What caught my eye this week.
Passive investing is a solved problem. Invest regularly into index funds or their ETF equivalents, allow your money to compound for 30 years, and then enjoy the fruits of the market’s return by spending down your portfolio in your later years.
Sorted. Next!
Well maybe. It’s been hundreds of years since much of anything stayed the same for long. So it seems likely to me our kids and grandkids (maybe future Monevator readers?) will be doing it their own savvy way.
Live and direct
Direct indexing seems very likely to replace index funds in time, for a start.
The idea is simple. Rather than put your money into an index fund, a robo-platform basically buys the index for you via the appropriate mix of shares (or fractions of shares). This approach cuts out the middleman and makes you a direct shareholder in all the companies in the index (rather than via a proxy, such as Vanguard).
One advantage if you do this outside of tax shelters is more opportunity to defuse capital gains and exploit capital losses to reduce your tax bill, since you’ll hold the index’s winners and losers at the individual level.
But I believe it is the push towards ESG1 investing that will drive the industry towards direct indexing.
I don’t want that one!
I’ve sat through at least a dozen start-up pitches over the past few years from fintechs arguing that millennials and their younger siblings want a way to invest that’s as easy as buying an ETF but without having exposure to a fossil fuel producer or an arm’s manufacturer.
Fair enough, target ESG investing towards them then. But understand that ESG is a moving target.
For instance in the past month, fast fashion darling BooHoo has been painted as a ruthless exploiter of workers after some investigations into aspects of the UK garment industry.
I’m not convinced this picture is fair – and I own shares in BooHoo – but I don’t intend arguing the toss today.
The point is, if I was an ESG-minded investor than a company I might have considered as previously no problemo I might now wince at owning.
I’m not saying that’s a very rationale way to think about shareholder democracy. I’m saying it’s how millions of people do think.
With a traditional ESG fund – active or following some ESG index – you’d have to wait weeks or months for a third-party to kick out BooHoo of the fund, assuming they do at all.
All the time your money in the company, ruthlessly exploiting away on your behalf…
But with direct indexing, you could do it yourself. You could own the market minus BooHoo after just a couple of clicks.
Everyone of us is different. You might believe that BP and Shell are transitioning to green energy, but you hate pharmaceutical companies for what you see as high drug prices – and you want extra-exposure to High Street retail because you believe it’s important for local communities.
Good luck getting an ESG fund to reflect that view!
However start with the index, dial up energy companies and retail exposure, dial down pharma, press the ‘Direct Index Me Up’ button and you’re away.
Coming soon
According to some, direct indexing could do for investing what Napster and the iPod did for music – and sooner rather than later.
Quoted in an article on MarketWatch this week, Dave Nadig, an index industry veteran, said the technology to do this is already available for the rich or institutional, and it will soon reach oiks like us:
“All that’s changed over time is the thresholds for accessing an index have gotten lower and lower.
It’s just a software problem. And the technology required to produce that customized account has plummeted to the point where it’s almost retail.
It’s not quite mom-and-pop, but it’s heading there.”
I doubt Vanguard and Blackrock and the other big passive fund investors are quaking in their boots just yet.
For direct indexing to truly take off it will need to be as easy to do as buying a tracker fund. And people will need to understand what they’re doing, too, which adds an educational burden. (Think how long it took to get investors to shift towards a passive mindset. Decades.)
Also, the potential for financial services industry chicanery is high.
I therefore expect it will take a while before the landscape is one where direct indexing is really challenging our favourite passive fund approach. But be aware you might well retire investing differently to how you first got started.
Have a great heatwave weekend, everyone!
