Rob Arnott:index Investors Buy High, Sell Low

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Rob Arnott:index Investors Buy High, Sell Low

Post by Random Walker » Fri May 18, 2018 9:10 am

http://www.etf.com/sections/features-an ... nopaging=1

This article is not about what you might think from the title: it’s not about bad individual investor behavior. Rather it’s about a potential weakness of typical market cap weighted index funds. Passive funds can be constructed to avoid some of the weaknesses associated with pure indexing. Some of of those behaviors include hold ranges and patient trading. Of course to avoid the weaknesses of pure indexing, the passive investor needs to tolerate some tracking error.

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Re: Rob Arnott:index Investors Buy High, Sell Low

Post by Lauretta » Fri May 18, 2018 9:27 am

Thanks for sharing, interesting post. Arnott mentions the problem that the changes to the S&P index are announced in advance; apprently this problem is even larger for the Russell 2000 and I've read it's one of the reasons why it underperforms the S&P 600. It should be possible for individual investors buying individual stocks to profit from these changes in the indeces known in advance...
Interesting point also concerning the largest stock in the index typically underperforming over the next ten years; though in the case of Apple I don't think Buffett would agree on this ;-) :D
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Re: Rob Arnott:index Investors Buy High, Sell Low

Post by Independent George » Fri May 18, 2018 9:33 am

That's was a good read, and his ideas seem sound to me. I don't think that really impacts retail investors like the most of us, though, because those minor gains from index arbitrage are comparatively tiny. He's talking about exploiting index tracking to gain roughly 0.5% - which is great if you're managing your own holdings and willing to put the legwork in, but not so great if you're a retail investor and that difference only comes out to 0.05% after fees. I think that the overall effect is not much different from factor investing (which is something else that I agree with in theory, but am unconvinced of its efficacy in practice).

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Re: Rob Arnott:index Investors Buy High, Sell Low

Post by Rick Ferri » Fri May 18, 2018 9:36 am

Don't listen to the arguments. Look at the data. If Rob is right, and this buy-high sell-low phenomenon in the markets is so easy to avoid, where is the outperformance by active managers?
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Re: Rob Arnott:index Investors Buy High, Sell Low

Post by Clever_Username » Fri May 18, 2018 9:52 am

If I understand his argument correctly, he seems to think that an S&P 500 index buys a company that gets added to the index on the day it gets added. I cannot imagine this is how such funds actually operate. Maybe I'm not reading his argument correctly.
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Re: Rob Arnott:index Investors Buy High, Sell Low

Post by CedarWaxWing » Fri May 18, 2018 9:55 am

Rick Ferri wrote:
Fri May 18, 2018 9:36 am
Don't listen to the arguments. Look at the data. If Rob is right, and this buy-high sell-low phenomenon in the markets is so easy to avoid, where is the outperformance by active managers?
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Re: Rob Arnott:index Investors Buy High, Sell Low

Post by triceratop » Fri May 18, 2018 9:59 am

Rick Ferri wrote:
Fri May 18, 2018 9:36 am
Don't listen to the arguments. Look at the data. If Rob is right, and this buy-high sell-low phenomenon in the markets is so easy to avoid, where is the outperformance by active managers?
Right. And, don't confuse claimed effect with impact of claimed effect; like, this one:
Rob Arnott wrote:We tested index data from 1989 to 2017, and found that over the next 12 months, additions underperformed discretionary deletions to the index by 2,300 basis points. That's huge.
Yeah, right, sure, but how many additions and deletions are there even in something like the CRSP U.S. Total Stock Market? And, what end of the market cap spectrum does this occur at? And, what does market cap weighting imply about the impact of even massive change at that end of the spectrum? Something like the Vanguard Total Stock Market effectively holds 100% of market capitalization, so the stocks it is adding/deleting just cannot possibly matter too much.
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Re: Rob Arnott:index Investors Buy High, Sell Low

Post by nisiprius » Fri May 18, 2018 10:27 am

1) Even if his argument were true, it would only apply to the S&P 500 index. For about twenty years now, index providers have been aware of the problem of front-running and have made it difficult, e.g. by randomizing the day when a stock is added to the index. So don't use an S&P 500 fund, use a total market index fund. Problem solved.

2) I think this is a fairly good answer to Arnott. The Schwab Fundamental US Large Company Index Fund, SFLNX, has given us over a decade's worth of real-world comparison between Arnott's firm's fundamental index and the icky-poo S&P 500. Implemented by real managers running real money on the real stock market.

