run out?

  • Take David Baker who managed the 44 of Wall Street Fund to

  • be the top performing us equity mutual fund in the 1970s.

  • He even beat the famed Magellan Fund managed by Peter Lynch

  • over that time period.

  • For the following decade

  • the 44 Wall Street Fund was the worst performing fund

  • with investors losing a 73% for the full time period

  • while the S&P 500 grew 17.6% per year on average.

  • Or how about the Legg Mason Value Trust Fund managed

  • by Bill Miller.

  • He beat the S&P 500

  • for 15 consecutive years ending in 2005.

  • Starting in 2006,

  • he led the fund to five years of mostly awful performance

  • before handing the management over to a new manager.

  • None of this should come as a surprise statistically

  • it would take 36 years of 2% alpha.

  • That is 2% of excess risk adjusted performance

  • with a standard deviation of alpha

  • of 6% for manager's skill to be statistically significant

  • at a 95% level of confidence.

  • 10 or 15 years about performance

  • it tells us almost nothing.

  • With no way to identify skilled managers ahead of time,

  • the argument that skilled managers make index

  • funds obsolete does not make any sense.

  • Before anyone says what about Warren Buffet,

  • please check out my last video

  • which covered the Oracle of Omaha in detail.

  • Has anyone tried to convince you

  • that index funds are bad investments?

  • Tell me about it in the comments.

  • Thanks for watching.

  • My name is Ben Felix of PWL Capital

  • and this is "Common Sense Investing".

  • If you enjoyed this video, please share it with

  • someone that you think would benefit from the information.

  • Don't forget if you have run out of

  • "Common Sense Investing" videos to watch,

  • you can tune into the weekly episodes

  • of the Rational Reminder Podcast

  • wherever you get your podcasts.

  • (upbeat music)

- I generally assume that most

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Reasons to Avoid Index Funds

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    Joy Hsu に公開 2023 年 05 月 08 日
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