From Monevator
Investing for beginners: Why do we invest? – Monevator
From the archive-ator: How to start a fund – Monevator
News
Note: Some links are Google search results – in PC/desktop view you can click to read the piece without being a paid subscriber. Try privacy/incognito mode to avoid cookies. Consider subscribing if you read them a lot!2
Bank of England says rate cuts from this level are now ‘less effective’ – ThisIsMoney
Surprise as UK house prices set record after four months of falls – Guardian
US payrolls increase by nearly 1.8 million, topping expectations despite virus resurgence – CNBC
UK greenlights £1.3bn to ‘shovel-ready’ infrastructure and housing spending – City AM
London and Birmingham top cities residents wish to leave in pursuit of green space – ThisIsMoney
Bitcoin’s main rival, Ether, is having an even better 2020 – via Abnormal Returns
Products and services
Travel and quarantines: Your rights on refunds and insurance – Guardian
Monzo reports annual losses of £113.8m: are your current account and savings safe? – Which
Sign-up to Freetrade via my link and we can both get a free share worth between £3 and £200 – Freetrade
Property fund investors face six-month lock-up in new FCA proposals [Search result] – FT
Homes for sale in a national park [Gallery] – Guardian
Comment and opinion
Don’t be that investor – Humble Dollar
Why markets don’t seem to care if the economy stinks – Yahoo Finance
We need to talk about investors’ problem with vaginas – Wired
Academically verified investment strategies that failed – Advisor Perspectives
The ten big questions for achieving financial independence [Video] – Humble Penny via YouTube
Does the market see a bridge to a vaccine, or to nowhere? – Investing Caffeine
Why would anyone own bonds right now? – A Wealth of Common Sense
The most important number in personal finance – Of Dollars of Data
CEO stress, aging, and death – Marginal Revolution
Gold 3: The return of inflation expectations – Abnormal Returns
Naughty corner: Active antics
Knowing when to ignore the numbers – Klement on Investing
Hedge funds might charge 2-and-20, but investors are paying a lot more – Institutional Investor
It’s directional, depending on a vaccine – The Reformed Broker
Creating anti-fragile portfolios – Factor Research
Technology stocks are among the big losers, too – The Irrelevant Investor
Coronavirus corner
Good news from Italy… and Sweden – Bloomberg
Melbourne now back in Stage 4 lockdown – Forbes
Japan is seeing a record rise in Covid-19 cases too – Guardian
Two cruise ships hit by coronavirus just weeks after industry restarts – Guardian
American Death Cult: Why has The Republican response to the pandemic been so bad? – NY Mag
How to evaluate Covid-19 news without freaking out – Scientific American
Kindle book bargains
Influence by Robert B. Cialdini – £0.99 on Kindle
How to Own the World: A Plain English Guide to Thinking Globally and Investing Wisely by Andrew Craig – £0.99 on Kindle
I Will Teach You To Be Rich by Ramit Sethi – £0.99 on Kindle
Super Thinking by Gabriel Weinberg and Lauren McCann – £0.99 on Kindle
Over-achieving mini-special
The sweet spot – Mr Money Mustache
Five steps to becoming insanely successful or… whatever – Mark Manson
Action creates motivation – Get Rich Slowly
Off our beat
Unlearn – Indeedably
I’m traveling, even though I’m stuck at home – The Atlantic
Reframe how you think about self-care – Harvard Business Review
Statement by Jeff Bezos to the US House Committee on the Judiciary – Amazon
In China, the panopticon is already here – The Atlantic
And finally…
“That ‘temporary’ arrangement essentially remains in place 50 years later. The world has been operating without an agreed monetary standard, with varying degrees of ‘floating’ and ‘fixing’, and with the dollar still the global reserve currency.”
– Paul A. Volcker, Keeping At It
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Comments on this entry are closed.
Wont there be more in transaction charges/spread? I can imagine it being more of a saving for wealthier people avoiding % fund fees, so if the wealthy stop paying that’ll have to be recouped from everyone else.
Maybe there would be less economies of scale in smaller transactions, or maybe theyd be more liquid?
Also it has implications for corporate governance – who holds the voting rights? Who would bother to vote?
With direct index investing I would be pretty worried about who really owned the securities you had paid for
With an investment trust, a unit trust and even an ETF its clear cut enough and there is a custodian which gives you some comfort
With these new ‘tech’ companies often the ‘innovation’ is simply a way to try to avoid regulation and a slick user interface
Prime examples being Uber and Airbnb
Whenever anyone says ‘financial innovation’ I hear ‘accident waiting to happen’
Direct indexing is a nice thought. Although if the robo platform is a third party offering to replace indexers like Vanguard. the problem of bearing the fee of one middleman doesn’t go away. Ideally, platforms should be smart enough to offer this kind of service as standard. That hasn’t happened thus far. Even when they push portfolio purchases, they have, for example, no facility for portffolio sells. Also, I would love a platform if they auto set relative stop losses to, say x% of previous days Closing price.
