Opinion

Felix Salmon

Calomiris’s ridiculous take on the mortgage settlement

Felix Salmon
Apr 12, 2011 14:15 UTC

Cheyenne Hopkins of American Banker, who first published the terms of the proposed mortgage servicer settlement in March, has now got her hands on a ridiculous paper from Charlie Calomiris, Eric Higgins, and Joseph Mason, which says that the settlement is a bad one which could cost the economy $10 billion a year.

You only need to look at the bottom of the first page of the paper to see where this thing is going.

EconProposedServSettlement0.jpg

First of all, there’s nothing in the proposed settlement saying that principal write-downs should be conducted “regardless of borrower distress.” To the contrary, the talk of principal reductions explicitly applies only to delinquent mortgages. Which actually the authors know full well, since on page 10 they say that “the settlement’s approach to loan modifications would encourage strategic default.” They can’t really have it both ways.

As for the fact that the paper was bought and paid for by the very banks opposing the settlement, Mason tells Hopkins that “we never allow any funder to dictate our conclusions.” But of course he doesn’t need to, since the authors know full well what they’re expected to produce. It’s basically a variation on that notorious Greenspan op-ed: attempts to regulate the financial services industry have failed in the past, therefore there’s no point in even trying any more.

Some of what the authors write about loan servicers defies belief:

NPV calculations are already used by servicers, exercising their fiduciary duty to maximize the value of payouts to investors, in determining whether a borrower qualifies for a loan modification…

That servicers have not modified more loans indicates that, under their NPV analyses, additional modifications would not result in higher payouts for investors, despite the benefits of avoiding a protracted and expensive foreclosure process…

Servicers already use NPV analyses as a matter of course. If a servicer finds a modification to be NPV-positive, then it will likely modify the loan without any regulatory oversight.

Even bankers aren’t making these arguments with a straight face any more. But, as HL Mencken famously said, there is no idea so stupid that you can’t find a professor who will believe it — and the banking industry, here, seems to have found just those professors.

In fact, this isn’t stupidity: Calomiris et al aren’t stupid. But it’s intellectual dishonesty: they know full well about the various lawsuits and other attempts that mortgage-bond investors are making to get servicers to change their ways, and they also know full well that banks’ servicing departments are badly-run and fundamentally broken. But somehow, after taking a long bath in bankers’ dollars, they’ve managed to persuade themselves that those banks always exercise their fiduciary duty to investors and never foreclose when doing so makes little financial sense. (And, for that matter, they’ve also persuaded themselves that taking large amounts of money to write papers for the financial services industry has no effect on what they end up writing.)

As for the authors’ attempts to quantify the costs of the settlement, they use numbers in the CFPB report uncovered by Shahien Nasiripour which says that “effective special servicing of delinquent loans would have cost 75 bps/yr more than the actual costs incurred” — except the way they put it is very different:

The CFPB recently estimated that five servicers avoided $24 billion in costs between 2007 and 2010, yielding a 75 basis-point reduction in interest rates.

Er no, the CFPB nowhere says or even hints that there was any kind of reduction in interest rates as a result of the banks’ broken servicing operations. (And it wasn’t five servicers, it was nine.)

I’m also particularly fond of the way that the authors calculate the increase in foreclosure inventory brought on by an increase in strategic defaults. “For simplicity,” they say in footnote 48, “we assume all strategic defaults result in foreclosure.”

What?

The entire reason why strategic defaults would go up, according to the paper, is that borrowers will know that if they default, they’ll get a loan modification. And yet somehow by the time we reach footnote 48, all those borrowers are mistaken, and in fact they won’t get a loan mod: they’ll be foreclosed upon instead.

It’s unclear whether this paper was ever intended for public consumption, or whether it’s just something for banks to quietly pass on to their lobbyists, who in turn will show it to lawmakers. But it’s certainly harder to take Calomiris seriously in his attempts to revisit Dodd-Frank when he’s happy churning out hack-work like this which shows him to be completely captured by Wall Street.

COMMENT

I’ve read 8 pages of Calomiris. He should read the Congressional Oversight Panel December 2010 report. Settlement terms rely on this excellent analysis. For example, we learn that the NPV inputs were managed by servicers so as to make a modification less worthwhile than foreclosure. A recent attempt of Treasury involves using an updated NPV formula to avoid gaming this aspect of modification.

Calomiris refers to early modifications (05-08). These mostly ended up increasing the amounts borrowers had to pay. No wonder further default resulted.

