Opinion

Felix Salmon

Counterparties

By Felix Salmon
February 18, 2011

Regulators to Hit Largest Mortgage Servicers with Enforcement Orders; Fines Likely — American Banker

Telling people to stay strong and keep their indexing faith is valuable advice, it’s not selling out — Trade Streaming

Flashback to Aug 09: Thom Yorke says there will be no more Radiohead albumsGuardian

A list of the dinner guests for Obama’s nerd dinner — NYT

Welcome, Anthony DeRosa, to the Reuters blogosphere — Reuters

When a $2 million minimum investment is far too small — CNBC

A fantastic post by John Powers on video art installation — Star Wars Modern

The Secret Weapon of the Rich: Money — Drum

Comments
9 comments so far | RSS Comments RSS

“…keep their indexing faith…”

“Faith” is a problematic word when it comes to investment. I think I know what you meant in using it, and yet…and yet…

I’d hate to think “faith” as a concept, ripped from the narrow semantic domain of that term of art, “keeping the faith,” has much to do with how I make invetment decisions. I’d hate to think that…which probably makes it at least a little bit true. But I like to tell myself that my investment strategy is hard nosed and steely eyed, grounded in empiricism and an appreciation for the currents of history and the frailties of the human mind. That is to say, to cultivate doubt and skepticism, to never accept that you have worked things out once and for all.

A pretty good recipe for neurosis, I suppose, and pretty far from what I think of as “faith.” I have faith in my wife, for instance: I don’t spend a whole lot of time checking on whether she’s being dishonest or deceitful with me. With my investment strategy, I have no such thing: I question it continually. I just don’t alter it out of fear. Or I try not to!

But still things worry me. All your reportage on the shrinking scope of publicly-traded joint-stock corporations, for one. We read of so many strategies that work brilliantly until “everyone” knows about them, and then their competitive advantages are arbiraged away, never to return. Dogs of the Dow, anyone? And now, “everyone” knows to be in stocks, and lots of us clever folk know to be in whole-market index funds. Which in one sense seems terribly clever: all we know is that we know nothing! But in another sense, have we not perhaps abdicated our responsibility as investors? Do we care about the fundamentals or prospects of a publicly-traded company? We do not! As long as you’re in the Wilshire 5000, that’s good enough for me! Where do I sign? This is troubling–it must be troubling. We are assuming that someone, somewhere, will be the responsible gatekeeper and ensure that a publicly-traded company is something more than a shell game. But not us! It’s something I turn over and over in my mind these days. If you’re sitting at a poker game, they say, and you don’t know who the sucker is…well, it’s you.

Am I leaving equities? I am not. The majority of my money remains in equity index vehicles. But I don’t have “faith” in them. I trust them as I would adders fanged.

Posted by ckbryant | Report as abusive
 

Great insight, ckbryant.

Following the universal consensus typically leads to poor returns. Applied in this case, index investing is bubble investing.

Posted by TFF | Report as abusive
 

Might I suggest an alternative?

Instead of investing in STOCKS, invest in COMPANIES. Study the business and take a stab at their earnings prospects over the next decade. Stay conservative in your estimates, always asking what might go wrong with the business model.

The number that comes out of that equation is your expected return. There are many companies that in my opinion have a negative expected return (unless everything breaks right) at their present valuations.

Posted by TFF | Report as abusive
 

Back in 1999, I looked at the make-up of the S&P 500 and realized that it was 40% technology. I stepped back, looked at my lifestyle and what we spent money on, and realized that I couldn’t see how technology could possibly be 40% of the economy. At the time, I reckoned that a rational percentage was likely 15%-20%.

I then set about finding mutual funds (mainly “Value” funds) that had less than 20% technology holdings and histories of good long-term results, especially in bear markets. It was a really tough slog as there weren’t many. By late 1999, I had my portfolio, still almost all equities, with a technology allocation of about 15%. As a result, my portfolio effectively broke-even over the next three years.

I wasn’t quite so lucky in 2008 because EVERYTHING was in a bubble then but my portfolio has still managed to bounce back quite nicely.

Most of the time, my portfolio is in index funds. But I reserve the right to shift those allocations to more defensive and active managers when the market appears bubbly. Now is one of those times as the Shiller 10-yr real PE and the Tobin Q factor are both at crash-indicating levels. Once again, it seems like most asset classes are high.

Posted by ErnieD | Report as abusive
 

Felix,

Thanks for the great links, as usual. But why did you obscure them through bit.ly? In my view these URL shortening services are bad for the web and should be avoided. I’ll make an exception if you’re beeping out a URL in Morse code (or using something equally archaic, like Twitter).

Posted by nedofbaker | Report as abusive
 

ErnieD, might I ask your present approach?

I agree with you on the frothy nature of the markets right now, but haven’t found an alternative that I’m wholly comfortable with either.

Posted by TFF | Report as abusive
 

ckbryant, TFF,

I’ve had the same concern. But my conclusion is we’re VERY far away from indexing groupthink. Most investors at all levels still think they know better. Active retail investing isn’t going anywhere. Proprietary trading isn’t going anywhere. The stock market over the last 15 years has clearly responded to fear and greed. And all that’s fine for us indexers. The market is efficient only insofar as investors in the aggregate believe it is not.

Posted by nedofbaker | Report as abusive
 

TFF

My current approach looks very bizarre right now because of concerns about the economy/market and our personal financial situation.

A significant percentage of our retirement savings is now locked up in company contributions to an illiquid ESOP in a wholly employee-owned company which was not the case even in the mid-2000s. I am still several years away from being able to take advantage of “diversification” options for this where we can start to transfer a percentage into our 401k options. As a result, I need to look at the ESOP as a risky equity and try to balance that risk with the rest of the IRA/401k portfolio.

So, the rest of the portfolio is a smattering of inflation, deflation, and US currency collapse protection, and some diversified equities.

My 401k is currently a combination of Pimco Total Return and a decent target date fund.

My IRAs have a smattering of cash, commodity ETFs and mutual funds, value equity funds, emerging markets, and precious metals. Once “diversification” starts with the ESOP, I can start to adjust my overall portfolio towards a more conventional stance especially if the monetary and equity markets start to get back to normal.

I don’t think this is the moment for me to make a massive bet in any one direction. If everything goes well with the economy, I should be sure of keeping my job and my ESOP should make us very comfortable down the road on top of other savings. If everything goes to hell in a hand-basket, then I have some smaller cushions positioned to help survive those scenarios.

I am a firm believer that it is more important not to die poor than to live rich. Unlike Wall Street, I can’t rely on the government to backstop me to make sure that I don’t become poor.

Posted by ErnieD | Report as abusive
 

Thanks, Ernie, for the detailed response. That ESOP definitely skews your picture, but the rest makes a lot of sense to me (and your philosophy is similar to mine).

Posted by TFF | Report as abusive
 

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