Index Investing

(27-12-2016, 03:43 PM)specuvestor Wrote: The excellent classic 30 year old literature to look at is this (disclaimer: I agree with probably 90% of it):
https://www8.gsb.columbia.edu/articles/c...rinvestors

IMHO index investing is as sexy as the nifty fifties or the portfolio insurance or dot coms. As always there are some fundamental truths in it that is extrapolated to stratosphere. I agree with Buffett though that if one doesn't want to spend effort, ETF are good investment alternatives.

Time is the enemy of the mediocre. Over time most ETF of say 3-5 years life you can see that they underperform their respective indices by the fees compounded and unlike managed funds that are worth their salt, of no way to recover.

(30-12-2016, 08:00 PM)thinknotleft Wrote:

(27-12-2016, 10:14 PM)specuvestor Wrote: If investment outperformance over a cycle is less than 0.3% annualised, then index funds should be the next best thing since sliced bread

Hi specuvestor, can u elaborate what you mean?

Anyway, spdr STI etf has annualised 1 yr returns of 5% as at Nov 16, which is not bad.

If u are looking for outperformance, then index investing is not the place to be in. If u are looking for a very lazy way to invest, index investing may be the place for u.

For the past 5 years 2012-2016 (Note FTSE calculation started in 2008), STI returned 27.9% (5% annualised) while SPDR returned 24.4% (4.5% annualised). This 50bps gap will continue to increase next 5 years and it will NEVER recover because that's the cost of the ETF and low tracking error, not outperformance, is the methodology.

For an absolute return fund worth its salt, over an up-down cycle, approximately from 1 Jan 2012 to 21 Jan 2016 (at cycle low), it should be able to beat 8.3% STI return over that 4+ years after fees, especially over and above the 50bps compounded "sliced bread" cost for ETF. That I think is the bottomline and a reference for VBs here.

By 2018 STI ETF will have a 10 year track record of underperforming FTSE STI by >5% and academics can argue again whether it makes sense.

Going forward I think that should be the value of active fund management vs ETF, not comparing just upside, just downside or tracking error, but over a full cycle. Unfortunately I think most long and hedge funds, as well as investors which don't give the right mandate or timeline, don't get this but focus on the latest trends or themes... resulting in the current bad repute.

Hi specuvestor, thanks for your detailed explanation.

(27-12-2016, 02:29 PM)hailstorm87 Wrote: Hi guys, I am still relatively new to investing and have read a bunch of literature to support the view that index investing is the 'way to go' for a passive investor who is looking at returns of 6-7% per annum (through dollar cost averaging) over the long term  on equity ETFs (e.g. STI, VWRD, A35, VUSD.L). This is of course contrasted with the 'value investing approach' - which is to buy individual stocks at an undervalue with the long term hope/ view that the markets will come to fully value such stocks. 

I believe the main literature supporting this view is 'A random walk down wall street' and this has spurned a large move into ETFs (such as the Vanguard funds) in the recent years. In sum, the main takeaway of the book is: it is almost impossible for the average investor to beat the market returns since the market is almost always perfectly prices and only the very best money managers can ever generate the 'alpha' to justify active management of funds. As such, it would be best to have the active management be done by the 'professionals' and average investors (like myself) should not even attempt to pick individual stocks.  

Would love to hear of the views and experiences are on this topic. 

(Mods: In case this topic has been created previously, please have this merged to the relevant thread. Thanks!)

Hi Hailstorm87,

My view on this for what it is worth is that the maths behind the whole indexing theory can be loosely summarized as below.

Let us assume you are a 'professional' investor and let us assume that I am the 'average' investor.

Let us also assume we are the only two investors in the market.

The total market return is let us say 8%.

As a 'professional' investor, your costs are around 2%.

As an 'average' investor, if you use an index fund (with cost of 0.3-0.5%) and accept the market returns, your return will be 7.5-7.7%.

In which case, the 'professional' investor can only make 6% (after costs) i.e. the 'average' investor will do better than the 'professional' investor. By accepting you are 'average', you will do better. In general, investors do not like to accept they are 'average'.