If this paper is intended for Congress, it must be for members absent from the investigating committees!

Treasury (or HUD) would be better off taking modification over on behalf of debt holders, but that would really be contentious.

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Counterparties

Felix Salmon
Apr 12, 2011 04:44 UTC

The Ceglia vs Zuckerberg lawsuit just got interesting. The emails which Facebook says are fake don’t seem that way to me — TBI

Traffic to NYT down between 5 and 15 percent in the wake of the paywall — Hitwise

Greek Debt – the Endgame Scenarios by Buchheit & Gulati — SSRN

Ikea’s U.S. factory churns out unhappy workers — LAT

Alma Guillermoprieto on the Mexican cooking of Diana Kennedy — NYRB

Microlender default alert! The financial crunch for Indian microfinance institutions is deepening — Business Standard

Wherein Aunt Thelma seeks to join Mrs Watanabe in playing the global carry trade, and is dissuaded by her nephew — Reuters

From the desk of Donald J Trump: “Graydon – I know far more about you than you know about me” — VF

With notably rare exceptions, the carry trade is a bonafide strategy that works well over time — Reuters

COMMENT

Actually, if people are engaging in precautionary savings of NYT clicks, perhaps the click-through rate from google news will pick up near the end of the month, both among people who have already hit their quota and people who saved more clicks than they needed to. Even supposing this is true, and supposing the other guess about the google news algorithm, I don’t know how quickly google news would respond to this change, but it will be interesting to see whether google news seems to link to the NYT more often around month boundaries than in the middle of months.

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Sob story of the day, vulture-fund edition

Felix Salmon
Apr 11, 2011 21:22 UTC

Matt Wirz probably can’t be held responsible for the headline the WSJ put on his story today — “For Vultures, Slim Pickings.” But there’s no doubt that distressed-debt investors in Lee Enterprises are angry. And they’re angry for a very weird reason: after buying Lee’s debt at a 20% discount to face value because there was such a high likelihood of default, they’re now set to be repaid in full. That’s a 25% return in just over six months. Which certainly isn’t my idea of “slim pickings.”

The calculation behind the vultures’ investment, as far as I can tell, was that Lee was a solvent company with a liquidity problem. Their plan was to buy up the debt, see it default, seize control of the company, and end up with assets worth much more than the face value of the debt.

If they think the company is worth much more than its $1 billion debt load, of course, they can always go out and buy Lee’s common stock: it’s trading at less than $3 per share, valuing the company at just over $100 million. But that’s not the way that vulture investors like to make money: instead they specialize in bankruptcy-court legal maneuvers, and identifying the exact point in any company’s capital structure where a relatively modest tactical investment can ultimately result in complete control of the firm.

It’s hard to see how this kind of skillset adds value to the economy. It looks like a negative-sum game to me: the bondholders who sold below par lose money, the original shareholders get wiped out completely, the courts and lawyers take their tithe, and the vultures — if they’re successful — rake in everybody else’s chips. I suppose the investors betting on default do help to support the price of the debt at the point when the company’s outlook is bleakest. But there’s nothing there to justify annualized returns of well over 50%. So well done to Lee Enterprises, and its bankers, for managing to remain afloat.

As for the vultures: stop whining. You made a large amount of money in a very low-interest-rate environment featuring precious few defaults. Go enjoy your spoils, rather than kvetching to the WSJ about how you missed out on even more.

COMMENT

Well, if the stock is overvalued, then this sort of strategy ought to bring the price down. More fundamentally, this sort of opportunity may indicate a company that is not being run optimally.

If in any case no value is being added, this is simply the price of a stable legal system.

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Should the SEC try to boost the IPO market?

Felix Salmon
Apr 11, 2011 21:04 UTC

Clare Baldwin and Sarah Lynch are unambiguous: “As US regulators review rules on shares issued by private companies,” they write, “they must not make it too easy for hot Internet companies such as Facebook or Twitter to avoid the scrutiny that goes along with an initial public offering.”

They’re talking, of course, about the letter which SEC chairman Mary Schapiro sent to Darrell Issa on Wednesday. It’s a long and pretty boring document, and it’s certainly not as revolutionary as some of the press coverage would make you think. Jean Eaglesham, who broke the news without printing the letter, set the tone of the subsequent discussion by saying that the SEC review “could remake the way American start-ups raise capital,” “would upend the normal path for fledgling companies to raise funds,” and “could shut out many ordinary investors from one of the fastest-growing market sectors.”

