tag:blogger.com,1999:blog-5465015914589377788.post7249073050414470332..comments2024-03-20T09:32:16.592-04:00Comments on Michael James on Money: Cap-Weighted vs. Fundamental IndexingMichael Jameshttp://www.blogger.com/profile/10362529610470788243noreply@blogger.comBlogger14125tag:blogger.com,1999:blog-5465015914589377788.post-83817752854880978922020-11-02T10:20:08.375-05:002020-11-02T10:20:08.375-05:00The comment above is a reply to Canadian Capitalis...The comment above is a reply to Canadian Capitalist's comment:<br /><br />You might be interested in Bogle's take on the matter:<br /><br />http://johncbogle.com/wordpress/wp-content/uploads/2006/08/WSJ%20op-ed.pdfMichael Jameshttps://www.blogger.com/profile/10362529610470788243noreply@blogger.comtag:blogger.com,1999:blog-5465015914589377788.post-87572983830813398862011-07-22T23:30:59.703-04:002011-07-22T23:30:59.703-04:00Bogle and Malkiel criticize fundamental indexing a...Bogle and Malkiel criticize fundamental indexing and its variants due to increased costs and increased taxes. Fundamental indexing and its variants tilt to small cap and value stocks. Bogle and Malkiel point out that historically such a tilt has outperformed. However, it is only relatively recently that this outperformance became known. Also, it is only relatively recently that investors had vehicles to try to tilt to small and value. Now that it is known and investors can try to take advantage of it, the possibility that the outperformance will decrease (or disappear?) is raised.<br /><br />The counterargument is that both the small and value tilts are risk premia. If they are risk premia, then they should persist. Most people seem to agree that the small premium is a risk premium. But you have to go quite small to get a premium of significance. Whether the value premium is a risk premium is hotly debated. Some say yes; others say it is a behavioral finance phenomenon. IIRC, William Bernstein tends towards the latter opinion.<br /><br />IMO, the small and value premia may persist, but I would not be surprised if they decline. If one tilts towards small and value in Canadian stocks, one decreases the diversity of one's Canadian stock exposure. IMO, the lack of diversity in Canadian stocks is a problem, even without a small or value tilt. As for foreign stocks, a tilt to value will result in increased dividends. It isn't difficult to pay 46% on foreign dividends in Canada. If you use American domiciled ETFs, your tax rate could be 61% on dividends, due to loss of the foreign tax credit.Anonymousnoreply@blogger.comtag:blogger.com,1999:blog-5465015914589377788.post-68670718033402405902011-07-22T13:13:50.531-04:002011-07-22T13:13:50.531-04:00Use fundamental indexes for emerging markets, out-...Use fundamental indexes for emerging markets, out-performance is strongest here.Thomas J Vennerhttps://www.blogger.com/profile/13098211700518302618noreply@blogger.comtag:blogger.com,1999:blog-5465015914589377788.post-64065993986853357542011-07-22T11:12:07.795-04:002011-07-22T11:12:07.795-04:00Come to think of it, Bogle is somewhat wrong in th...Come to think of it, Bogle is somewhat wrong in that the potential for fundamental indexes to outperform cap-weighted indexes would be less in an efficient market. If you reduce exposure to an overvalued stock at the right time, that does give you above average returns at the expense of those who don't. And that can't happen if the market is inefficient.<br /><br />But that potential is only realized to the degree that the fundamental index gives you the right weightings at the right time. That comes back to the challenge of active management except it's done with a formula instead of someone's judgement. Since a formula can't change frequently it may be easier for traders to get ahead of the fundamental index funds. Nortel makes a nice example but not all mispricings are that noticeable.Value Indexerhttp://valueindexer.wordpress.comnoreply@blogger.comtag:blogger.com,1999:blog-5465015914589377788.post-471180113517700172011-07-22T10:17:19.534-04:002011-07-22T10:17:19.534-04:00@Zamphir: That's a useful feature for those w...@Zamphir: That's a useful feature for those who like to make frequent modest-size additions to their portfolios. There is no reason why this has to be linked to fundamental indexing, but in practice it is right now.<br /><br />@Value Indexer: I can believe that there will always be bad investors, but that doesn't necessarily mean that fundamental indexers will be the ones who take their money. I guess time will tell.Michael Jameshttps://www.blogger.com/profile/10362529610470788243noreply@blogger.comtag:blogger.com,1999:blog-5465015914589377788.post-73226046188453103542011-07-22T10:05:03.054-04:002011-07-22T10:05:03.054-04:00It's interesting how Bogle opens his piece by ...It's interesting how Bogle opens his piece by challenging the assumption that a new model can take on the dominant success story of the past. I wonder what his index funds did differently 30 years ago :)<br /><br />He is of course right that the average return will always be the cap-weighted index. That means the fundamental indexes have to get their marginal returns from active managers who underperform. If this would happens it seems like it would be because those active managers undervalue enduring value (such as profits) and favor trends with nothing behind them. Or the fundamental indexes could get some extra returns from individual investors who underperform their funds through bad timing.