5 stupid things about passive investment

Positive and negative investment debates are ruthless. If you do a simple cost/benefit analysis, the supporters of passive investment have convincing facts.

– According to the latest SPIVA scorecard, 82% of US large equity mutual funds have lagged behind the S&P 500 in the past five years.

– The cost ratio of active mutual funds is usually between 0.5% and 0.75%, while the cost ratio for most passive index funds is between 0 and 0.25%.

Why spend three to four times more money to buy a product that has an 82% chance of causing poor results? This makes active management look like a stupid value proposition.

However, like many investment topics, there are some nuances worth considering.

For the fair competition, here are five stupid things about passive investment:

1. It’s stupid to increase investment just because something is done well in the past.

The energy sector accounts for 5% of the S&P 500 index and the dividend yield is 3.8%. Ten years ago, the sector accounted for 15% of the index, with a yield of 2.2%.

Is it better to buy energy stocks now than in the past?

Investors who are concerned about dividends may think so. But ten years ago, passive investors had much more energy stocks.

According to Graham’s point of view, the secret of investing is to calculate the value of something and then buy it with less money, which he calls a “safe margin.” But most passive products ignore the notion of basic values ​​and safety margins, and they are driven by price.

The formal definition of “passive” is a market-weighted basket of all stocks in a market. When stocks outperform the market, they receive a higher percentage of weight, while those that perform poorly receive lower weights. The rationality of price movements does not matter – price is the truth.

If you believe in the Effective Market Hypothesis (EMH), then this architecture may be right for you.

However, after you have experienced some asset bubbles, you may realize that EMH is talking big. This makes it easier to find investment misplacements and it is even harder to ignore fundamentals.

2. The stock index is more stupid than stocks

The number of stock market indices in the world is more than 70 times that of listed stocks (source: Index Industry Association). In other words, it’s like saying that in a sports league, the team is more than the players.

Why are there so many indicators?

Tim Edwards of the S&P Global Index Investment Strategy team said: “Users of index products look more active than they seem.”

Jack Bogle, founder of the index fund giant Pioneer Group, may have altruistic intentions when it comes to creating this tool to help investors save money, but this is not the norm.

There are so many indexes because they make active trading easier.

When volatility accelerates, the demand for ETFs is particularly strong. For example, BlackRock’s data shows that in December last year, the ETF accounted for 37% of all stock transactions in the United States.

3. It’s stupid to have multiple passive products overlapping

The market is determined by supply and demand. Passive investors should be aware that the surge in ETFs creates an additional layer of demand that benefits certain stocks more than other stocks.

For example, Microsoft gets a direct quote from an investor who studies the company and chooses to buy shares in the company.


– Microsoft is the number one shareholder of the SPDR Standard & Poor’s 500 Index ETF (asset management scale of $273 billion).

– Microsoft is the number one shareholder of the iShares S&P 500 Index Growth ETF (asset management scale of $23.6 billion).

– Microsoft is the second-largest shareholder of the iShares Momentum Factor ETF (asset management scale of $10.6 billion).

Passive investors should be cautious and avoid the situation where the herd effect may cause a serious disconnect between the price and the fundamentals.

4. It is stupid to think that anyone is a purely passive investor.

Do you know who always allocates 100% of financial assets to a passive index fund? Anyway, I am not like this.

In addition, what constitutes a suitable passive benchmark?

Many people associate passive stock investments with 100% S&P 500 index funds, just like SPY.

But if anyone puts all the money into SPY, we can say that they are actively betting because the US only accounts for about 54% of the global market.

In fact, most “passive” investors are active and passive. In other words, they actively rotate risk exposures between different asset classes, countries, industries and styles.

5. Passively managing risk is stupid

Passive investment has been around for a long time, but it has only become popular in recent years because the conditions are ripe. In an environment represented by a large increase and a small drop, 100/100 is a good ratio.

But the problem is that the investment cycle means recovery over a certain period of time. In the end, we will see a period of low returns and high volatility over the years. So is the passive 100/100 ratio still the right strategy?

Studies have shown that investors hate losses as much as they like income, which means we react more to losses.

In my company, we don’t believe that most people who hire professional financial managers want someone to “passively” monitor them, so we are a positive investment camp.

It is much harder to study stocks than to invest in indices. The only reason I chose to do this is that I know that active risk management can help investors clear the obstacles in the process. At a critical cycle turning point, it can even determine whether a person can retire.

In order to illustrate the different performance of the strategy, our company’s core equity strategy has a historical up/down capture ratio of 94/74. This means that in the months when the market closed higher, we gained 94%, and in the months of negative returns in the market, we assumed a 74% downside risk.

As a person who responds to market volatility and customer sentiment fluctuations, I am much more satisfied with my risk/reward ratio (100/100). Especially now we are in a post-cycle environment.

But that’s just me, and what works for me doesn’t necessarily apply to everyone.

Both positive and negative investments have a clear positive and negative side. Depending on the framework, both methods may seem silly. Conversely, if investors have the discipline that adheres to both methods, these two methods will work overtime.


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