Excellence

Business Week Lauds Indexing

Excellence

Business Week's courageous February 22 articles on index indexing, are obligatory reading for any retail investor. Tapping a strong array of data surrounding indexing, Business Week writes convincingly and elegantly about the key issues in indexing.

With titles like "Who Needs a Money Manager?", Business Week shows its integrity by asking the tough questions that most finance magazines sidestep. And no wonder most magazines are shy about the subject, since actively managed funds spend Millions of advertising dollars (collected from excessive fund management fees) in those same publications. There must be terrific pressure in many of these magazines to ignore the inconvenient fact that index funds clobber actively managed funds year after year. No doubt Business Week's ad reps this week are taking the heat from their actively managed fund advertiser clients.

Kudos to Business Week's editors for pointing out the emperor has no clothes. Pick up an issue at your newsstand or read the articles in their entirety online.

Writers Anne Tergeson and Peter Coy pull no punches in "Who Needs a Money Manager?" Commenting that the record strongly supports the indexer's view that matching the market may be the best one can do, they conclude, "In this supercompetitive environment, the only investors with a sure advantage are those trading on illegal information. With the odds of being right 50% in every transaction, picking stocks that beat the benchmarks is no different from correctly calling a coin toss."

Wow. The financial trade press simply didn't write things like that in years past.

A fascinating short interview features a sheepish Byron Wein, U.S. equity strategist at Morgan Stanley Dean Witter, and a nearly gleeful John C. Bogle, founder of Vanguard Group.

Wien can be remembered as the author of "I Hear the Death Rattle of Indexing", a 1993 essay with a dead-wrong prediction that indexing would fade. Here he attempts to cloud the issue by suggesting that active funds are soon likely to beat the S&P 500, where average capitalizations are bigger on average. That is hardly an indictment of indexing, simply a comment that large cap firms have had their run and are unlikely to keep posting above average returns indefinitely.

Wien's endorsement of active management seems hesitant at best: "Some money managers, over longer periods, have beaten the market by quite a lot. There's no guarantee they will do it in the future, but that's the way to bet." Active investing sounds almost like casino gambling. Why bet at all when the house is shaving a few points off each hand and when you can play it safer with an average return?

Bogle, meanwhile, rightly stresses the importance of looking beyond the S&P 500. He even admits that many people buy his S&P 500 fund for motivations similar to those of active fund investors. "People are investing very heavily in the S&P because they are always looking for the hot fund. But where index funds find their finest fruition is in the total stock market [the Wilshire 500 Index]," he says.

Also of particular note is the excellent article "The Real Decision: What to put where? The crucial art of allocating assets hinges on using the right index funds" by Christopher Farrell. Cutting to the chase, the real game of indexing is succinctly presented: which of the many indexes should the investor select? An S&P 500 investment is perhaps a necessary component of a diversified portfolio, but it certainly is not the only index available.

Asset allocation, or selecting the right mix for an individual's risk tolerance, time frame, and other needs is rightly pointed out as the key. Strong supporting data, charts and tables are presented with somewhat dry effect. Maybe at such a point every commentator on indexing should stop and point out that defining one's personal "risk tolerance" is a highly subjective, gut-checking affair. There is no clear formula to follow. Few of us find it natural to translate feelings of fear of risk and enthusiasm for gain into numbers for how much of an asset class to buy and what annual return to seek. Most commentators generally sidestep this process, as it defies easy analysis and is relatively little understood. On the other hand, it's not a problem limited to indexing and may merit separate and thorough examination.

Similarly, Farrell stresses diversification as a key component of asset allocation, since various types of equities and bonds help smooth out variability. But diversification is not important uniquely to indexers. Active investors are often so busy chasing hot stock tips and fund managers that they have less time for the more mundane but crucial business of asset allocation