Good reads from around the Web.
Dale Carnegie, writing in his famous book How To Win Friends and Influence People, stressed the pointlessness of criticizing people – because 99% of people will never believe they have done anything wrong, ever.
Among the evidence Carnegie cites is this quote from one self-delusional focus of the critics:
“I have spent the best years of my life giving people the lighter pleasures, helping them have a good time, and all I get is abuse, the existence of a hunted man.”
The downtrodden joy provider in question?
The gangster, Al Capone.
Wise guys
If mob bosses, arsonists, and serial killers can go to their grave believing themselves to have done nothing wrong, then nobody should expect the gilded scions of the fund management industry to be any different.
Of course, I’m not equating an active money manager on a high six-figure income that’s accrued by tithing 2.5% a year from pensioners with a crook, or anything like that.
The fund managers I’ve met have all been very likeable, intelligent people I could happily spend hours chatting with.
They’re invariably driven, and as far as I can tell conscientious about their clients.
However the fact is they operate in a racket that has over the decades extracted trillions from the world’s more socially useful wealth generators – and that now that their bluff has been called they’re not going down without a fight.
A reminder. Active investing is a zero sum game. It cannot be otherwise. Because of higher costs, active managers in aggregate must under-perform the market and also cheaper index tracking funds.
For most people, then, the rational choice is to use index funds.
For most fund managers, the best use of their time would be in another job.
Of course back in the days when returns were higher and knowledge about passive investing was lower – or even non-existent – the industry grew fat on fairy tales about its prowess.
You know the sort of thing:
- That a company had the winning managers (for a year or two maybe)
- That index trackers were okay in bull markets but bad in bear markets (only because active funds must hold some cash for redemptions which saves them a tiny bit from the falls; asset class wise it’s still a zero sum game)
- That fine, perhaps they couldn’t beat the market in aggregate but that skilled managers could nimbly get in and out of the market while everyday investors panicked and sold up (sounds good, but actually it’s active managers who clog the airwaves warning that bear markets will persist or bull markets will never end – so sell, sell, sell, or buy, buy, buy – and who under-perform due to their timing errors, whereas the evidence from the likes of Vanguard is its passive investors just keep on keeping on…)
As these justifications have been pervasively debunked – first from the fringes like the Bogleheads in the US and, well, Monevator in the UK, and latterly even in mainstream media – the industry is turning to more outlandish reasons why it deserves to continue in the future as it has in the past.
Such as, for instance, claiming that passive investing is effectively Marxism.
Reds in the head
Now this isn’t the first time that anti-capitalist charges against index funds have been raised – as one writer put it behind the FT paywall this week, as passive investing grows in popularity the tendency of it to be equated with communism seems to tend towards certainty – but this time it has made headlines.
Unfortunately, I can’t link to the original paper, snappily entitled: The Silent Road to Serfdom: Why Passive Investing Is Worse Than Marxism.
Produced by New York research house and brokerage firm Sanford C. Bernstein, as far as I know it’s only available to Bernstein clients.
So I’ve only read the media reports and seen it debated on CNBC.
But according to Bloomberg, the money shot quote runs thus:
“A supposedly capitalist economy where the only investment is passive is worse than either a centrally planned economy or an economy with active market led capital management.”
Now this is of course a classic straw man argument. We’re nowhere near all money being run passively, so the argument is moot. You might as well put out a paper saying that it’d be terrible if all money was invested by Smaug the Dragon from The Hobbit.
I suspect the authors actually know that, as according to comments I’ve heard even from its detractors, the paper itself is very detailed and a decent piece of research.
Perhaps it’s like one of those Buzzfeed articles you can’t help yourself with, where the headline is irresistible bait that lurks above a more interesting but less sensational piece of content that most would otherwise ignore.
Either way, the irony of suggesting that passive investors should go active and accept lower returns for an alleged common good – or else be labelled as communists – is hilarious and contradictory.
Passively invest for yourself, not for the masses
I expect to hear more of these sorts of complaints in the future.