Of course, if the 'average' investor incurs losses, then the 'professional' investor can make higher than market returns, i.e. capture the returns from the 'average' investor.

Having said that, clearly, one has to believe that, 

1) I as an 'average' investor have no edge over a 'professional' investor. 
2) My best bet is to dollar cost average and reap the benefits of an index constructed by 'professional' investors.

In my experience, across around 76 trades, with an average holding period of 1.5-2 years, I have observed an out-performance of around 5% on average over the index in Singapore Exchange trades. The positive trade ratio was around 76%, i.e. 76% of the trades were gains

In overseas markets (NASDAQ, NYSE, Xetra, Paris, LSE, AEX) , across around 390 trades, with an average holding period of 1 year, I observed an out-performance of 10% on average over the index. The positive trade ratio was around 46%, i.e. 46% of the trades were gains

However, it is very time-consuming and I was not able to convince myself that I was out-performing because of any noticeable edge in stock picking. With a positive trade ratio of around 46%, it was no better than chance, in my opinion.

In addition, work pressures increase as you grow older and I was not able to devote the attention one needs to devote to it.

As a result, I have slowly started to my portfolio to consist of ETF to obtain exposure to various countries / markets (S&P 500, Nasdaq, DJIA, Europe, ASX, CSI, Japan etc).

When I say slow, I mean really slow, so, over the last four years, slowly, ETFs are around 60% of my portfolio now.

One thing I have noticed with ETF investment is that growth is really slow, like watching grass grow.

I sometimes fondly remember the excitement with which I scooped up Keppel Land at $1.09 and watched it turn into a multi-bagger (including dividends) by the time of its privatization. However, I then remind myself of the disaster that was NOL, bought at the time of Rights for 1.6 and then rights at 1.3 and held for close to seven years and had to watch it being acquired for the same 1.3, so, 0% return for 7 years sunk cost and all the stress of seeing it plunge below 80 cents, with a nearly 50% paper loss at one point. 

In contrast with those 'exciting' investments, the STI ETF which i bought for 3.2 in 2013, at its lowest went to 2.6 and has rebounded now to around 3, i.e. a maximum drawdown of around 20% (which actually was the trigger for me to buy some more).

Within the ETFs, the most 'exciting' one is the China ETF, which is a roller-coaster ride, but since it is only 5% of my portfolio, it is tolerable.

The second thing is that it is not at all interesting to talk about ETF investing in your average small talk with colleagues etc, however, if you are investing in something like Sembcorp, Genting, Vicom etc, you are likely to be way more popular. If you are talking ETF, Random Walk etc, most people's eyes just glaze over and they mumble their excuses and leave.

One other thing, I would recommend that you do not believe statements like "Markets are perfectly priced". In the long run, probably, they may be perfectly priced, but there is enough irrational behavior in the markets for an investor to benefit from, if one has the inclination to do so.

The most important thing is to only invest in something you genuinely believe in. Investment is a 'brutal' business and takes no prisoners. I have seen a few instances of my friends burn their fingers very badly some in 2008 and then a few others in 2013.

I hope this is helpful.

(04-01-2017, 02:12 PM)Shrivathsa Wrote:

(27-12-2016, 02:29 PM)hailstorm87 Wrote: Hi guys, I am still relatively new to investing and have read a bunch of literature to support the view that index investing is the 'way to go' for a passive investor who is looking at returns of 6-7% per annum (through dollar cost averaging) over the long term  on equity ETFs (e.g. STI, VWRD, A35, VUSD.L). This is of course contrasted with the 'value investing approach' - which is to buy individual stocks at an undervalue with the long term hope/ view that the markets will come to fully value such stocks. 

I believe the main literature supporting this view is 'A random walk down wall street' and this has spurned a large move into ETFs (such as the Vanguard funds) in the recent years. In sum, the main takeaway of the book is: it is almost impossible for the average investor to beat the market returns since the market is almost always perfectly prices and only the very best money managers can ever generate the 'alpha' to justify active management of funds. As such, it would be best to have the active management be done by the 'professionals' and average investors (like myself) should not even attempt to pick individual stocks.  

Would love to hear of the views and experiences are on this topic. 

