The data that's been coming out over the last year or so is strongly in favor of passive indexing. Here's a recent FT article that makes a convincing case for investing passively:
https://www.ft.com/content/e139d940-977d-11e6-a1dc-bdf38d484582
These types of articles have been constantly popping up in the media. The response from the public and financial fiduciaries has been to switch to passive strategies (market-cap type indexing). On the face of it, this seems perfectly rational. Why pay more for an active manager if that manager can't beat a low-cost index fund after fees? (Answer: You shouldn't.)
However, whenever I hear that funds are consistently flowing into a specific strategy or asset class, it makes me wonder if the valuations in those areas are being stretched. If they are, that could lead to some epic declines -- and I don't like losing money.
Another thought I have when I read these stories is: Could the fund flows be the cause of the outperformance? In other words, is there some reflexivity going on (i.e., a circular relationship between cause and effect)? Could the heavy fund flows be increasing the prices of the underlying stocks in the indices, and thus enticing other people to invest in passive strategies, which then further drives prices up (and so on)?
Now, I'm not saying that passive investing is in a bubble. It is a popular strategy, but that doesn't mean there's not some good reasoning behind it. And for all I know, this shift from active to passive could continue for quite a while. (Frankly, I do think we have quite a few active managers that do not deserve their fees -- and should be fired.)
Ultimately, though, I think it comes down to valuation. What are getting for your money? This is the litmus test that investors should use.
To be continued....
https://www.ft.com/content/e139d940-977d-11e6-a1dc-bdf38d484582
These types of articles have been constantly popping up in the media. The response from the public and financial fiduciaries has been to switch to passive strategies (market-cap type indexing). On the face of it, this seems perfectly rational. Why pay more for an active manager if that manager can't beat a low-cost index fund after fees? (Answer: You shouldn't.)
However, whenever I hear that funds are consistently flowing into a specific strategy or asset class, it makes me wonder if the valuations in those areas are being stretched. If they are, that could lead to some epic declines -- and I don't like losing money.
Another thought I have when I read these stories is: Could the fund flows be the cause of the outperformance? In other words, is there some reflexivity going on (i.e., a circular relationship between cause and effect)? Could the heavy fund flows be increasing the prices of the underlying stocks in the indices, and thus enticing other people to invest in passive strategies, which then further drives prices up (and so on)?
Now, I'm not saying that passive investing is in a bubble. It is a popular strategy, but that doesn't mean there's not some good reasoning behind it. And for all I know, this shift from active to passive could continue for quite a while. (Frankly, I do think we have quite a few active managers that do not deserve their fees -- and should be fired.)
Ultimately, though, I think it comes down to valuation. What are getting for your money? This is the litmus test that investors should use.
To be continued....