The incumbents will, naturally enough, do almost anything to justify their position – including talking nonsense to criticize index funds, as I have read and also heard several doing on live television in the past few days.
Besides the standard flimflam, one money manager even argued that passive investing was bad because lower fees meant fewer jobs in finance and a smaller fund management industry – which was bad because it meant fewer taxes would be liable on their inflated incomes.
Hey, at least it’s honest.
The more esoteric debates about whether a world of say 90% passive investing are worth having, but only in the sense that various other philosophical mind games are fun diversions.
i.e. Not in any urgent sense until we’re at least three-quarters of the way there.
Even that revered font of good thinking, the financial journalist Jason Zweig, admitted as much this week in his comprehensive overview of where this latest missive fitted into the Passive Investing Is The Road To Damnation thesis.
In an article for the Wall Street Journal, Zweig wrote:
Economists showed long ago that in a market in which everyone has equal information, it must pay off for someone to make the extra effort to obtain superior information.
So active management is unlikely ever to disappear.
Though there are no clear harms yet from index funds, the rhetoric against them will keep escalating. Don’t be passive about this topic. Pay attention.
I believe there will always be more than enough active managers willing to take money off those who’d like to try to beat the markets to keep said markets efficient.
I mean, as most of you know, unlike my co-blogger The Accumulator I myself invest actively, despite fully understanding the theory behind why I shouldn’t.
Previously I’ve presumed I was just egotistical, addicted, or maybe in a hurry.
But now I have learned mine is a noble quest that serves to keep Marxism from the door, I’ll pay my trading fees with a glad heart.
Enjoy the long weekend!
From the blogs
Making good use of the things that we find…
Passive investing
- How volatility can help you [via rebalancing] – AWOCS
- One million market beaters – The Irrelevant Investor
- Being boring – Bason Asset Management
- An interview with Larry Swedroe – The Evidence-based Investor
- Clarifying true diversification [US, but relevant] – Longboard
Active investing
- Survivorship bias – Dancing with the Trend
- 3 things every [active] investor must understand – The Reformed Broker
- Meb Faber explains his Trinity portfolio [Podcast] – Meb Faber
- CAPE is not Kryptonite for markets – Musings on Markets
- How companies tart up their accounts – The Value Perspective
Other articles
- Why ‘unicorn’ valuations are not in a bubble – 500 Hats
- The benefits of working remotely – Quincy Larson
- Gym and tonic – SexHealthMoneyDeath
- Advice for students – Oddball Stocks
Product of the week: Things change fast these days in the low stakes world of savings rates on cash. For instance, the new one-year bond from Charter Savings Bank being lauded as a table-topper by The Telegraph pays 1.46% – ahead of the competition, but noticeably lower than when I last wrote about such bonds here, which feels like two Saturdays ago. Act quick.
Mainstream media money
Some links are Google search results – in PC/desktop view these enable you to click through to read the piece without being a paid subscriber of that site.1
Passive investing
- The case for diversifying more by sectors, sort of – Schwab
- Research highlights active managements shortcomings – ETF.com
- Uber is nudging its drivers towards passive investing – Business Insider
Active investing
- Neil Woodford to warn of £1 trillion pension black hole – ThisIsMoney
- The giant of Tokyo’s stock market reveals its secrets – Bloomberg
- UK manufacturing at two-year high after Brexit vote – Reuters
A word from a broker
- The top 25 British fund managers [Careful now…] – TD Direct Investing
- Three retirement questions every couple should ask – Hargreaves Lansdown
Other stuff worth reading
- UK retail investing fees stuck above 2.5% [Search result] – FT
- Row over misleading Help to Buy ISAs continues – Telegraph
- How to beat the Help to Buy ISA “catch” – ThisIsMoney
- Are we on the verge of a house price crash? – The Guardian
- British economy escapes Brexit blow, for now – Reuters
- Don’t be fooled – there will be damaging Brexit fallout – The Guardian
- Families “broke” on £50,000 or more a year – ThisIsMoney
- The risk of dying rich [US but relevant] – Morningstar
- Does your work have purpose? Does it matter? – Fast Company
- How to tell you’re sitting next to an economist [Old-ish] – The Economist
- 20 big questions about the future of humanity – Scientific American
Book of the week: Occasional Monevator contributor The Analyst is raving about a classic investing tome he just read called 100 to 1 in the Stock Market. And when I say classic, I don’t just meant classic in the sense of it being a good read. I mean like when you buy a classic car or a classic watch, you’re going to have to pay up. First published decades ago, copies on Amazon currently run to £39.95 for the paperback or £49.95 for a hardback. Still, if 100-1 does teach you to identify 100-baggers as touted then it’d be cheap at the 100-times the price…
Like these links? Subscribe to get them every week!