<br /><br />If you're telling me fundamental indexes can only succeed when other investors make short-sighted and poorly-informed moves... well I can believe that pretty quickly :) But maybe a cap-weighted value index works just as well as a fundamental index.Value Indexerhttp://valueindexer.wordpress.comnoreply@blogger.comtag:blogger.com,1999:blog-5465015914589377788.post-31092405523441666922011-07-22T00:48:05.154-04:002011-07-22T00:48:05.154-04:00Another benefit of CRQ or any Claymore ETF that is...Another benefit of CRQ or any Claymore ETF that is fundamentally weighted is the ability to dollar cost average on a monthly basis without paying for the trading costs. I don't know why this hasn't made bigger headlines for the average retail investor. So I'm happy to pay slightly more of an MER and not pay trading costs.Zamphirhttps://www.blogger.com/profile/02024347093129659793noreply@blogger.comtag:blogger.com,1999:blog-5465015914589377788.post-30731948283787906542011-07-20T12:20:26.136-04:002011-07-20T12:20:26.136-04:00@CC: Thanks for the pointer. Bogle makes a stron...@CC: Thanks for the pointer. Bogle makes a strong and convincing case for market-weighting.Michael Jameshttps://www.blogger.com/profile/10362529610470788243noreply@blogger.comtag:blogger.com,1999:blog-5465015914589377788.post-21244721355244293022011-07-19T15:47:26.404-04:002011-07-19T15:47:26.404-04:00@Patrick: Good point. It isn't enough for th...@Patrick: Good point. It isn't enough for the fundamental index supporters to criticize market-weighting. They must also demonstrate that any particular method they choose for valuing companies will lead to excess returns.Michael Jameshttps://www.blogger.com/profile/10362529610470788243noreply@blogger.comtag:blogger.com,1999:blog-5465015914589377788.post-40678806884403742522011-07-19T14:53:04.068-04:002011-07-19T14:53:04.068-04:00I believe the folks behind fundamental indexes hav...I believe the folks behind fundamental indexes have identified a real problem, but not a real solution. The approach requires a formula to tell you the intrinsic value of a company more accurately than its market cap. I'm skeptical such a thing exists.Patrickhttps://www.blogger.com/profile/16816252455472704262noreply@blogger.comtag:blogger.com,1999:blog-5465015914589377788.post-6784707267274857032011-07-19T10:13:58.578-04:002011-07-19T10:13:58.578-04:00@Mike: You're right that the volatility of fu...@Mike: You're right that the volatility of fundamental weightings has been lower in back-testing. This has some value. For example, if fundamental weightings reduce standard deviation of returns from 20% to 19%, this boosts compound average returns by about 0.2%. This should all be factored into any well-done back-testing of return data.Michael Jameshttps://www.blogger.com/profile/10362529610470788243noreply@blogger.comtag:blogger.com,1999:blog-5465015914589377788.post-26956683021989791922011-07-19T10:06:32.049-04:002011-07-19T10:06:32.049-04:00I have the same opinion as you - I'm not sure ...I have the same opinion as you - I'm not sure that any extra returns (if any) will beat the increased costs.<br /><br />One benefit of a fundamental index is potentially less risk. Having an index with one stock making up 33% of the index might or might not affect returns, but it definitely makes the index riskier.<br /><br />I suspect both approaches are fine and it's the investor's saving rate and behaviour that will make the biggest difference, rather than the decision to go cap-weight vs fundamental.Mike Holmanhttp://www.moneysmartsblog.comnoreply@blogger.comtag:blogger.com,1999:blog-5465015914589377788.post-77779654352861349082011-07-19T09:04:19.240-04:002011-07-19T09:04:19.240-04:00@Potato: I didn't realize that financials mak...@Potato: I didn't realize that financials make up 45% of CRQ. That has looked good over the recent past, but who knows if it will look good in another 10 years.Michael Jameshttps://www.blogger.com/profile/10362529610470788243noreply@blogger.comtag:blogger.com,1999:blog-5465015914589377788.post-77374342558613719942011-07-19T02:24:42.086-04:002011-07-19T02:24:42.086-04:00In general I follow the logic of the fundamental i...In general I follow the logic of the fundamental indexes, and am inclined to agree. But the eternal passive investing question remains: I can control the fees, but not the returns. Will the returns beat out the increased fees?<br /><br />For CRQ vs XIC, there's about a half a percent difference in MER. If that was all there was to it, I might be tempted to go with CRQ on the theory that the fundamental index has the potential to outperform by more than 0.5%. However, it seems to be counterproductive in terms of diversification: financials are already a big part of the Canadian market, almost 30% of XIC. But in CRQ they're over 45%!!!<br /><br />It just seems to trade one problem for another, so I guess I'll stick with cap-weighted as well (though I'm with e-series, so I don't have much choice there).Potatohttp://www.holypotato.netnoreply@blogger.com