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Who’s Afraid of Index Funds?

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If passive investing creates market distortions, active managers can win big.

Challenges to the status quo—political, economic or social—always evoke strong emotions, from enthusiastic support to fierce criticism. The loudest critics often have the most to lose, even if they acknowledge some benefits of the new regime.

This clash is now unfolding over ascendant investment vehicles: index and exchange-traded funds, or ETFs. The dramatic growth of such products has been revolutionary. More investors are choosing indexing over funds managed by traditional stock pickers, known in the industry as active managers. Since 2009, U.S. index funds have seen inflows of some $1.7 trillion, compared with outflows of nearly $1 trillion for actively managed mutual funds.

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'Speculative Frenzy': Tech Stocks Haven't Done This Since the Dot-Com Bubble

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One measure of U.S. technology stocks has just surpassed its dot-com bubble high, raising concerns for one widely followed strategist about unsustainable levels in U.S. stocks.

By: Evelyn Cheng
CNBC News, May 22, 2017

One measure of U.S. technology stocks has just surpassed its dot-com bubble high, raising concerns for one widely followed strategist about unsustainable levels in U.S. stocks.

The MSCI USA Growth Index, whose top three holdings are Apple, Amazon.com and Facebook, has outperformed the MSCI World Value Index so much that the ratio of their performance topped this month a high last seen during the tech bubble in 2000, Bank of America Merrill Lynch's chief investment strategist, Michael Hartnett, said in a note Monday.

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The Uncertainty Paradox

As markets fluctuate it can be difficult to uncouple emotional uncertainty from financial decisions. However, uncertainty and risk will always be a part of investing in financial markets. By learning about how uncertainty affects markets and your financial decision making, it is possible to craft a better investment strategy--one that can see you through times of greater risk and uncertainty, and keep your emotions from clouding your judgement. 

Doubt is not a pleasant condition, but certainty is an absurd one.
—Voltaire

“The market hates uncertainty” has been a common enough saying in recent years, but how logical is it? There are many different aspects to uncertainty, some that can be measured and some that cannot. Uncertainty is an unchangeable condition of existence. As individuals, we can feel more or less uncertain, but that is a distinctly human phenomenon. Rather than ebbing and flowing with investor sentiment, uncertainty is an inherent and ever-present part of investing in markets. Any investment that has an expected return above the prevailing “risk-free rate” (think T-Bills for US investors) involves trading off certainty for a potentially increased return.

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The Mutual Fund Landscape in 2017

The US mutual fund industry comprises a large universe of funds covering securities markets around the world. These funds reflect diverse philosophies and approaches.
How has the industry performed as a whole? What should investors think about when selecting funds?

Research provides insight.

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Surveying the Landscape

Each day, the global financial markets process millions of trades worth hundreds of billions of dollars. These trades reflect the viewpoints of buyers and sellers who are investing their capital. Through these inputs, the market functions as a powerful information processing mechanism, aggregating vast amounts of dispersed information into prices and driving them toward fair value. Investors who attempt to outguess prices are pitting their knowledge against the collective wisdom of all market participants.

The mutual fund industry offers one test of the market’s pricing power. Across thousands of funds covering a broad range of manager philosophies, objectives, and styles, the study tells a compelling story: Many of the funds evaluated have not outperformed benchmarks after costs.

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The Expensive Ingredient of Cheap ETFs 02

by Jason Zweig
(This article originally appeared in The Wall Street Journal, April 14, 2017)

One portfolio manager estimates that the hidden costs of trading exchange-traded funds exceed $18 billion a year.

The costs of trading are one of the worst destroyers of investment returns. That’s a fact of life in the markets, although it’s easy to overlook in exchange-traded funds, in which commissions and management fees have shrunk almost to zero.

And during placid markets like today’s, when buying or selling tends to become cheaper, investors can form a bad habit of ignoring the costs of trading. That can come back to haunt you when turbulence resumes and trading becomes more expensive.

Often dirt-cheap to own, ETFs can still be costly to buy and sell. In a study just published in the Financial Analysts Journal, portfolio manager Antti Petajisto of LMR Partners, a London-based hedge fund, looked at about 1,800 ETFs from 2007 to 2014. He wanted to see how often, and how much, their market prices differed from the value of their underlying assets.

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