- Note some articles can only be accessed through the search results if you’re using PC/desktop view (from mobile/tablet view they bring up the firewall/subscription page). To circumvent, switch your mobile browser to use the desktop view. On Chrome for Android: press the menu button followed by “Request Desktop Site”. [↩]
Thanks for the links this week.
On your central thesis, I remain amazed at the perseverance of the wealth management industry (a friend has just launched yet another fintech wealth management company), and the FT article on wealth management fees (not the 2.5% one, but the “How much does he charge”) is a good but very gentle poke at it (and note the comments section for the Monevator plug!). But then I was surprised that the coal industry went on for as long as it did. And the vinyl business. And dinosaurs. They lasted millions of years. Anyway — alls well that ends well.
In fact the most damning article this weekend is Jonathan Ely writing in the FT (god, I miss him in the Finance section) where he discloses his personal investments and how his overwhelmingly passive portfolio has performed. Also – what fortitude to admit that he made a silly choice. That’s the way forward to a better future.
But with that behind us, it’s SexMoneyThingyandWhatsit this week that strikes a chord with his hymn to the happy hour in the gym. And the realisation that he is able to have that he needs to fit that in even on return to work. The underlying insight is even stronger: you need to do the exercise and life a healthy life (and I include sleep and eating with all the well-being together with exercise, and reading). If you get to fit some work in around all that, then that’s fabulous. There’s — in fact — loads of time left for all the productive work you need to get done, and if that means a little less checking of twitter, facebook and email in some kind of mindless addictive behaviour while chained to a desk, then you’re probably doing some of the winning.
Arguably balance-sheet management is one of those things, too. Anyway no time for writing more – must go to the gym.
PS – anyone else utterly terrified by valuations yet?
There is still plenty of scope for either side to up their game, I have a relatively well-educated, professional circle, who genuinely surprise by having such conservative financial habits given their social advantage.
It seems apathy and fear of making a mistake or decision that could lock in inflexibility, leaves most simply devaluing their savings away through procrastination in sh*t mainstream bank current accounts.
When I get any further with them, they make me want to gnaw an arm off in frustration at their reverence for a standard IFA, while they’d be horrified to try what I suggest on the basis of my proven portfolio gain of ~10%p/a for the last 2 years that I’ve had a go at this. Mainly because I have no formal financial qualifications. We repeat this regularly, yet seeing me not having to work, year after year, doesn’t seem to convince them I could possibly be doing something right. (People are funny; peculiar, not haha)
Bernstein’s paper seems like drivel. In the world where major central banks do what they’ve been doing for the past 8 years, pointing to tracker funds as the source of correlation of stocks is beyond ludicrous.
However, there are some aspects of investing, which tracker funds do not currently do well. I’m not saying that they can’t, only that they don’t at present.
I’m talking of ethical investing. Climate change and gun control are good examples. Again, I’m not talking about the financial performance, only about the ethical sensibilities that some people may wish to take into account in their investment decisions.