I think the biggest problem of direct indexing for the average investor is the tendency to meddle. Index funds work because the only thing you can meddle with is buying or selling the fund (so asset allocation). The fund strategy is pre-defined and likely to persist through good and bad times. If you can buy the index and then alter what makes up that index on a whim, the risk is you start active investing, timing the market or day trading which undos the benefits of the indexing approach or any strategy originally put in place. Even if you are a controlled eco investor as in the article, the risk is a knee jerk reaction to an initial media report which may not be the best approach. The saving grace here is one company is unlikely to have a major impact so it maybe doesn’t matter.
As you say, it needs education. It feels like an advanced investing method aimed at advanced users. I can’t see it being for mainstream, everyday investors. Which of course is perfect if that is how it is positioned and sold. I can see a lot of benefits for the advanced user who wants to try and get the benefits of passive while still trying to squeeze out more with some active investing. Or the investor with a clear strategy that they promise to adhere too, such as the eco investor.
I have yet to convince myself that not owning the more controversial shares in an index would make much difference to their existing or not. However you own an index, you do not vote at the AGM. If you own the share, you can actively work towards change, but supply and demand is the driver of most business. Would tobacco companies and arms manufacturers exist if I excluded them from my index? – Yes. And if they were unpopular with investors and still making money would that attract investors? Probably, not ESG investors, but investors. Most companies have some social cost, I have struggled with this in the past and have not come up with an answer as to how to mitigate or balance this with the social good that they do. Answers on a postcard please.
JimJim
The ‘E’ in ESG isn’t Ethical.
Having had an ‘Ethical’ Pension for more than a decade I can relate to the comments on ESG funds. When you dig down into the underlying assets they all fall short of their proclaimed virtues. For ESG the elephant in the room is Privacy/Human rights with many large holdings in these funds active in privacy abuse/facial recognition. Another worrying feature is the blind faith in renewables. With over statement of forward electricity pricing, these companies are making the same mistake as oil companies overstating reserves/forward pricing with the added problem that as solar/wind tech advances more consumers will make their own electricity at home.
Interesting idea, although I suspect most non-Monevator people would not bother.
I’m reminded by the very English “no problemo” that:
El problema is masculine
La solución is feminine
in Spanish anyway.
How about the occasional female contributor to Monevator ? Certainly my wife is the driving force behind our ESG investing.
@jimjim – re AGM voting I can’t see much of that happening with direct indexing – hundreds if not thousands of companies – even then itd be an insignificant stake. Imagine 500 AGMs a year for tracking the s&p!!! Basically only the big companies/controversial AGMs would ever get voted on – I’d wager more voting gets done by vanguard/blackrock etc than we could ever do
But I dont see why fund managers can’t ask our input – then again its probably in our best interests if they dont ask us!
Direct indexing is clearly a logical extension of what we have, but I do worry about its value to passive investors, as others have noted – there will be a terrible tendency to tinker on headline news, specific campaigns and the views of ‘investment gurus’.
Considered in their limit active investment portfolios and direct indexed portfolios converge. In active, you start with nothing and add in the companies you like the look of. In direct indexing you start with an approximation to ‘the whole of the market’ and knock out the companies you don’t like the look of. Done thoroughly it leaves you with an active portfolio. I guess the saving of the idea is that companies you know nothing about will stay in your index. So a bit passive with a strong top layer of active.
I don’t think I could cope with that, and I guess it is true of many others.
I thought the Dollars and Data article on how you should think about your wealth was interesting, but misguided as a way for the average punter to think about wealth. It may be different in the US, but in the UK anyone who knows their total lifetime income from all sources has their finger so firmly on the pulse of their finances they are unlikely to be confusing themselves about whether and to what degree they have achieved financial independence.
I have no idea about my lifetime income and absolutely no interest in finding out. What matters is what I am doing now and in the future, not patting myself on the back for a scoring well on an arbitrary definition of fiscal discipline.