But it’s hard to see anything in the letter which really supports Eaglesham’s reading. Mostly the letter is dry and legalistic, and in fact it takes pains to say that “the Commission seeks to minimize the costs of being a public company in the United States and provide a regulatory environment that encourages companies considering going public.” The part of the letter which talks about revisiting the 500-shareholder rule makes it clear that any change is overdue in any case, given how the rule isn’t having its intended effect:

500.jpg

All of this seems much more like a common-sense view of a rule which hasn’t really been updated since it was enacted in 1964, and much less like a revolutionary attempt to kill the IPO market by making it particularly attractive to stay private. Certainly there doesn’t seem to be any point in forcing companies to give out options, or phantom stock, or stock appreciation rights, or other such weird and wonderful inventions, just as a means of getting around a rule which has been around for half a century and is showing its age.

And it’s easy to overstate what exactly goes on in places like SecondMarket:

The SEC is wrestling with the needs of private companies to raise capital against the investing public’s need to make informed decisions.

The issue has jumped into the spotlight as Wall Street banks and electronic markets offer investors a chance to buy and actively trade stakes in hot Internet companies such as Facebook, Twitter, Groupon and Zynga before they go public.

Investors are indeed being offered the chance to buy stakes in companies like Facebook — although Facebook is sui generis and is much more of an outlier than it is typical. But as far as I know, no one is actively trading any of these properties. The auctions come up irregularly, they often require shareholders to hold on to their stock for a period of years, and the trading costs are very high — on the order of 5% per trade. Meanwhile, Goldman’s attempt to come up with a private exchange where shares could be actively traded has fizzled embarrassingly, and never attracted any hot internet companies.

As Jason Zweig says, there’s a good reason retail investors are barred from investing in private placements: they are very risky and dangerous things. But global high net worth individuals are increasingly interested in buying in to such placements, and the SEC has no real reason to stop them from doing so. I’m not a fan of this development. But that doesn’t mean I think the SEC should keep its rulebook in 1964, just because doing so might allow companies to prosper in private hands a bit longer.

COMMENT

Between frank-Dodd and Sarbanes, companies have figured out that it isn’t worth the effort to be traded on US exchanges. the next step is for Facebook to list somewhere else. Maybe a place with good regulations and a strong currency.. Switzerland comes to mind

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The value of MarketRiders

Felix Salmon
Apr 11, 2011 14:52 UTC

Last year, looking at MarketRiders, I asked how much rebalancing is actually worth, in terms of basis points. I didn’t get a clear empirical answer — the responses in the comments ranged from zero to 150bp. But now Burton Malkiel, of all people, has come out against the service:

Investors could save more money on their investments and improve their returns by skipping services such as MarketRiders and making decisions themselves, said Burton Malkiel, professor of economics at Princeton University and author of “A Random Walk Down Wall Street.” The 10th edition of the book was published in January.

He recommends investors hold a mix of the Vanguard Total World Stock Index exchange-traded fund and a broad-market bond exchange-traded fund such as the iShares Barclays Aggregate Bond Fund or the Vanguard Total Bond Market exchange-traded fund, and rebalance annually.

“I don’t want to pay 25 basis points to anybody to do that for me,” said Malkiel.

MarketRiders responded to Malkiel’s comments obliquely, on their blog, by praising Malkiel and his advice of investing in ETFs. But I think that they could have been quite a bit stronger: Malkiel’s criticism is a little bit off-base.

For one thing, MarketRiders doesn’t charge 25bp for its rebalancing service. Instead, it charges a flat $10 per month (or less if you pay annually) — which is only 25bp if you’re investing less than $50,000. And indeed even MarketRiders recommends that you simply buy a target-date fund rather than try to do clever things with rebalancing if your portfolio is under $25,000.

What’s more, the MarketRiders fee doesn’t actually come out of your investment returns at all. I know that economists like to think of money as fungible, but speaking personally I can certainly say that if I spend $10 less each month on my credit card, that is not going to mean that I save $10 more each month in my ETF portfolio.

One of the reasons that individual investment returns nearly always lag the market as a whole is simple laziness: while I’m quite sure that Burton Malkiel has the discipline to be able to rebalance his investment portfolio annually, most of us forget, or never get around to it, or let dividends pile up uninvested, or that kind of thing. Investing is a chore, and the value of MarketRiders is only partly in the rebalancing.