Now, while there has been enough talk of carbon bubble and a potential disruption that a transition to low carbon economy may cause in financial markets, Mercer’s 2015 report makes it quite obvious that a well diversified global portfolio should be able to ride out that scenario without a problem. Hence I don’t buy the argument “trackers load up on bubble assets”. But. If, as an investor, one wanted to know that not a single $ of their money was invested in coal, oil, chemicals, arms manufacturers, Monsanto… you name it, there are no passive investment vehicles on the market for that. The reason seems quite obvious — there are too many variations of what “ethical investing” means. Some people don’t want to go anywhere near coal, but don’t mind oil, others vilify GM agriculture but don’t mind arms manufacturers and military service companies (controlling the human population one person at a time?), and so on. Business conglomerates further complicate the situation. In short, ethical investing requires active management. Therefore I do think that there will always be a place for active funds in this specialty area, even after passive investment becomes the default mainstream choice.
I’ve just read the CAPE article by Musings on Markets. Not a regular read of mine and well done on finding this and digging out some genuinely new analysis on this debate.
The comparison of CAPE to Bond PE is particularly insightful. The author fails to mention discount rates, which is odd in a conversation about valuation, but the bond PE is an implicit substitute for that. We would expect higher valuations in a low interest rate world as future cash flows are worth more to us now than they otherwise would be — so we’d expect CAPE to look a little “toppy” compared with the historical means.
However, the question with all directional arguments like this is “how much” and that ratio answers it really elegantly. So if CAPE scares you, then bond prices should really scare you. Stick it all in Gol… oh no – look at the price of the useless yellow stuff now!
It is ridiculous. There are more and more passive “smart” beta funds that want to outperform the market. Even without active funds investors can keep markets efficient.
That article on familes broke on £50k is typical Daily Mail fare. Every one of the examples could slash their spending easily and soon be saving £1000 a month.
The interesting thing is financial repression is killing the fee model of the fund management and banking industries
You can’t charge somebody 2.5% a year to manage a portfolio that yields less than 2.5% a year
The only solution is “efficiency savings” which anyone in any other industry knows means jobs cuts and offshoring
Can’t shed many tears about that
@MRF
Getting their kids adopted should just about do it!
Seriously though I doubt there will be much sympathy for them. Although I didn’t realise child care was so expensive.
My wife stays at home to look after ours, and we manage ok on less than they all earn.
“They’re invariably driven”: when did “driven” become a euphemism for obsessively ambitious and unscrupulous? Why does anyone see it as a merit?
@mathmo. I also find the lack of discussion about discount factors odd since it’s key. People focus on low/negative policy rates but long-dated rates are is more important for most risk assets (equities, property etc) since it impacts PV(cashflows). In a world where 10-year yields say 3% and then move to 0.5%, the 10-year discount factor rises by around 50%. Similarly when a 30-year bond yield moves from 4.5% to the current 1.5%, the 30-year discount factors increases by 175%. A 2% dividend looks like a 4% dividend stock used to in PV terms; in that sense valuations are not stretched at all. I suspect a large proportion of property and equity capital gains in the last five years can be put down to this. It’s not as though equity fundamentals have been great; we’ve had poor aggregate demand, anaemic growth and deteriorating productivity. Instead when long-dated gilts have returned 100% since 2011, any long-term cashflow generating asset like equity or property should at least benefit by as much. If the’re not, it’s arguable they are underperforming.
The problem is that if long-dated rates ever rise, this PVing effect will unwind, risking large capital losses. We can hope the driver of the rise in long-dated yields (say higher growth or productivity) would somewhat offset that. In such an unwind, all asset classes (bonds, equities and property) could be positively correlated and any diversification impact will be lost. Globalization and years of central bank policy action risk leading to higher cross-country and cross-asset correlations.
Passive investing is correct on an asset class basis (if you want to buy US equities, just buy an S&P tracker etc) but it doesn’t really help with the correlation issue. So (heresy starts here) I’ve moved some of my portfolio toward low correlation strategies (such a long vol funds) and alternative assets (non-conventional fixed income etc). Yes, I’m trying to “extract alpha” (boo hiss) but finding something that is uncorrelated from “the discount factor” effect is important (end heresy).
Zx, as part of your portfolio, hold a reasonable amount of cash on FSCS protected deposit. I don’t mean emergency cash either. Cash has zero duration risk.