(Mods: In case this topic has been created previously, please have this merged to the relevant thread. Thanks!)

Hi Hailstorm87,

My view on this for what it is worth is that the maths behind the whole indexing theory can be loosely summarized as below.

Let us assume you are a 'professional' investor and let us assume that I am the 'average' investor.

Let us also assume we are the only two investors in the market.

The total market return is let us say 8%.

As a 'professional' investor, your costs are around 2%.

As an 'average' investor, if you use an index fund (with cost of 0.3-0.5%) and accept the market returns, your return will be 7.5-7.7%.

In which case, the 'professional' investor can only make 6% (after costs) i.e. the 'average' investor will do better than the 'professional' investor. By accepting you are 'average', you will do better. In general, investors do not like to accept they are 'average'.

Of course, if the 'average' investor incurs losses, then the 'professional' investor can make higher than market returns, i.e. capture the returns from the 'average' investor.

Having said that, clearly, one has to believe that, 

1) I as an 'average' investor have no edge over a 'professional' investor. 
2) My best bet is to dollar cost average and reap the benefits of an index constructed by 'professional' investors.

In my experience, across around 76 trades, with an average holding period of 1.5-2 years, I have observed an out-performance of around 5% on average over the index in Singapore Exchange trades. The positive trade ratio was around 76%, i.e. 76% of the trades were gains

In overseas markets (NASDAQ, NYSE, Xetra, Paris, LSE, AEX) , across around 390 trades, with an average holding period of 1 year, I observed an out-performance of 10% on average over the index. The positive trade ratio was around 46%, i.e. 46% of the trades were gains

However, it is very time-consuming and I was not able to convince myself that I was out-performing because of any noticeable edge in stock picking. With a positive trade ratio of around 46%, it was no better than chance, in my opinion.

In addition, work pressures increase as you grow older and I was not able to devote the attention one needs to devote to it.

As a result, I have slowly started to my portfolio to consist of ETF to obtain exposure to various countries / markets (S&P 500, Nasdaq, DJIA, Europe, ASX, CSI, Japan etc).

When I say slow, I mean really slow, so, over the last four years, slowly, ETFs are around 60% of my portfolio now.

One thing I have noticed with ETF investment is that growth is really slow, like watching grass grow.

I sometimes fondly remember the excitement with which I scooped up Keppel Land at $1.09 and watched it turn into a multi-bagger (including dividends) by the time of its privatization. However, I then remind myself of the disaster that was NOL, bought at the time of Rights for 1.6 and then rights at 1.3 and held for close to seven years and had to watch it being acquired for the same 1.3, so, 0% return for 7 years sunk cost and all the stress of seeing it plunge below 80 cents, with a nearly 50% paper loss at one point. 

In contrast with those 'exciting' investments, the STI ETF which i bought for 3.2 in 2013, at its lowest went to 2.6 and has rebounded now to around 3, i.e. a maximum drawdown of around 20% (which actually was the trigger for me to buy some more).

Within the ETFs, the most 'exciting' one is the China ETF, which is a roller-coaster ride, but since it is only 5% of my portfolio, it is tolerable.

The second thing is that it is not at all interesting to talk about ETF investing in your average small talk with colleagues etc, however, if you are investing in something like Sembcorp, Genting, Vicom etc, you are likely to be way more popular. If you are talking ETF, Random Walk etc, most people's eyes just glaze over and they mumble their excuses and leave.

One other thing, I would recommend that you do not believe statements like "Markets are perfectly priced". In the long run, probably, they may be perfectly priced, but there is enough irrational behavior in the markets for an investor to benefit from, if one has the inclination to do so.

The most important thing is to only invest in something you genuinely believe in. Investment is a 'brutal' business and takes no prisoners. I have seen a few instances of my friends burn their fingers very badly some in 2008 and then a few others in 2013.

I hope this is helpful.

Can't disagree with any of this.