“The beauty of it for me is that monthly e-mail that just says ‘Here’s how to do it,’” said Cohen, who has been using MarketRiders for about two years. “If I didn’t get that e-mail I’d never do it.”

MarketRiders says that it suggests a rebalancing roughly 2-4 times per year, depending on how frequently you ask to be alerted and how volatile the market is. Personally I’d probably dial that down a bit so that the rebalancings were even less frequent, closer to Malkiel’s once per year. This is the only part of the MarketRiders business model which gives me pause: if people are paying $10 a month for a service, they want that service to do something — even when the best thing to do, most of the time, is nothing at all.

Most elegant of all, however, is the way in which MarketRiders does lots of rather complex calculations for you when you add to your savings. The screenshot looks like this:

rebalancing.png

The idea here is that rebalancing should never, or almost never, involve selling something you’ve already bought: instead, you can just put your new money into the asset classes where you’re currently underweight. Again, financial sophisticates might be able to work these sums out on their own. But in practice, there’s real value in letting an impartial algorithm do them for you — especially since the whole point of rebalancing is that you’re going to be buying beaten-down asset classes which are out of favor and therefore psychologically difficult to commit money to.

I’m still agnostic, then, on the financial value of rebalancing, as it might be expressed in basis points per year. And Malkiel might be right that the value of MarketRiders’s rebalancing advice, in dollar terms, is less than the $100 per year that it charges — especially if you’re going to be rebalancing anyway on your own. But there are other sources of value in the MarketRiders service. It encourages people to stick to their big-picture asset-allocation strategy rather than change their mind at what’s probably exactly the wrong time — and it also provides an important nudge to actually do the financial legwork that most of us love to put off until tomorrow. From a classical perspective, then, MarketRiders may or may not provide value. But from a behavioral perspective, I think it makes a lot of sense.

COMMENT

Three years on, this is especially amusing since Malkiel is now CIO at Wealthfront, a firm which charges 25bps to rebalance your portfolio.

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Counterparties

Felix Salmon
Apr 11, 2011 06:17 UTC

The Wall Street Mind: Oblivious — NYMag

Never tell someone they’re wrong on the internet without saying where & why — Culturing Science

In which Hempton applauds the Australian authorities for vetoing the takeover of their stock exchange by Singapore — Bronte Capital

In which Donald Trump complains about Gail Collins — NYT

“Nothing motivated me to get this tattoo except a love of liberty and the fact that I was at Mardi Gras & pretty drunk” — Pete Eyre

In an Ivory Coast hotel, “bunker down and hope” — Reuters

COMMENT

Trump, mind you, said that the last recession was an act of God. I tell you what…if he gets to St. Peter’s gate, he can ask if God caused the last recession. If he doesn’t make it to St. Peter’s gate, we’ll probably know: reruns of his insipid shows.

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Should bloggers get embargoed World Bank reports?

Felix Salmon
Apr 8, 2011 22:56 UTC

Does the World Bank have a beef with bloggers? According to Aidwatch it does:

This morning we learned that the World Bank does not consider bloggers journalists. According to Bank policy, it won’t give press accreditation to bloggers, denying them access to the media briefing center where new reports are released under embargo before they are published for the public.

In this case, the report we won’t be allowed to see an advance copy of is this year’s World Development Report, on Conflict Security and Development.

The Bank’s David Theis responds in the comments that they offered to email the report to Aidwatch in advance, but the blog’s Laura Freschi is having none of it:

I applied for the user name and password required to enter the Online Media Briefing Center through the World Bank web page this morning.

After several phone calls with other press center staffers who told me the registration was pending, we spoke and you told me that as a matter of policy, the World Bank does not give early access to blogs.

Your offer to email Bill the report directly a few hours early is not the same as allowing us access to the protected areas of the site for “accredited media outlets.” I don’t know when the WDR report was put online, but presumably those journalists registered by the Bank have had access to that report for days, and did not have to send several emails and make phone calls to get it.

My sympathies are with Freschi on this one. “Bill”, here, is William Easterly, the proprietor of Aidwatch and a former senior Bank staffer. Offering to email an advance copy of the report to Easterly is absolutely not the same as letting Aidwatch bloggers onto the same playing field as other journalists. Reuters, for instance, was shown a summary of the report weeks ago, and was also offered an interview with Sarah Cliffe, one of its lead authors. The full report arrived yesterday, and then there was a conference call today where journalists were walked through its main points. Come Sunday evening, when the embargo is lifted, there will be an informed story up and ready to go.