@zxspectrum48k thank-you for your post. Elegantly describing the terrifying conclusion. How do you unwind low discount rates without affecting all assets that have any future income streams? Don’t your alpha solutions have the same issues? Cash and gold? Yikes. Or rely on increasing equity fundamentals — errr.
But hasn’t this always been the case? Wouldn’t assets have always been correlated if this factor were true? Or is it just that interest rates are so extreme right now that this effect is dominant?
And why isn’t anyone talking about this?
@myrichfuture. Dunno about that DM article. I sometimes think of returning to the UK as there are some interesting jobs, until I see the salary info and start thinking about the living costs.
Never seen good internationally comparative data on living costs, salaries etc, but they can’t be good. Not surprised that people struggle.
On a point of mathematics, adding the enterprise risk to the riskfree rate will dampen the movement of the discount from the bond price. So a halving of long interest rates does not have as proportionately large effect on long risk assets such as property as it does on bonds. Anyway – suspect this has got a little esoteric for TI’s comments, and I’m unwilling to risk another deletion and associated absence! Will think on it and see if there’s an obvious solution.
Hi All
I think I read somewhere that the great John Bogle of Vanguard said that 99.9% of stock exchange transactions were between investors and the 0.1 % was monies raised for investment. As far as I am concerned the sooner the 99.9% becomes index trackers the better and the stock exchange reverts to its proper purpose-i.e. raising money for investing in industry.
At the moment it is more like a casino!
However Index Trackers seem to be approaching 30% of the market so it is not all bad news!
Malcolm Beaton
@mathmo
Come on old chap, that was very particular circumstances and in an environment where there’d been a specific request not to revive a particularly thorny political football. 🙂 Your self-imposed exile was understandable but regrettable as far as I am concerned, and I’m glad it’s over.
I agree your comments can be esoteric, but I can’t imagine deleting them in the normal run of things. I love the little reviews you do of the weekend reading links, too!
(Deleting really is rare, for all my hot air. Living aside obvious spam, in normal times I can easily go a week or three without deleting anything. And the first bar is stupid three-line Telegraph comments style snidery that you vault over without breaking stride. 😉 )
Regarding your question — why is nobody talking about unwinding low discount rates — I think (as you must know, so perhaps you were speaking rhetorically) this is certainly being debated. 🙂 There was a lot of discussion about it in the run up to Janet Yellen’s latest (non) pronouncement in Jackson Hole, for example.
I don’t blog on it here partly because of my previously-discussed tilt away from most active posting, which I think this assuredly would be, and partly because I don’t think I have anything much of value to add!
(Not that I couldn’t waffle on about it for hours, but whether it would be truly of any *value*. 🙂 )
@ Monevator – The value you could add is explaining this in layman’s terms to the probable vast majority who don’t understand what @ Mathmo is talking about. I’ve read these comments several times and even attempted to model some PV and discount rates in a spreadsheet, but I’m still none the wiser! And what on earth are “long vol funds” and “non-conventional fixed income etc”?
Re the Active v Passive.
Firstly very much a fan of Trackers such as VWRL (Global Stocks), which is the benchmark used to compare all other funds.
Now here is the BUT.
In retirement we tilt to yield, since dividends come along on a regular calendar basis, whilst capital gains do not (nevertheless very welcome when CGs do arrive).
For most here, the younger long- term investors, this would not of course be a sensible approach.
Like ‘The Greybeard’ we favour Investment Trusts with a yield mandate, where someone is at the tiller, assessing the ongoing likelihood of secure dividend growth; but these ITs are held alongside Broad Market Trackers, not instead of.
Sometimes the ITs do well, sometimes the Trackers, but our main focus in retirement is on the steadily growing income.
Our one venture into ETF yield focused funds (semi-passive?) did not work out at all well!
Have seen criticims of Trackers along the lines of :-
– At the start of the 20th century railroad stocks represented 63% of US market and just 0.2% a century later.
– Russia , India and Austria-Hungary represented 25% of global Stocks in 1899 and less than 1% a century later.
– Japan rise and fall (oft quoted)
– The rise and fall of Tech Stocks.
Maybe the answer to such objections is that The Market is The Market, so who cares? Investors must press on regardless.