Only thing I'd add is that when most people say they outperform the index by X Amt...
At least part of the reason is that they're calculating their performance wrongly
Tracking your returns such that u can compare Apple for Apple with an index return, or if u compare against a certain fund, is actually next to impossible for a retail investor
That's why they have entire operations tracking returns
I myself learnt this only recently from discussions n some research

The closest n most accurate way for retail investors to have an HOMEST tracking system for comparison is by the XIRR function in excel
Even then, most ppl do it wrongly
If u really want to be honest with yourself, and u certainly should, then you'd have to time weight all the funds that you give yourself to invest, EVEN when you are not buying anything
Cash holding is a big drag on returns, n just ignoring the time effect of idle cash, or worse still eliminating cash totally, will make your returns look better than they really are.

The other point I'll mention, and I personally have given this a lot of thought, is that like all things in investing, if too many people do it, then it's probably not a gd thing to do
So imagine now, the whole world, all the funds, all retail investors, all gov linked entities are convinced and everyone indexes.
What happens?
The companies in the indices will be incredibly efficient.
You can safely assume the price always reflects the intrinsic values

Any company NOT in the index will almost cease to be listed. Cos everybody buys the ETF index right
This means that even a company that's fundamentally excellent, competitive etc, will not have any interest
In other words, the rest of the universe NOT in the index, becomes exactly opposite: they become terribly inefficient

And when they are terribly inefficient, deep value investors NOT indexing, will have more opportunities for outsized returns.
And that's what I think will happen.
Now, as more n more $$$ goes passive, the contrast between the terrible and the great active managers will be even more apparent
Cos inefficiency works both ways: there will be lousy companies that get masked by the reduced funds in non indexed components.

(04-01-2017, 02:12 PM)Shrivathsa Wrote: Hi Hailstorm87,

My view on this for what it is worth is that the maths behind the whole indexing theory can be loosely summarized as below.

Let us assume you are a 'professional' investor and let us assume that I am the 'average' investor.

Let us also assume we are the only two investors in the market.

The total market return is let us say 8%.

As a 'professional' investor, your costs are around 2%.

As an 'average' investor, if you use an index fund (with cost of 0.3-0.5%) and accept the market returns, your return will be 7.5-7.7%.

In which case, the 'professional' investor can only make 6% (after costs) i.e. the 'average' investor will do better than the 'professional' investor. By accepting you are 'average', you will do better. In general, investors do not like to accept they are 'average'.

Of course, if the 'average' investor incurs losses, then the 'professional' investor can make higher than market returns, i.e. capture the returns from the 'average' investor.

Having said that, clearly, one has to believe that, 

1) I as an 'average' investor have no edge over a 'professional' investor. 
2) My best bet is to dollar cost average and reap the benefits of an index constructed by 'professional' investors.

In my experience, across around 76 trades, with an average holding period of 1.5-2 years, I have observed an out-performance of around 5% on average over the index in Singapore Exchange trades. The positive trade ratio was around 76%, i.e. 76% of the trades were gains

In overseas markets (NASDAQ, NYSE, Xetra, Paris, LSE, AEX) , across around 390 trades, with an average holding period of 1 year, I observed an out-performance of 10% on average over the index. The positive trade ratio was around 46%, i.e. 46% of the trades were gains

However, it is very time-consuming and I was not able to convince myself that I was out-performing because of any noticeable edge in stock picking. With a positive trade ratio of around 46%, it was no better than chance, in my opinion.

In addition, work pressures increase as you grow older and I was not able to devote the attention one needs to devote to it.

As a result, I have slowly started to my portfolio to consist of ETF to obtain exposure to various countries / markets (S&P 500, Nasdaq, DJIA, Europe, ASX, CSI, Japan etc).

When I say slow, I mean really slow, so, over the last four years, slowly, ETFs are around 60% of my portfolio now.

One thing I have noticed with ETF investment is that growth is really slow, like watching grass grow.

I sometimes fondly remember the excitement with which I scooped up Keppel Land at $1.09 and watched it turn into a multi-bagger (including dividends) by the time of its privatization. However, I then remind myself of the disaster that was NOL, bought at the time of Rights for 1.6 and then rights at 1.3 and held for close to seven years and had to watch it being acquired for the same 1.3, so, 0% return for 7 years sunk cost and all the stress of seeing it plunge below 80 cents, with a nearly 50% paper loss at one point. 