I loved the Mark Manson tirade. Refreshing and true!
Off topic but earlier this year I said in the context of the impact of Covid that I would provide a quarterly update on the dividend income from my ITs. True to my word, I’m able to say that each of the five dividends due in the months May to July 2020 has been paid on time and in full, including the one from my REIT.
From now on, I think it better that I only provide a report if any dividend is not received timeously and/or in full. No news will be good news!
The Jeff Bezos thing was interesting read…why did he have to produce this?
The Scientific American interview with Carl Bergstrom is good; and really everyone should read his new book “Calling Bullshit” too. The principles are universal and very relevant to the current deluge of disinformation about Covid.
The book is an easy read and often funny (I’m in chapter 4 and skimmed through the rest).
There are quite a few figures so print is better than ebook.
@factor glad your income arrived from your investments.
I was looking at an investment trust today, that has a substantial holding in direct property holdings and trades at a 30% discount, it has promised to not only maintain the dividend but to continue increasing it from reserves.
Taking into account the shortfall in dividends and rent anticipated, cost of its significant gearing and expenses the net income will be around zero….but investors will receive the dividend.
The true discount is far less than 30% when you make some sensible assumptions about the true value of the assets, probably fair value, market is reasonably efficient!!
I do like thinking of different measures of wealth and progress though usually find something to nitpick. The Of Dollars & Data wealth ratio piece mentions student loans in passing but it seems significant that most people are well negative on this measure for part of their life.
I’ve found it more useful to use lifetime amounts. Work out how much we can save every year and sum it forward to retirement, which gives an upper bound to lifetime savings. Then get the total cost of each major life expense (eg total mortgage repayment cost, total student loan payments until repaid/forgiven, etc) and subtract those blocks. What remains is available for lifestyle and retirement.
This gives a ballpark total for retirement and clear levers to alter it: retirement age, savings amount (aka salary+spending), housing.
I read the article on creating anti-fragile portfolios by factor research a couple of times and with some interest but was unable to draw any actionable conclusions tbh. The author references declining populations as a major barrier to economic growth (which by nation state seems plausible) and yet the UN forecasts global population growth from 7.8 billion to 10.9 billion by the end of this century. Presumably these people will largely all aspire to a typical ‘middle class’ living even if not fully attainable to all. It then also talks about acquiring assets that are long volatility but again doesn’t really seem to come up with anything that’s particularly investable to the layman (perhaps selling puts on an index is an option). The obvious asset that springs to mind in such a scenario of declining growth that is counterbalanced by governments printing money would seem to be gold hence it’s recent strong performance and why I continue to think a small allocation of it to your portfolio is a good idea. Think of it as an insurance (which hopefully needs not drawing on) or something uncorrelated. The premium being the opportunity cost of not deploying your capital to assets that are levered to economic growth. Hardly innovative thinking but perhaps simpler to understand and implement. Hopefully the price declines in the future and the cost of insurance becomes cheaper.
A tangible conclusion of anti-fragile debates would seem to be the clear inadequacy in viewing future volatility and safe withdrawal rates though a historical looking glass.
With regards to some of the comments around investment trusts paying dividends I am sure people generally realise that paying money out of reserves to pay an unfunded dividend is either typically done by increasing gearing or selling assets so it’s quite feasible for you to manufacture the same if you just index invest. There is no ‘free lunch’ although I recognise the psychological benefit of people receiving a ‘regular’ income is powerful. In fact if you offered somebody a capital investment that started at 100 and would end at 109 at the end of the period and no dividends and another that would end at 100 but pay two interim dividends of 4 then it would probably be easier to market the income fund. The danger with the investment trust is generally you pay for that income smoothing through higher costs, the fund manager concentrates their holdings in income paying stocks and most dangerous there is the temptation for the holder to think all is well when it isn’t as recovery is dependent upon the stock recovering and then catching up on the over distribution. At least with an index fund the dividend falls provides a tangible signal that you need to be thinking about your spending if you are in drawdown. Presumably it is psychologically harder to keep spending on ‘wants’ when you are having to sell stock to fund those desires as opposed to the fuzzy warm feeling of the ‘income’ cheque.