@neverland – finished Ed bunkers no beast so fierce. Very good. I can’t quite remember why you originally recommended it. Possibly for the subtle FIRE parallels? I did visualise RIT as a Max Demo character sat in his Mediterranean villa dreaming of his next heist.
@zxspectrum48k – Excellent post. I’m thinking along near the same lines. I’ve been 100% long on long duration/perpetual fixed interest on an active and concentrated basis since 2009, but just this month, I’ve been selling down into cash and awaiting opportunities.
I agree that the bringing forward of returns is a real cause for concern though. Whereas we’ve had inflation of capital assets in the past, this has usually been associated with increases in expected future returns. Not so since 2009, where it has been the exact opposite and this has been the great heist, the transfer of wealth on an unprecedented scale, since it means what people bought 10 years ago, no-one 10 years younger can buy today to produce the same return, unless they pay much, much more.
The 4% 2060 GILT displays this succinctly, issued in 2009 (after the onset of the financial crisis) and now priced at 200:
http://www.dmo.gov.uk/SubRPTView.aspx?rptcode=D3BSubrpt&reportpage=D3BSubRpt1&prompt0=GB00B54QLM75
I make it about 10% compounded (tax free) capital appreciation, in addition to the 4% taxed coupon, with the remaining return not much more than a 1% yield to maturity for the next 44 years. That means you have to buy about £4000 of that GILT to get the 4% you would have got from £1000 of the same GILT in 2009. No wonder nearly all the defined benefit pension schemes are in trouble.
I would argue that one measure of the true risk free rate has been something like 14% since the onsite of the financial crisis, or over 12% post tax, even if held in the most tax inefficient way possible. In that context, nearly everything else has underperformed, house price inflation included. Of course, it isn’t just in the UK either, the same story has played out across, EUR, USD and CHF.
The unwinding from low interest rates, particularly if uncontrolled, is just impossible to predict, so I think it’s a case of sit and wait and see what carnage it offers up (if it happens), much in the same way as happened in 2009. I think we can say it will be brutal for long duration GILTS, but it’s hard to say how bad it will be for other assets. There is no value in prediction with a crystal ball or listening to experts in advance. I think the key is to be nimble and make good judgement calls as the opportunities are thrown up, which is why I’m keen on cash right now, particularly as short duration fixed interest is nearly all negative (particularly once trading costs are factored in) and with very low rates on long duration bonds, the risk of capital loss is very real and ever present. In contrast, the cost of sitting on the sidelines is close to nothing.
Whereas crises in the past have been much more local in nature, this one transcends both asset classes and geography, as the central banks and politicians have tried to move in step. Also, whereas to get to this point there has been a gradual pile up of problems over time, first banks in the US/UK, then the sovereign in Europe, then the peripheral European Banks, then resources sector, then more peripheral European Banks etc – which has allowed for great active investing in switching – going back the other way is likely to see seismic change across the sectors and geographies over a much more compressed timeframe.
I LOVE Dale Carnegie’s ideas. But onto passive/active investing, active investing mutual funds have underperformed the market so much to the point where it’s almost robbing people of their money. This is why I like to keep track of my own investments and not trust others to do it for me. Can’t be dependent!
TI – thanks for the kind words. Water under the bridge, off a ducks back, etc. Nice to be back.
@David – apologies if a little obscure. Sometimes my enthusiasm to understand something exceeds my efforts to make it accessible.
The Longboard piece by Stephen Scott interested me, as diversification is right up our street, yes? But then I remembered that Americans speak a different language (and have access to a different set of investments), so I need help translating this into UK-speak (and investments). His list of 6 True Diversifiers comprises;
*Gold – no problem, lots of Gold funds available
*US Treasuries – no problem, short-dated Gilts
*TIPS – methinks inflation-linked gilts
*Trend – “represents the SG Trend Index” which “calculates the daily rate of return for a group of the largest 10 trend-following based CTAs” , um…., this equates to Momentum, eg VMOM?
