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February 16, 2017 at 05:26 AM
The perfect anti-anxiety investing solution for countering the uncertainty triggered by Donald Trump’s taking office as president? Index investing, Charles “Charley” Ellis, esteemed investment strategy consultant and author of the classic “Winning the Loser’s Game,” tells ThinkAdvisor in an interview.
In his new book, “The Index Revolution: Why Investors Should Join It Now” (Wiley), Ellis, who founded and led institutional investing consultants Greenwich Associates for three decades, continues to vigorously argue that active management is “a loser’s game” – and he explains why.
In the interview, Ellis, 79, discusses the ways that indexing can help financial advisors, why active managers have underperformed for the past several years (they can be their own worst enemy, he says), and how trying to beat the market can hurt far more than help. He talks too about meetings he enjoyed with the legendary economist and investor Benjamin Graham.
Today, Ellis, who invests almost entirely in index funds, is a consultant to large institutions like the California Public Employees’ Retirement System, the GIC (Government Investment Corp.) of Singapore, and the Future Funds of New Zealand and Australia. Five years ago he joined Wealthfront’s advisory board.
Ellis’s current mission is to help investors – ranging from modest to high net worth – achieve retirement security through index investing. He has long advocated a strategy of low-cost indexing, ever since he wrote his doctoral dissertation on the subject.
Ellis has served on the faculties of Harvard Business School and Yale School of Management, and for 11 years was a Yale University successor trustee. He graduated from Yale and received his MBA from Harvard Business School and his Ph.D. from New York University. He is one of 12 to be honored by the CFA Institute for lifetime contributions to the investment profession.
ThinkAdvisor recently spoke with Ellis, on the phone from his office in New Haven, Connecticut. He believes that indexing is ideal for today’s market because, as he writes in “The Index Revolution,” it “eliminates or reduces all the ‘little things’ that, like termites, eat away at returns: high fees, taxes, errors in selection of managers and more.” Here are excerpts from our conversation:
THINKADVISOR: How do you see Donald Trump’s presidency affecting Americans, and investors in particular, in the short term?
CHARES ELLIS: There’ll be a period in the Trump presidency where there’s more worry and anxiety on a macro level. Fear of war and the possibility of serious mistakes will be a real part of the calibration of what people are thinking. So, there may be more flutter, or anxiety, expressed in the market or in individuals themselves. Whether or not Trump reduces corporate taxes could have a real impact on investing. Meanwhile, [foreign] investing will give people reason for anxiety too because of everything that’s going on internationally.
Can index investing be of help with any of this?
One of the things that’s important about investing in index funds is that you can kind of relax. The reduction in anxiety that goes with investing in them is an offset to the uncertainty that’s [causing] anxiety with the new administration. With indexing, you avoid being distracted by the tricks of the market.
What are the top four reasons for indexing?
You’re able to get higher returns than any other way. You’ll outperform other investors in large numbers, for sure. You have lower cost, which is kind of comforting, and lower anxiety. And because you know that everything will be done correctly, you don’t have to worry about operation or implementation. Therefore, you can concentrate on what’s really important about investing, like what you’re trying to accomplish, what resources you have, how much time you have and which portfolio structure would be best for you.
Why have active managers consistently underperformed over the last several years?
As a group, active managers are more talented than they’ve ever been. They have more information than they’ve ever had and better computer power. There’s only one problem: There are too damn many people doing this fascinating and deeply enjoyable work and which pays extraordinarily well.
You’re talking about heightened competition?
Yes. People are competing for the same process. About 50 years ago, there might have been as many as 5,000 active managers. Today, there’s got to be at least a million. Further, in 1965 there were half a dozen firms starting to produce research available to anyone who was willing to buy it for commissions. Senior management would take you out to dinner and tell you what was going to happen in their companies. You could get all the information on your side. That was the secret sauce of active investment management.
What happened to upset that applecart?
Today, the [Securities and Exchange Commission] requires that any public company that delivers any useful information for investment purposes must make sure everybody gets the same information at exactly the same time.
How do financial advisors view index funds?
Those that are really working for their clients would say, “This is really great — an enormous positive. We can compose a portfolio in each asset class for our clients that’s beautifully suited to a particular client and help them understand why they ought to stay with it or when they should modify it. And we don’t have to worry that the manager is going to make a mistake that will cause us embarrassment and require us to apologize to our clients.”
What about advisors who don’t have that attitude?
If they think, “My business is to find ways to beat the market rate of return,” then that’s a mistake in definition of purpose. They have a real challenge because they’re not going to be able to beat the market.
If indexing performs better than active management on a long-term basis, why is only 30% of total investment dollars in indexes?
Twenty years ago, it was zero. More and more people are indexing now. The curve of acceleration is astonishing. In the last couple of years, there have been major flows from active investing to indexing. And I don’t see any reason for that to slow down.
What’s behind the increase?
Until the last two-and-a-half or three years, the data on all mutual funds wasn’t available. Now that data is being produced, and it’s stunning. [It shows that] it’s [very difficult] to do better than the benchmark 10 years in a row. That’s important because most people buying a mutual fund don’t expect to get out of it in less than 10 years. But they get terrible results and drop out, or the fund disappears. Nobody should invest in stocks unless they’ve got at least a five-year horizon — 10 years would be better.