I like the idea of actually “owning” the shares in a company and being able to attend AGMs if I wanted etc. But having the ability to pick and choose which sector, company type etc. feels like a slippery slope towards amateur active investment to me. I wouldn’t be surprised if 10 years after direct investing is introduced, a study looking back concludes that the best returns were from passive index’s
ANTS – The possible future direction of ETFs?
This article from evidence based investor talks about ANTS where and ETF sits on top of an active managed fund. The big pros include much lowers costs and the ability to buy and sell directly however there are some cons….
https://www.evidenceinvestor.com/the-drawbacks-with-ants-active-non-transparent-etfs/
Important addition to the Covid antibody research here:
https://www.imperial.ac.uk/media/imperial-college/institute-of-global-health-innovation/Ward-et-al-120820-REACT-2.pdf
Results very consistent with the smaller ONS rolling survey, with about 6% overall prevalence, higher in London and in younger people, and an estimated IFR of 0.9% (in the community, excluding the care home deaths).
Interesting new (to me) finding that asymptomatic infection more common in the elderly (half of cases) than in younger people (a third of cases).
There is an offhand comment that infection may be underestimated, as antibody response may have declined or been too weak in some infections, but it isn’t given any prominence as an important factor.
I have to say the speed with which infection rates have picked up globally as distancing is relaxed would seem to confirm the absence of significant population immunity (or the presence of any ‘dark matter’). Back to hoping for a vaccine.
Thanks @Vanguardfan for that gem.
I had seen a throwaway comment elsewhere about the high rate of asymptomatic infections in the elderly. The speculation is that prior exposure to other coronaviruses (some types of cold) may provide partial protection that weakens symptoms, with older patients having had more opportunities for that exposure.
Whether the antibody test underestimates the real number is a big question, particularly if antibody levels decline with time. (Also whether immune protection correlates with antibody levels or can result from persisting T cell responses in the absence of antibodies). In that study 20% of those with previous positive PCR tests had no antibodies, 70% of those with doctor-identified symptoms had none, and 80% of those with self-identified symptoms. Also the researchers estimate the Infection Fatality Rate from their data to be 0.9%, when the best international estimates of the “real” value are around 0.4%. So if you wanted to you could argue from their data that their measured 6% of the UK having had Covid-19 could mean anywhere between 7.5% and 20% had been exposed.
@jonathan, yes I was surprised there wasn’t much discussion in the paper of the extent to which antibodies correlate with prior infection, and how much infection may be missed by antibody testing. I don’t know enough of the science to be able to judge the debate in this area with confidence – how to sort the wheat from the chaff – and with the covid debate there has certainly been a lot of misleading chaff in the areas I can critique. So I am wary of jumping to conclusions either way.
And of course the key question is the extent and duration of immunity. Still seems almost no actual evidence on that one.
While I broadly agree, I am not 100% at the point of abandoning hope for dark matter / wider immunity. The reason for this is the infection rates have certainly increased as you point out, but superficially they appear to be in areas that weren’t hit hardest originally.
So we have more infections up North in the UK, or in Florida in the US but not (yet?) in London or New York.
If it all kicks off in either of those places (or Lombardy etc) then that’ll be pretty convincing, but for now I’m still not convinced we’re not seeing a rolling near-inevitablity as the virus spreads globally and there’s not a massive amount to be done about that at the population level (if we want to preserve the economy, way of life etc) though as ever important steps to be taken to protect vulnerable, flatten curve for health services, etc.
Well, current rate of new cases is running at 7.2 per 100k in London, vs 9.6 per 100k in the rest of England (case data from the GLA website, my approximate calculations). My understanding is that central London is still pretty quiet with lots of wfh? (No idea, not been recently). Remain unconvinced that there is much significant immunity, although clearly the antibody prevalence is a minimum figure for previous infections, and 1 in 6 with previous infection will reduce transmission to an extent.
