A cynic’s guide to spooking indexers

Here are four reasons to stop wasting time keeping fees and taxes low and to stop being diversified and disciplined. Because nothing good comes from this investment approach, right?

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From the Summer 2016 issue of the magazine.

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stock market

Times are tough if you’re a fund manager, a financial advisor who picks stocks or mutual funds, or the chief economist of an investment firm. As more investors get wise to the long-term failure of active managers, money is pouring into index funds and exchange-traded funds (ETFs). In January, Morningstar reported that in the U.S. more than $207 billion flowed out of active mutual funds during 2015, while index funds saw more than $413 billion in new assets. That’s a lot of lost revenue.

If you try to defend old-school thinking, you can’t rely on highfalutin concepts like evidence and performance. It’s much more effective to rely on fear-mongering with vague but dire warnings about the risks of indexing. Investors are a jittery bunch; it’s easy to get them to second-guess their strategy.

With that in mind, here is some advice to those hoping to shake the confidence of index investors. These scare tactics work especially well with a healthy dose of hyperbole, a few red herrings and a little smugness.

Tactic 1: Say we’re in a stock picker’s market. Sure, about 70% to 90% of funds trail their indexes over most five- and 10-year periods, but your goal here is to convince Couch Potatoes that market conditions have changed, and this decades-long run of success can’t continue.

Start by claiming markets are now more volatile and there’s lower correlation between stocks, which creates a “stock picker’s market.” Do this annually, as part of your list of excuses about your underperformance over the previous 12 months.

When using this rhetorical strategy, do your best to ensure no one ever follows up with actual data. For example, Bloomberg News didn’t do you any favours when it recently reported that in the first quarter of 2016, “active managers got what they’ve been hoping for” with the best conditions for stock picking since 2012, yet managed to trail their benchmarks “by one of the highest rates in two decades.”

Tactic 2: Scare investors away from bonds. If proclaiming a stock picker’s market was a punch to the stomach, it’s time to follow with an uppercut to the jaw: Tell them bond index funds are doomed, too.

This one will be tricky, because you’ve been saying “interest rates have nowhere to go but up” for five or six years, and they’ve actually gone down. So rethink your doom-and-gloom scenario and start warning about negative interest rates. Mention Japan a lot.

Make sure you’re as vague as possible about how bonds will respond to a prolonged period of less-than-zero yields. Then suggest complicated, high-fee products they won’t understand, such as principal-protected notes and equity-linked GICs. By the time people see they’re rotten investments, there will be a new bond crisis to exploit.

Tactic 3: Play the macro card. Continue to do everything you can to make investors feel insecure about the global economy and financial markets. Mention disappointing Chinese gross domestic product figures and the trickle-down effect this will have on commodity producers in Canada. Then pound your fists on the table and trumpet about central banks artificially repressing risk. Invoke the ongoing Puerto Rican sovereign debt crisis. And when you sense it’s time to deliver the coup de grâce, say “Grexit.”

Now that you’ve scared the daylights out of investors with globally diversified portfolios, swoop in and save them with your superpowers—and high fees.

A quick pointer: Change the subject if you’re asked why the current crises du jour are fundamentally different from all the ones that came before them, or the ones that will inevitably follow in the future. Ignore the piles of evidence that economic forecasts are worthless, since they are already priced into the markets.

Tactic 4: Blame index funds and ETFs for wrecking the markets. Failed to unnerve Couch Potato investors with tales from the economic crypt? Go for the cry of the truly desperate. Attack the tools of their trade: index funds and ETFs.

Tell clients one of the reasons active managers like you lag their benchmarks is that indexing distorts the markets. The strategy has become so popular that stocks in large indexes such as the S&P 500 are being bought and sold in huge volumes by dumb indexers who don’t care about the companies’ fundamentals. Meanwhile, bond index funds are a time bomb that could send fixed-income markets crashing.

Once again, the key is to ignore the facts. Index funds have been around for more than 40 years and proved their mettle during the 2008–09 financial crisis. Stick with fear-mongering; the true villains here are those who give investors a way to build diversified portfolios at extremely low cost.

These four tactics should convince some investors to stop wasting time keeping their fees and taxes low, and stop staying diversified and disciplined. Because nothing good ever comes of that.

One comment on “A cynic’s guide to spooking indexers

  1. Why is an indexer like DeGooey constantly bashing Bond ETFs?
    This post is brilliant. Thank you for keeping it real!

    Reply

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