Tuesday, July 12, 2005

Index funds

Jeremy Siegel's new book, The Future for Investors, Why the Tried and True Triumph Over the Bold and the New, includes an interesting exercise in what happens when you invest in an index fund. The current incarnation of the S&P 500 dates back to 1957. The index has been adjusted over the years, because it has to be. Some companies merge, spin pieces off, or are bought by others. The economy is changing over time, and the Index needs to evolve with it to remain an accurate barometer.

Professor Siegel posed the question, what if I bought the original 500 stocks instead of replicating the index? He had three alternatives for dealing with corporate reorganizations, from sticking to the originals only to owning all their descendants. The critical point is that none of the portfolios ever added any of the 917 stocks added to the S&P 500 over the years.

I was surprised to learn that Professor Siegel's portfolios beat the S&P 500 handily. No Microsoft? Limit yourself to big firms from the 50s, and beat the returns from firms delivering the information age economy? But of course it's true, which is why it made it into the book.

This seemed like just the thing to share with the readers of our Investment and Trust Newsletter, so I did a one page summary of Siegel's findings. I was promptly chastised by our clients, who fell into two camps. One side claimed we were slamming index funds, which was a problem become some trust departments rely on index fund investing for smaller trusts. The other school objected that we were endorsing index funds, or at least offering approval of a passive investment approach, which was inconsistent with their investment service.

Needless to say, we respond quickly to client concerns, and the page now covers tax basis and tax management for investment portfolios.

Any suggestions for covering investment matters for wealth management customers in a way that won't ruffle any feathers out there?
Posted by Jim Gust at 12:03 PM

2 comments:

JLM said...

I bet Jim Gust's favorite outdoor recreation is to walk around his backyard with a stick, swatting hornets' nests.

How else to explain his ability to offend both friends and foes of index funds?

On a number of web sites this year I've encountered the thought that investment management is becoming a commodity. With everybody offering much the same steak, marketing becomes more than ever a matter of selling the sizzle. That's impossible to do for a whole bunch of different money managers.

I suspect the page on Jeremy Siegel was about four-fifths of a page too long. JBG might have gotten away with one paragraph on Siegel's findings, followed by a second pointing the morals for individual investors: Be patient, and don't chase tech stocks selling at high p/e's. Of course, those are pretty tame thoughts; Warren Buffet has been voicing them for a generation.

Incidentally, I see that Jeremy Siegel now has a commercial web site. Looks like he's following in the footsteps of Roger Ibbotson and going into the data-gathering and pesentations business.

P.S. Here's an even better hornets nest to whack: David Swensen, who's credited with producing a 16% average annual return for Yale's endowment over the past 20 years, has written a book addressed to individual investors. Judging from this article in the Yale Alumni Magazine, Swensen is definitely not a fan of mutual funds other than index funds.

"Overwhelmingly," says Swensen, "mutual funds extract enormous sums from investors in exchange for providing a shocking disservice." That is, mutual funds change their investors big fees and usually fail to deliver returns that beat the market.

4:15 PM
Jim Gust said...

Hitting the hornets' nests with stick is more valuable than you might think--at least then you know where not to walk in the future.

Great link to the Yale endowment manager--think he could consult for the trust industry? The article seems to prove that the rich definitely do get richer.

6:34 PM

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