At the same time, however, Reuters doesn’t have the same specialized interest in the World Development Report that Aidwatch has. The Bank puts out a lot of enormous reports in advance of its two big meetings, in the spring and the fall, and generalist reporters simply don’t have the time, in a world full of important breaking news stories, to give them all the attention they deserve. Dedicated bloggers, on the other hand, do. As Freschi says, you’d “think they would WANT bloggers to write about it”.

On the other hand, I’m not entirely clear why bloggers like Freschi want this kind of insidery pre-publication access to the Bank’s reports. The value of blogs is their status as outsiders — what’s wrong with just downloading the report on Sunday, when it’s made public, taking as much time as is necessary to read it, maybe even phoning up the authors to talk about it, and then writing about it on your blog? Do blogs like Aidwatch really want to play the Bank’s PR game — the one where they put an artificial embargo on reports so that everybody will write about them at the same time without really having digested their contents or having had the opportunity to get reactions from people who know what they’re talking about?

The more media outlets which ignore embargoes the better, as far as I’m concerned. When the World Development Report goes live, Aidwatch should link to it, download it, and start reading it. As and when they find interesting bits, they should blog them. A discussion, ideally, will ensue, around a document which is public. That’s the heart of blogging — not the privilege of being told in advance what to write by a bunch of Bank staffers. So while the Bank’s refusal to grant Aidwatch media-outlet status is silly, Aidwatch’s dudgeon is I think misplaced. Honestly, try being on the embargo list sometime. You’ll love your life once you’re off it.

Update: If Aidwatch adopted the policy of Universe Today, there wouldn’t be an issue here. (h/t Oransky.) Embargoes are a bit like the VIP room at Lot 61: the only reason you’d ever want access is just because you don’t have it.

COMMENT

Felix,

The idea that the world bank would exclude people like you from an “approved access list” is absurd. Isn’t Krugman considered a blogger at this point… I mean he has a blog?

In a fair and balanced world news gathering orginizations like NPR, NYT, WSJ, and your beloved Reuters should be awarded credentials at the entity level and then assign them to who ever they wish.

Best hopes for grayhairs everwhere (a demographic I very recently joined) realizing that web baised journalism is now the most widely consumed.

Keep up the great writing Felix.

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Annals of C-suite dysfunction, Goldman Sachs edition

Felix Salmon
Apr 8, 2011 21:45 UTC

Ian McGugan has a good review of Bill Cohan’s huge new book on Goldman Sachs which includes an intriguing quote about how Bob Rubin “encouraged a culture of undisciplined risk taking” — something which goes directly against the reputation he’s spent many years cultivating. It comes from Chapter 15, which starts in the dangerous year of 1994 and which is full of juicy gossip about the very human frailties of the people running Goldman. Here’s more of it:

“For a long time he just sort of sat in his office,” one partner said of Corzine. “He would sit in his office breaking out in tears at various times while the firm was losing all this money.”…

As the losses in 1994 mounted, many partners became increasingly nervous that the firm was at risk… Some forty partners left Goldman at the end of 1994, the first time anything like that many partners had voted with their feet. “People resigned out of fear,” one partner said. “That should tell you something.”… Howard Silverstein, the partner in charge of Goldman’s Financial Institutions Group, left. “He was perceived as being an expert,” one partner on the Management Committee said. “And all he did was just do a simple calculation if this continues. You know: wiped out.”…

Paulson cut people, travel expenses, allowances for overseas living, and many of Goldman’s vaunted perks. He even cut back on the use of a corporate jet and recalled grueling overseas trips flying around Europe and Asia on commercial flights…

Goldman’s problems at that time weren’t only ones of cost and bad bets. A culture of undisciplined risk taking had built up over many years. “A lot of these practices were set up when [Rubin] was there,” one top partner said. “Okay? The lack of a risk committee, trusting individual partners, model-based analytics — that by God you can be smart and figure it all out — and letting traders become too important and being afraid to confront them if they’ve been big moneymakers. All that sort of stuff built up.” …

Aside from why Friedman had seemingly botched his departure, the other lingering question that remained among many of the Goldman partners was how Corzine could have emerged as the firm’s leader when he was leading the very division — fixed- income — that had lost hundreds of millions of dollars in 1994…

Goldman had selected as its new leader the very person who had just presided over a complete meltdown in Goldman’s fixed- income business and who, as a result, never fully had the trust and faith of the firm’s investment bankers. “That is one good question,” one Goldman trading partner said. “At a normal place, it would be discordant. You couldn’t imagine it. And I guess at this place, somehow you could.”