@ Vanguard Fan – London’s not far off back to normal I reckon although the West End and City are quiet. I’ve done a couple of Rishi’s Deals at lunchtime and the pubs were reasonable well attended. Lots of WFH home though, as you say, and in the business where I’m a NED we’ve no plans to ask staff to return to the City for the simply reason that there’s no one there for them to go an market or wares to. Optimistically, people are saying October.
It’s very difficult for the layman to make head or tail of some of these stats – Carl Heneghan, who seems to be one of the saner heads, is rapidly moving towards a IFR of 0.1% by the time the final reckoning is done. Others that the virus will burn out once it reaches a saturation level of 20%. Maybe they are all cranks, I don’t know, but I’m taking little notice of infection levels given that the testing regime has been something of a fiasco and will only get concerned about second waves and so on when the body count rises, and there’s no sign of that currently as far as I can see. Somebody coined the word ‘casedemic’ the other – infections but no one ill I believe – and that seems to be where we are for my untrained viewpoint. I’m inherently suspicious of anything that comes out of Imperial as they made such a noise at the beginning of this they have a position to defend and I don’t suppose they are going to give up their IFR of 0.9% lightly. The scientific establishment in this country appear to be pretty expert at circling wagons and supporting one another.
@vanguardfan — Yes, I think we’re at the tail end of a rolling first wave here in the UK. My point is what’s driving the ongoing higher numbers worldwide mentioned (E.g. US cases) higher appears to be areas that weren’t much affected when E.g. NYC was a nightmare.
As opposed to a big rise due to NYC or London going bonkers *again*. (Counterfactual.)
It’s long seemed possible that this virus just has a natural history that runs rampant but burns out (very infectious but mostly apparently harmless and often asymptomatic) And there’s not much you can do about that once it’s embedded beyond a few dozen cases.
This is the case against super strong lockdown and instead “doing a Sweden” of course, as much discussed and debated here and elsewhere. 🙂
We’ll see.
p.s. On the other hand, the graph here shows New York City 7-day restaurant traffic still 75% below its peak, so perhaps it’s true that the reason places that were thwacked hard in round one aren’t seeing a second wave (yet?) is because residents learned their lesson the hard way…
https://www.calculatedriskblog.com/2020/08/high-frequency-indicators-for-economy_9.html
“Immunology Is Where Intuition Goes to Die” – great new piece, and an epic headline from Ed Yong. His coverage of the pandemic has been excellent.
https://www.theatlantic.com/health/archive/2020/08/covid-19-immunity-is-the-pandemics-central-mystery/614956/
London is hardly back to normal. At the end of July, bus journeys were still -50% and tube -75% vs pre-pandemic. Similar to NYC as it seems.
https://www.economist.com/britain/2020/08/01/londons-transport-agency-needs-a-new-funding-model
From where we live, commuter traffic into London is still a lot less than usual.
Govt policies (“the lockdown” etc) and people’s behaviour are really quite different things.
@ Sparschwein – if you lived in London you would likely think different. Yes, the tubes and buses are quiet but the traffic is awful and the number of people milling around seems like normal to me. Some shopping streets are now traffic free zones at the week end and the bars on those have been heaving, helped by the weather of course, with people sitting outside. But what do I know, I just live here.
FWIW I don’t think London is back to normal at all. Superficially it looks much busier — perhaps after our expectations were reset by lockdown — and I agree with @Ruby that traffic in particular seems choking and polluting again.
But all shops are emptier (even supermarkets), no bars are heaving, restaurants I’ve been to are socially distanced (still waiting to see how infamously crowded Barrafina re-opens) and yes, the tubes are very quiet. The latter may gave been displaced by more local activity instead of traveling in, but I have to think it’s a proxy.
Finally, nearly everyone I know directly who works normally in Central London is still working from home. A couple of exceptions are going in 1-2 a week, staggered with other colleagues.
The little sandwich shops etc in Central London are bereft of customers. And the free Evening Standard is now just a dozen or so pages and stacked in ignored piles every evening.
I’m at my dentist on Harley Street. (La Dee dah! There are reasons… 🙂 )
Anyway tube was mostly empty at 1pm on Saturday afternoon and oxford street quiet.
I think @Vanguardfan (I think? On mobile!) is right that de facto distancing is still overwhelming any immunological gains here in terms of keeping cases down.