In contrast with those 'exciting' investments, the STI ETF which i bought for 3.2 in 2013, at its lowest went to 2.6 and has rebounded now to around 3, i.e. a maximum drawdown of around 20% (which actually was the trigger for me to buy some more).

Within the ETFs, the most 'exciting' one is the China ETF, which is a roller-coaster ride, but since it is only 5% of my portfolio, it is tolerable.

The second thing is that it is not at all interesting to talk about ETF investing in your average small talk with colleagues etc, however, if you are investing in something like Sembcorp, Genting, Vicom etc, you are likely to be way more popular. If you are talking ETF, Random Walk etc, most people's eyes just glaze over and they mumble their excuses and leave.

One other thing, I would recommend that you do not believe statements like "Markets are perfectly priced". In the long run, probably, they may be perfectly priced, but there is enough irrational behavior in the markets for an investor to benefit from, if one has the inclination to do so.

The most important thing is to only invest in something you genuinely believe in. Investment is a 'brutal' business and takes no prisoners. I have seen a few instances of my friends burn their fingers very badly some in 2008 and then a few others in 2013.

I hope this is helpful.

*cautionary note on a long post ahead*
 
 

(04-01-2017, 03:08 PM)TTTI Wrote: The other point I'll mention,  and I personally have given this a lot of thought, is that like all things in investing, if too many people do it, then it's probably not a gd thing to do
So imagine now, the whole world, all the funds, all retail investors, all gov linked entities are convinced and everyone indexes.
What happens?
The companies in the indices will be incredibly efficient.
You can safely assume the price always reflects the intrinsic values

Any company NOT in the index will almost cease to be listed. Cos everybody buys the ETF index right
This means that even a company that's fundamentally excellent, competitive etc, will not have any interest
In other words, the rest of the universe NOT in the index, becomes exactly opposite: they become terribly inefficient

And when they are terribly inefficient, deep value investors NOT indexing, will have more opportunities for outsized returns.
And that's what I think will happen.
Now, as more n more $$$ goes passive, the contrast between the terrible and the great active managers will be even more apparent
Cos inefficiency works both ways: there will be lousy companies that get masked by the reduced funds in non indexed components.

hi TTTI,
When index investing gets too popular, i don't think it will be incredibly efficient. On the contrary, liquidity is a curse and so, as much as it is efficient most of the time, the end game may be overvaluation and a lot of people rushing for the exit doors when the music (liquidity) ends. But yes, on paper it is easier to hunt in the other universe instead, especially in emerging markets if one has the skills and willing to put in the hard work with the necessary intellect.

Here is something from Jason Zeig i read recently that is related: 
http://jasonzweig.com/a-portrait-of-the-...young-man/ (P.S pretty long article and you need to read till the end)

(05-01-2017, 03:53 PM)weijian Wrote:

(04-01-2017, 03:08 PM)TTTI Wrote: The other point I'll mention,  and I personally have given this a lot of thought, is that like all things in investing, if too many people do it, then it's probably not a gd thing to do
So imagine now, the whole world, all the funds, all retail investors, all gov linked entities are convinced and everyone indexes.
What happens?
The companies in the indices will be incredibly efficient.
You can safely assume the price always reflects the intrinsic values

Any company NOT in the index will almost cease to be listed. Cos everybody buys the ETF index right
This means that even a company that's fundamentally excellent, competitive etc, will not have any interest
In other words, the rest of the universe NOT in the index, becomes exactly opposite: they become terribly inefficient

And when they are terribly inefficient, deep value investors NOT indexing, will have more opportunities for outsized returns.
And that's what I think will happen.
Now, as more n more $$$ goes passive, the contrast between the terrible and the great active managers will be even more apparent
Cos inefficiency works both ways: there will be lousy companies that get masked by the reduced funds in non indexed components.

hi TTTI,
When index investing gets too popular, i don't think it will be incredibly efficient. On the contrary, liquidity is a curse and so, as much as it is efficient most of the time, the end game may be overvaluation and a lot of people rushing for the exit doors when the music (liquidity) ends. But yes, on paper it is easier to hunt in the other universe instead, especially in emerging markets if one has the skills and willing to put in the hard work with the necessary intellect.