This, remember, is the world’s best investment bank. It’s worth bearing in mind when you see those eight-figure salaries and wonder whether they’re earned. And when you hear politicians bellyaching about the importance of keeping US banks “competitive” on the international stage. If this is competitive, it might well be best to just drop out of the competition all together.

COMMENT

Felix, by definition, those salaries are earned because the owners of the company have agreed to pay them.

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Adventures with stock market indexes, Nasdaq 100 edition

Felix Salmon
Apr 8, 2011 19:33 UTC

Dave Nadig and Paul Amery of Index Universe have the best explanation (and excoriation) of the weird Nasdaq 100 Special Rebalance this week. In a nutshell, when the Nasdaq 100 wanted to become an exchange-traded fund and make lots of money in the process, Microsoft would have accounted for more than 25% of the index if it was simply cap-weighted. So the index gurus artificially depressed Microsoft’s weighting in the index, while boosting the weighting of smaller companies.

Fast-forward to today, and you end up with a rather silly situation where Microsoft and Apple, with similar market capitalizations, account for 4.3% and 20.3% of the index respectively. Enter the rebalancers:

Here’s the rule, which was just triggered: When any security gets over 24 percent; or when the aggregate of positions of more than 4.5 percent is greater than 48 percent; or whenever Nasdaq feels like it—seriously, that’s the trigger this time—a rebalance is triggered.

Apple isn’t over 24% of the index, and the aggregate of positions of more than 4.5% is just 25.25%, well below the 48% maximum. So there’s no reason at all to do this rebalancing now, beyond an unpredictable desire “to ensure the NASDAQ-100 Index remains a relevant benchmark for investors around the world who track the performance of the U.S. equity market.”

But the bigger picture is that all indexes are arbitrary by nature. For instance, the Nasdaq 100 itself is very weirdly comprised, as Nadig explains:

To get into the Nasdaq 100, here’s what you have to do:

  1. Happen to have Nasdaq as your primary listing
  2. Not be a financial company (for no particular reason)
  3. Be “seasoned,” which means being on Nasdaq for two years, or being in the top 25 percent of the Nasdaq 100 in terms of market cap

And other indexes, while not being as bad, are also pretty arbitrary:

If you’re new to indexing, you may be surprised to find out that the membership criteria for companies entering the world-famous S&P 500 and Dow Jones Industrial Average indices are also highly subjective.

The Dow’s components are chosen by an “averages committee” comprised of the managing editor of The Wall Street Journal, the head of Dow Jones Indexes research and the head of CME Group research.

Selection for the S&P 500 is also at the discretion of an index committee, the goal of which is “to ensure that the S&P 500 remains a leading indicator of US equities, reflecting the risk and return characteristics of the broader large cap universe on an ongoing basis”.

According to one well-founded analysis of the S&P 500 index committee’s stock picking record, the committee members are subject to the same style biases and drift as the average active manager. They boosted the index’s weighting in tech stocks during the bubble of the late nineties, only to remove several of the same names shortly thereafter; and they relaxed a longstanding prohibition on including holding companies in 2001, allowing lots of real estate investment trusts to be added to the index during the greatest real estate bubble in US history.

Amery concludes that “when you’re selecting a tracker product it’s worth casting a very sceptical eye over the index being used.” But it’s also worth noting that stock-market indices tend to outperform the broad market, at least according to this paper. And that at the margin, the narrower the index, the more it’s likely to outperform — at least in bull markets. (In bear markets indices underperform, but stocks do tend to go up more than they go down.) That might explain how Dimensional Fund Advisers tends to outperform the S&P 500 by following an indexing strategy: it just invests in narrower indices which perform better.

I had a great conversation with Bob Pozen yesterday, who was in town to plug his new and exhaustive book on mutual funds. We talked a bit about active vs passive investment strategies; Pozen reckons that passive strategies won’t ever be much more than about 20% of the market. But the fact is that just about all funds use some big index — often but not always the S&P 500 — as their benchmark. And insofar as that index is a bit arbitrary, that skews the entire market in unhelpful ways. I doubt I’ll ever get the everything bagel I’m looking for in terms of a single global fund. But as far as US stocks are concerned, many people think the S&P 500 performs that role very well. And I’m not at all sure that it does.

COMMENT

It would make sense to have this index product capped at something like 10 per cent so that if something really bad happened to one component of the index the downside would be limited.

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