*MLPs – “represents the Alerian MLP TR” which “is a composite of the 50 most prominent energy MLPs” which “measures the performance of energy segment US equity securities” which seems to be mainly gas & petrol? Best UK equivalent would be, er LGCF?? (seems to be very swappy, which I suppose is par for this sector). I’m slightly surprised that this is classed as a diversifier, but Commodities aren’t.
*Municipals – “represent the Barclays Municipal TR” which “measures the performance of USD-denominated long-term tax exempt bond market, including state and local general obligation bonds, revenue bonds, insured bonds, and pre-refunded bonds” – sounds very US-centric; do we have an equivalent in the UK?
@magneto re: investment trusts for reduced income vol. The standard deviation of total return is still much lower in the market cap tracker. It means you have to be prepared to sell units rather than live off divis, which doesn’t feel as nice though.
@TI, I think the reason that people are arguing the toss on whether the world would be a worse place for everyone passively investing is that if it’s morally wrong for everyone to do it, it must be wrong for anyone to do it. Not that it stops fund managers or myself from owning trackers in our own portfolios.
@david — Hmm, I could give it a go, though if you’re modelling present values in spreadsheets I think the “entry level” nature of an article is likely to be too simplistic for you. It is a huge issue, but an intractable one where the outcome will only look obvious in hindsight I suspect.
@magneto — All that stuff about “trackers would have owned railroads at the start of the 20th century” is a red herring. Yes they would have, and over time that allocation would have dwindled to nothing as railroads faded. In their place would have come, say, car manufacturers who went from start-up to global giant status, and that trackers would have bought and owned along the way. In the meantime no doubt some active fund managers would have been decrying those new-fangled cars and doubling/tripling down on railroads.
When you see the long-term graphs of market returns, those are tracker returns (minus small costs) so I have no idea where the alleged force of the “railroad argument” comes from.
Also, active is always a zero-sum game, so, in aggregate, half the actively invested money must have lost to the other half, just like today.
The argument for not using trackers is 1901 is simple: You couldn’t.
@boardgamer — Municiples (aka Munis) can be thought of as sort of “less good” government bonds or even “sort of like corporate government bonds”, if that makes any sense. They are liabilities issued at the US state/other government entity level. So they are government-money backed, but it is not the same level of backing as US Treasuries. We don’t have them in the UK.
They have a long record for being higher yielding but boring, but they do sometimes default. There are big tax benefits as I understand it to US investors, particularly richer ones. Best ignored from a UK POV, as there’s not really any equivalent and anyway IMHO US state-level financing is hard to assess over the cycle, not least given unfunded liabilities (or even funded liabilities such as state pensions that are funded by stock market investments, say, which would move in same direction as markets in a crash and thus seem to offer less diversification benefit anyway).
Sorry, forgot to add on MLPs, your proposed ETF proxy (LGCF) would be a terrible substitution. 🙂
MLPs (aka Master Limited Partnerships) are in practice companies that own much of the energy infrastructure in the US. If you want to transport gas from some extraction point in Texas to some refinery on the coast, you might use pipes that ultimately benefit an MLP. As you’ll appreciate, such pipelines are rare and expensive to install; MLPs are thus more like utility companies (say a national grid) than a bundle of raw commodities. Like utilities, the emphasis is usually on yield and there may be excessive debt problems (IMHO), too, from time to time.
I suppose they have acted as diversifiers because they move with the energy cycle than the stock market cycle (though those two are correlated to some extent). I’d be surprised if a deep analysis revealed them to be very good diversifiers though (almost anything can look like a diversifier if you squint a bit and pick the right timeframe. 🙂 )
@ TI
“When you see the long-term graphs of market returns, those are tracker returns (minus small costs) so I have no idea where the alleged force of the “railroad argument” comes from.” TI
Yes! That was really the point being made.
One either accepts the whole market warts and all, or become too clever by half!
How much pain would have been avoided by eliminating railroads over such a long period as a century? Probably very little.
In the long run whole market return is more than adequate.
The Japan history over a shorter period is a little more troubling; but with present-day geographical weightings in Global Stock Funds, such as VWRL and IWRD, do not see any reasons for alarm. Nothing looks seriously out of line. Not even IMHO the US weighting.