Here is something from Jason Zeig i read recently that is related: 
http://jasonzweig.com/a-portrait-of-the-...young-man/ (P.S pretty long article and you need to read till the end)

hi weijian
Hmmm why would liquidity be a curse? The ETFs can issue new units as more and more people buy ETFs, they're not limited by shares like companies.
Unless you mean the ETF buys up ALL the shares in the constituent companies that back up the ETF units, but that's the ultimate extreme scenario and before we even reach that scenario, the share price would logically shoot up to high heavens
All this is hypothetical of course.

(05-01-2017, 08:51 PM)TTTI Wrote: hi weijian
Hmmm why would liquidity be a curse? The ETFs can issue new units as more and more people buy ETFs, they're not limited by shares like companies.
Unless you mean the ETF buys up ALL the shares in the constituent companies that back up the ETF units, but that's the ultimate extreme scenario and before we even reach that scenario, the share price would logically shoot up to high heavens
All this is hypothetical of course.

hi TTTI,
You can imagine a poor person who has somehow just inherited a property from the parents and most probably nothing good will come out of it (yes, i used something from your blog :))  In the US, there is an entire TV documentary chronicling the (unfortunate) aftermaths of the top Powerball winners in history. On hindsight, Alan Greenspan's decision to keep interest rates low for too long after the 911, laid the foundation for the housing bubble. Is it easier to get rich or stay rich? Most probably those who got rich slowly, will stay rich, but not vice versa....So liquidity is more of a curse at times.

A synthetic ETF issue new units by collateralizing it with the same amount of shares it buys on the open market. So as more liquidity goes into ETF funds, then managers can only continue to buy the index shares regardless of valuation. Shares will be traded at higher and higher prices - We all know how this can end and what happens in the opposite direction. I subscribe to Minsky Financial Instability Model :) Markets don't allocate resources optimally and they are not stable. They have their own waves of asset inflation/credit expansion followed by waves of asset deflation/credit contraction.

(05-01-2017, 10:12 PM)weijian Wrote:

(05-01-2017, 08:51 PM)TTTI Wrote: hi weijian
Hmmm why would liquidity be a curse? The ETFs can issue new units as more and more people buy ETFs, they're not limited by shares like companies.
Unless you mean the ETF buys up ALL the shares in the constituent companies that back up the ETF units, but that's the ultimate extreme scenario and before we even reach that scenario, the share price would logically shoot up to high heavens
All this is hypothetical of course.

hi TTTI,
You can imagine a poor person who has somehow just inherited a property from the parents and most probably nothing good will come out of it (yes, i used something from your blog )  In the US, there is an entire TV documentary chronicling the (unfortunate) aftermaths of the top Powerball winners in history. On hindsight, Alan Greenspan's decision to keep interest rates low for too long after the 911, laid the foundation for the housing bubble. Is it easier to get rich or stay rich? Most probably those who got rich slowly, will stay rich, but not vice versa....So liquidity is more of a curse at times.

A synthetic ETF issue new units by collateralizing it with the same amount of shares it buys on the open market. So as more liquidity goes into ETF funds, then managers can only continue to buy the index shares regardless of valuation. Shares will be traded at higher and higher prices - We all know how this can end and what happens in the opposite direction. I subscribe to Minsky Financial Instability Model  Markets don't allocate resources optimally and they are not stable. They have their own waves of asset inflation/credit expansion followed by waves of asset deflation/credit contraction.

Ah I see. I misunderstood what you meant.
I thought that you mean that as more and more people go passive and buy ETFs, liquidity would be a problem, that is, it becomes illiquid and hence it is inefficient.
Hence my reply that ETFs won't be illiquid cos they can keep issuing units and there won't be "insufficient" units.

What you really mean, is that the prices will keep rising as there is increasing demand for ETFs. Which is similar to what I said.
And in the meantime, there'd be larger misallocation in the non indexed companies.
This is of course, hypothetical. In reality, there'd always be ppl hunting in the active management space.
We all like to think we are all superior. Something that is impossible, by definition.