As you might already be aware, I am not a big fan of active investing. I honestly don’t believe that I can systematically outperform a broad index consistently (read more than 10 years). I am happy getting the index returns, compounded over a very very long period.
I am not for a moment saying that there aren’t people who can outperform the broad index on a consistent basis. I am sure there are. What I am saying is that I am not one of them and I don’t know of a way to find such investment managers ex-ante.
On the other hand, I haven’t heard one active manager say that he would likely perform poorer than the average. All of them promise alpha, or above average returns. How can everyone be above average? Mathematically impossible! When Jack Bogle started index funds close to 4 decades ago, a financial service firm on Wall Street distributed posters asking investors to stamp out index funds as it was un-American. How can Americans settle for anything average, which the index fund invariably delivers, and not strive for extraordinary returns?
Actual Poster
Who’s having the last laugh now? What was un-American has become the cornerstone of most investing portfolios.
I am sick of charlatan active managers and closet indexers who point to the fantastic track record that Warren Buffett has had and say “see here is a clear example of someone who has beaten the dumb f****** index”. The more well read among them even point you to an article written by Warren, in 1984, titled “The Superinvestors of Graham-and-Doddsville”, chronicling the investment performances of value investors who have modeled their investing approach on Graham and Dodd, which is “looking for values with a significant margin of safety relative to prices”.
Warren Buffett and indeed the other investors of Graham-and-Doddsville are extraordinary, no doubt about it. But one should ask the question if the out-performance was owing to less liquid or more inefficient markets? Could it be one of the factors? I haven’t done any empirical analysis, but am taking a wild swing. The market for publicly traded, large US companies (read constituents of S&P 500) is definitely more efficient today than a decade ago and more so than two decades ago and so on. Given the rapid advances in the speed at which information is disseminated, is it still possible to have long runs of out-performance in publicly traded large-cap stock portfolios? I don’t know the answer to this question, however, I have noticed a few curious things in the annual letters that Buffett writes to his shareholders. He seems to be more and more pro indexing. Here are some of the things he’s said in his letters
Letter of 2016:
“When trillions of dollars are managed by Wall Streeters charging high fees, it will usually be the managers who reap outsized profits, not the clients. Both large and small investors should stick with low-cost index funds.”
“Over the years, I’ve often been asked for investment advice, and in the process of answering I’ve learned a good deal about human behavior. My regular recommendation has been a low-cost S&P 500 index fund”.
“To their credit, my friends who possess only modest means have usually followed my suggestion. I believe, however, that none of the mega-rich individuals, institutions or pension funds has followed that same advice when I’ve given it to them.”
Letter of 2014:
“Huge institutional investors, viewed as a group, have long underperformed the unsophisticated index-fund investor who simply sits tight for decades. A major reason has been fees: Many institutions pay substantial sums to consultants who, in turn, recommend high-fee managers. And that is a fool’s game.”
Letter of 2013:
“The 21st century will witness further gains, almost certain to be substantial. The goal of the non-professional should not be to pick winners — neither he nor his ‘helpers’ can do that — but should rather be to own a cross-section of businesses that in aggregate are bound to do well. A low-cost S&P 500 index fund will achieve this goal.”
Letter of 1993:
“By periodically investing in an index fund, for example, the know-nothing investor can actually outperform most investment professionals. Paradoxically, when ‘dumb’ money acknowledges its limitations, it ceases to be dumb.”
I have purposely ordered his quotes in reverse chronological order for you to see how his views have evolved over the years.
Later in his life, Ben Graham, the father of value investing, also tilted towards indexing. Buffett acknowleges this in chapter 16 of The Little Book of Common Sense Investing when he says “A low-cost fund is the most sensible equity investment for the great majority of investors. My mentor, Ben Graham, took this position many years ago, and everything I have seen since convinces me of its truth.”
So, I am not asking you to follow my advice, far from it. I am asking you to follow the Oracle of Omaha!
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