Wednesday, May 10, 2017

What does Jack Bogle, Jeff Gundlach and... GMGH have in common?!

What does Jack Bogle, Jeff Gundlach and GMGH have in common?

How about all of us being geniuses? (haha, I'm just kidding about myself)

Okay, so what is it that we really have in common? Well, it's that while we all think index investing is wonderful, there are limits to it being a forever successful strategy.

Don't get me wrong. Don't get triggered so fast.

I own ETFs and I think that indexing is a very decent strategy for most people. However, there is NO strategy that is infallible. There is no holy grail investment with low/no risks and high returns. There are obviously some strategies that are better than others (value, growth, momentum, etc) and some which are worse than others (buying stocks that start with a certain alphabet, or based on your horoscope). Index investing falls into the category of the "better strategies", but that is not to say that indexing is perfect, meant for everyone, in every situation, all the time.

One of the things that irks me is the fact that almost no one ever talks about the risks and problems about indexing.

Yes, even Jack Bogle, the freaking guy that started Vanguard, one of, if not, the biggest asset managers in the world (couple trillion AUM) that is literally built upon indexing, has said that indexing has a limit. The same limit that I mentioned 3 years ago - the problem if everyone starts indexing.

With 25% of the US market already indexed, and growing, the financial markets are steadily marching to a world where everyone becomes a freeloader and hopes for average market returns. Of course, you wouldn't need to be a professional freeloader to know that if more people are freeloading than contributing... it doesn't work out. Price discovery breaks down and the net worth of countless of people can be pushed around on a daily basis by the remaining and actual market participants.

Gundlach is even more critical of index investing, but his points are absolutely valid. Indexes are still created upon a set of rules that someone has come up with. The only difference is that a computer follows those rules without question, while the human that created those rules, can choose to follow or break those rules, and also charges a more expensive fee.

However, his point isn't about the more expensive fees. His point is about how indexes are still subject to human creation and influence, which means that managers can still decide which stocks to include and exclude from an index, and in what amounts...... HEY WAIT A MINUTE, THAT SOUNDS LIKE ACTIVE MANAGEMENT.

Because it is.

Really, the only differences is the fees. Which is fine if your main argument is that ETFs are cheaper, and that is the main reason for the outperformance over traditional active managers. Basically, you have to think that indexing performs well because of the savings in management fees, not because the index includes, excludes or allocates to stocks better than active manager. The index itself neither gives nor has an special magical powers to generate superior returns.


It's one layer above stock picking within the index, but it still requires active decision making. Do I want to have emerging markets exposure? Which countries / continents / currencies do I want to avoid and which ones do I want to overweight? What asset classes should I be in? Hey, isn't that a commodity index? Should I also have commodities?

If you think that by deciding a few years ago to only invest in 1 ETF *COUGH COUGH STI ETF COUGH COUGH* and that is called passive investing and it's a super solid strategy to weather all conditions, you might want to really think if that particular index is right for you.

Sure, investing solely in the STI ETF is still indexing. But so is choosing to buy an ETF that follows the index of diseased livestock.

ETFs don't magically make risks disappear. They reduce unsystematic risks based on number of holdings in the index and the allocation to them, but they hold plenty of systematic risks. And that right there is the biggest issue I have about people anyhow promoting indexing. They say all the good stuff and gloss over or leave out any of the bad stuff.

Indexing is a decent strategy. To get to the point where the majority of the market is indexed is still some ways out in the future, which is a different problem to deal with for a different time. However, let it be known that there are risks involved in indexing investing.


  1. No worries about ETFs destroying the world. In fact we are seeing the "stockification" of ETFs i.e. creation of all kinds of ETFs based on weird indexes, smart beta, multi-factor-based, algorithmic rules-based indices, ETF of ETFs, etc etc. There'll be as many ETFs as stocks in the markets. Everybody will always try ways & means to gain an edge. Investors, managers, gurus, salesmen will always be flipping & flopping from 1 flavor of the month, hot hand, hot trend to another.

    For myself, I'm still using basic UTs & ETFs and using momentum & trend-following. Serves me well enough since 2000 till today. Everybody just find & adapt a method that fits in with their psychological profile, size of assets, liquidity needs, and sleep well at night factor.

    BTW Vanguard just hit USD 4 trillion AUM and officially the biggest asset mgr in the world.

    1. Hi Anon,

      Yeah, the stockification of ETFs is a thing now, with all sorts of weird ETFs popping up everywhere. Since the market is not finite or limited to a fixed number, I don't think this is necessarily a negative, but it goes on to exaggerate the point that investors still choose what to "passively" invest in.

      Do the UTs and ETFs apply momo and trend following, or do you stick to the big basic ETFs and use your own methods to calculate when to enter and exit?

      Vanguard oh vanguard... when are you coming to SG? Haha

  2. If you watch the interview that Bogle gave, he doesn't think that 100% of investment will be in ETFs. Maybe around 75%, ETFs becomes a problem as trading slows. There will be people who make money trading shares, unlike many who are replacing their unit trust with ETFs.

    Next, STI ETF only accounts for 30 stocks in hundreds listed. Reit ETFs also also covers a small part of total listed companies. Maybe someday there will be enough ETFs to cover the entire universe of shares, but like Bogle, i don't think this is likely.

    Gundlach is right that index is just a composition of a basket of shares that supposedly able to provide a glimpse of how the market is behaving. Unlike a fund manager who uses his judgement to pick shares and try to beat the market, ETFs does not seek to do that.

    The issues with Gundlach's argument is highlighted by Buffett. The managers are charging too much and are unable to beat a simple index. I am most happy to invest in a fund manager that will only charge me a fee when they can deliver return in excess of the index. One good example is Aggregate Fund Management but we need to accredited investor.

    For most people, with modest means and time, ETFs are the ideal choice.

    1. Hi bigbluecat,

      Yeah, 100% into ETFs is not really possible, but I think for it to become the majority of the markets in a decade or so is not a far stretch of imagination.

      Aye, I too think that the main benefit of ETFs is the much lower fees compared to normal managers. ETFs are a good choice, but people mustn't be fooled that it is without risks.


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