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Blog | The Portfolio Doctor

The Portfolio Doctor

My blog provides valuable insights into Nobel Prize-winning financial strategies for investors. By utilizing decades of worldwide peer-reviewed capital markets research and analysis, I demonstrate how to build better investment portfolios with lower risks. I also examine common financial media misinformation and how investors can make better financial decisions.

Swedroe: Indexing No Risk To Market

By: Larry Swedroe

Over the past few decades, there has been a substantial shift from active to passive investment strategies. This shift has occurred as investors have become more aware of the persistent failure of active management, as demonstrated in the S&P Dow Jones biannual Indices Versus Active (SPIVA) reports.

A January 2019 Federal Reserve Bank of Boston study, “The Shift from Active to Passive Investing: Potential Risks to Financial Stability?”, found that “Passive funds made up 45% of the assets under management (AUM) in equity funds and 26% for bond funds at the end of 2017, whereas both shares were less than 5% in 2005.”

Wall Street has been attacking and ridiculing passive investing for decades. Among the arguments are that the rise of passive investing results in a reduction in price discovery efforts, leading to prices being distorted and capital allocated inefficiently. This occurs because indexing either has too large an influence on prices or it inhibits price discovery because it lowers aggregate market trading volume.

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The Randomness of Global Equity Returns

Investment opportunities exist all around the globe.

Across more than 40 countries, there are over 15,000 publicly traded companies. 1 If you listen to the news, however, some countries may seem like better places to invest than others based on how their economies and stock markets are doing at the time. Fluctuations in performance from year to year only add to the complexity, providing little useful information about future returns. Daunted by the prospects of sorting it out, some investors look to the place they know best—their home market. There can be good reasons, such as tax benefits, for prioritizing an investment close to home, but too much home bias could mean underweighting or missing out on part of the investment universe.

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Perspectives on Factor Investing

March 2019

Dimensional Fund Advisors launched the first factor based fund in 1981 – the US Microcap Portfolio. Since then financial factor research and products have mushroomed. Academic papers have identified over 400 equity factors. There are currently 130 open-end mutual funds and over 600 ETFs that are factor based.

The primary reasons for this radical change are the low cost of ownership and return attribution. In a diversified stock portfolio, academic research (as well as own internal studies) have shown that 90%-99% of return variability can be explained with just five financial factors: Beta, company size, relative value, profitability, and momentum. This fact has profound implications for investors because the research shows where the overwhelming majority of equity investment returns (and premiums) come from. It also means focusing on other issues such as individual stock selection, active manager selection, and market timing are unnecessary and very likely counterproductive. It then begs the question how does an investor put together a portfolio of equity factors designed to have the highest probability of success? The answer rests on four primary considerations:

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Perspective on Premiums

March 2019

Investors may be tempted to extrapolate recent returns into the future, which can lead them to abandon their investment philosophy at potentially inopportune times. While negative outcomes are disappointing, investors should view them with the proper perspective and stay the course.

When you leave your server a tip, do you round it to a whole-dollar amount and often in multiples of $5? Does a 60th birthday seem more significant than a 59th? If you answer yes to these questions, you’re not alone. Most of us prefer round numbers.

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Getting to the Point of a Point

March 2019

A quick online search for “Dow rallies 500 points” yields a cascade of news stories with similar titles, as does a similar search for “Dow drops 500 points.”

These types of headlines may make little sense to some investors, given that a “point” for the Dow and what it means to an individual’s portfolio may be unclear. The potential for misunderstanding also exists among even experienced market participants, given that index levels have risen over time and potential emotional anchors, such as a 500-point move, do not have the same impact on performance as they used to. With this in mind, we examine what a point move in the Dow means and the impact it may have on an investment portfolio.

IMPACT OF INDEX CONSTRUCTION

The Dow Jones Industrial Average was first calculated in 1896 and currently consists of 30 large cap US stocks. The Dow is a price-weighted index, which is different than more common market capitalization-weighted indices.
An example may help put this difference in weighting methodology in perspective. Consider two companies that have a total market capitalization of $1,000. Company A has 1,000 shares outstanding that trade at $1 each, and Company B has 100 shares outstanding that trade at $10 each. In a market capitalization-weighted index, both companies would have the same weight since their total market caps are the same. However, in a price-weighted index, Company B would have a larger weight due to its higher stock price. This means that changes in Company B’s stock would be more impactful to a price-weighted index than they would be to a market cap-weighted index.

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