All Best
@David
I had a run at a model based on your question.
Imagine a business that will have a single earnings spike in 30 years. Perhaps it’s a business that has won the monopoly contract to sell water but just for the calendar year 2046. The expected earnings are £1,000,000.
The question is how should an investor value that. The classical solution is that he looks at the risk-free rate (the 30-year gilt) and adds on an equity premium for this venture’s risk (contract might be voided, water prices might change, humans might evolve to no longer require water…) to get a discount rate. And then discounts back the £1m 30 times to get the present value.
30 yr gilts are 127bp. Let’s choose 400bp for the equity risk premium so the current value of that £1m is:-
£1m / (1+527/10000)^30
Which is 214k
Now I notice that the 30-year gilt has moved from 155bp a month ago. So if I’d done the calculation then, that figure would be 198k — an 8.3% difference. So the equity value of this business should have increased 8% in the last month.
If you remove the risk premium, then these two figures are:-
630k and 685k. A change of around 8.6%
Changing it to 10% risk premium, and the valuation change is still around 7.8%. (So my assumption in my post above that the risk premium provides a damping effect on the valuation is true, but limited).
* * * *
So why haven’t equities increased by 8% in the last month? Well they aren’t just 30 year cash flows, but all the years from 1 to 29 as well as 31 onwards.
Repeating the exercise with a 2 year flow (17bp up from 13bp), we’d currently value £1m in 2018 at £921.6k, down from £922.2 — a fall of 0.1%.
But companies are a sum of all their cashflows, so let’s allow our company two shots at selling water. Adding the two flows together, the 2-year flow starts to dominate and the valuation becomes really sensitive to the equity risk premium — risk free moves up 3.3%, while the 10% risk moves up just 0.3%.
* * * *
I’ve uploaded the spreadsheet if you want to copy it and play:-
http://bit.ly/DiscountRates
The fund manager problem seems endemic in the west today. An awful lot of people who get paid outlandish amounts to deliver nothing of value or worse. Unfortunately they are very clever and highly motivated and indeed fighting to the last to protect their privileges. The Bernstein report seems to be an example of this.
Double-speak is a key characteristic of these people. “Investment” for example. Investing in the stockmarket is simply shuffling around the ownership of existing assets. Real investment is building new or improving existing assets. There hasn’t been enough of that recently hence the low productivity growth that mystifyingly seems to baffle economists. Another classic is “wealth creator”. Invariably a synonym for parasite.
Indeed, an unfortunate human cognitive bias is to equate complexity with cleverness, so when the average individual is bamboozled with technical industry-specific jargon, their eyes glaze over with the confusion sooner or later, but many obviously sign up, impressed that the confident speaker understands it.
Too often, all that has really happened is that they’re the proud new owners of a needlessly over-complicated financial ‘product’ designed to disguise they just transferred the bulk of any gains to the flashy suit.
You know your cynicism is sadly justified (to give an example)when a BOE economist says he can’t understand how modern pensions work; credit to him for his honesty:-
http://www.thisismoney.co.uk/news/article-3762131/Bank-England-chief-said-didn-t-understand-pensions-says-better-putting-money-PROPERTY-pension-84-000-year.html
slight tangent, possibly one for the greybeard, but what does one think about the 1.8% contribution charge levied on the defacto govt NEST workplace pension? seems a little steep to me on top of the 0.03%AMC..
http://www.nestpensions.org.uk/schemeweb/NestWeb/public/whatisnest/contents/nests-charges.html
from what i can make out, whatever costs are incurred by the underlying funds comprising the pension are also charged in addition, i.e. on top of the 0.03%AMC and the 1.8% contribution charge. Although what these charges may amount to is not totally expicit..
anyone going for this, either through choice or necessity?
I note also that you cannot transfer in or out and annual contribution is currently capped at £4600. It also looks like there are additional restrictions on how you can access it at the other end, to be fair, they look like reasonably sensible restrictions, but restrictions none the less..