Business | Investment
Indexing is not just simpler but smarter way to invest
Author argues no one can consistently pick winning stocks and bonds
- By Paul Sullivan, Bloomberg
- Published: 00:00 February 20, 2010
- Image Credit: Bloomberg News
- A TV anchor reports from the Nasdaq market in New York. In his new book, Burton G. Malkiel - of 'A Random Walk Down Wall Street' fame - urges the wealthiest investors to use index funds to diversify their money across asset classes.
Index Funds, Dowdy to Some, Get a Notable Endorsement
New York For the wealthy, index funds have an image problem. They are considered the economy cars of the investing world: they'll get you there but not in style and you're always worried they may break down. Anyone at a serious level of wealth, the thinking goes, needs the equivalent of a luxury sedan, with strategic stock choices, hedge funds, private equity, real estate.
Burton G. Malkiel says this is all hogwash.
Best known for his classic investment treatise, A Random Walk Down Wall Street, Malkiel has just published The Elements of Investing with Charles Ellis, an investment consultant. The book is focused on the cleanest, simplest ways for people to invest their savings.
Malkiel, a professor of economics at Princeton University, has long advocated index funds. What's striking now is his belief that the wealthiest would have fine returns without the volatility and high fees if they simply used indexes to diversify their money across asset classes.
"This is still a strategy that is good for people of all income levels," he said. "If I took all the mutual funds that existed in the early 1970s and asked the question how many really beat the market through 2009, you can count them on the fingers of one hand."
There are plenty of dissenters to this view. James T. Tierney Jr., a senior vice-president at W. P. Stewart & Company, which has $1.6 billion (Dh5.8 billion) invested in 15 to 20 stocks, equated indexing to judging baseball players against the league average. "It's like saying all hitters hit .275," he said.
Two sides of the story
The argument between advocates of the two approaches — indexing versus active managing — is an old one and will not be resolved here. But. Malkiel's assertion that even the wealthiest investors should use indexes is intriguing. What follows are his main arguments in favour of indexing and the rebuttals from advisers who earn their livings doing the opposite.
Malkiel has long said that no one can consistently pick winning stocks and bonds. He argues that index funds are the best, low-cost ways to invest money you will need. "We say to people in the book, ‘Don't try to time the market'," he said. "It's not that you can't do it; it's that you won't do it. The emotions will get ahold of you."
He pushes everyone to stick instead to a balance of stocks and bonds that are right for their age and to rebalance this annually so the proportions are the same.
On the other hand, Tierney argued that W.P. Stewart's concentrated approach to stock-picking serves high-net-worth investors better. "We're selecting high-quality companies with earnings streams and eliminating all the bad stocks in the S&P that you have to own because it's an index," he said.
Tierney pointed out that his strategy has consistently beat the Standard & Poor's 500-stock index. Since the fund's inception in 1974, it has outperformed the S&P in its 28 positive years, 23.3 per cent to 19.9 per cent, and in the index's seven down years, negative 2.9 per cent versus negative 13.7 per cent.
Strongest feelings
Of course, all of W.P. Stewart's returns were reported with its average management fee of 1.2 per cent. And this is the area where Malkiel's feelings are strongest.
While the old adage says you get what you pay for, Malkiel argues the opposite. "The one thing I'm absolutely sure about is the less I pay to the purveyor of the service, the more that will be left for me," he said. When it comes to fees, Malkiel reserves his harshest words for those favourite pre-recession investments: hedge funds. He contends that no one should invest in them, mainly because of their fees — typically a 2 per cent management fee and 20 per cent of gains. Hedge funds, he said, are "great deals for the hedge fund managers but not super deals for the investors."
Rex Macey, chief investment officer of Wilmington Trust, who calls himself an admirer of Malkiel, begs to differ. "Being able to short stocks is a very important tool," he says. "If you're long only, all you can do is not hold a stock. If you have an opinion and insight into a company that is not good, you have to be able to short it."
But Macey added, "Burton is absolutely right that you have to be careful of fees."
Still, even if hedge funds' fees were not so high, Malkiel has another objection to them. "There are very few that are any good," he said. He added that his research had shown the good hedge funds of one era were not the good ones of another. And even if the hedge fund is a good one, he said, it's likely to be selective in its investors or simply be closed to new ones.
This comes back to his argument for indexing broadly and avoiding alternative investments. "You don't need a commodities fund if you're really well diversified and into emerging markets," he said. "You're going to have some investments in Brazil, which is natural resource rich. It's simple."
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