In that time a $10,000 investment in his fundamental index did beat an S&P 500 fund, VFIAX. By twenty-four bucks. Even if everything Arnott said were absolutely right, it's still not important. It's more important to keep your CVS ExtraBucks coupons organized.

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Re: Rob Arnott:index Investors Buy High, Sell Low

Post by JoMoney » Fri May 18, 2018 10:39 am

Looking at PRF , an ETF that tracks RA's RAFI 1000 , according to Portfolio Visualizer over the 12+ years of the fund it barely squeaked out a little more return that VTSAX (Vanguard Total Stock Market) but with higher standard deviation , lower Sharpe.
Even a slight tilt to smaller more volatile stocks like 90% VTSAX 10% VEXAX (extended market) and the portfolio outperformed PRF.
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Re: Rob Arnott:index Investors Buy High, Sell Low

Post by Lauretta » Fri May 18, 2018 10:41 am

Rick Ferri wrote:
Fri May 18, 2018 9:36 am
Don't listen to the arguments. Look at the data. If Rob is right, and this buy-high sell-low phenomenon in the markets is so easy to avoid, where is the outperformance by active managers?
To be fair he addresses the question at the end of his piece
Most active managers anchor on the market. They're also worried about tracking error. So if Tesla and Netflix are in the index, they're happy to go underweight if they think they're expensive. But they're not happy to eliminate them entirely. Or, take Apple; they might be willing to underweight it, but, "My goodness, that's the largest stock in the index; I don't dare not hold it!" So you're left with anchoring on the market as an important source of performance drag for active managers.

Active managers are also human beings. As human beings, whatever has given us joy and profit, we want more of; that means we tend to buy high. Whatever's given us pain and losses, we tend to want less of; that's why we sell low. As investment managers, it's really hard to say, "This stock has been dreadful, I want more of it."
Also, there's the question that any gains that can be achieved by active managers may be swamped by fees. However implementing a simple low cost strategy which profits from market inefficiencies (e.g. the fact that the holdings of indeces are changed at dates known in advance) might indeed work IMO.
Many people think that beating the market is not hard (e.g. Shiller said beating the market is easy, and his friend Swensen has shown it can be done consistently):
https://www.youtube.com/watch?v=Tn-A7eCUrYk
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Re: Rob Arnott:index Investors Buy High, Sell Low

Post by selters » Fri May 18, 2018 10:59 am

https://www.bloomberg.com/news/videos/2 ... lion-video

Is the fact that the VTI managers are able to track the fund's benchmark index perfectly (not underperform it by its expense ratio) due to dumb luck? Even if you account for securities lending revenue of two basis points, VTI still performs two basis points better than you would expect. Maybe it's dumb luck, but I doubt it. I think there are some market inefficiences that can be exploited. Vanguard has found some of them and they manage to eke out a whopping two basis points a year of extra annual performance. I'm sure other players in the market have found other inefficiencies of about the same magnitude that they are able to exploit.

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Re: Rob Arnott:index Investors Buy High, Sell Low

Post by Random Walker » Fri May 18, 2018 11:02 am

I think the argument stating that the use of active management to overcome these potential weaknesses of pure indexing is a bit of a straw man. The real comparison should be to passive funds that are willing to accept a little tracking error to overcome the weaknesses of pure indexes.

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Re: Rob Arnott:index Investors Buy High, Sell Low

Post by nisiprius » Fri May 18, 2018 2:31 pm

Random Walker wrote:
Fri May 18, 2018 11:02 am
I think the argument stating that the use of active management to overcome these potential weaknesses of pure indexing is a bit of a straw man. The real comparison should be to passive funds that are willing to accept a little tracking error to overcome the weaknesses of pure indexes.

Dave
Would you be thinking of "passive funds that are willing to accept a little tracking error" in general, or would you be thinking specifically of Dimensional Fund Advisors (DFA?) I ask because DFA is the only fund family I personally am aware of that does this. What other fund families did you have in mind? Well, DFA is the one I know, so I'll use DFA. Did DFA achieve a big advantage by accepting a little tracking error?

The most suitable comparison to an S&P 500 index fund would appear to be the DFA US Large Company Portfolio, DFUSX. Except that it literally is an S&P 500 index fund. For the record, since inception, DFUSX actually did outperform both the Vanguard 500 index Fund, VFIAX and the S&P 500 index itself. Since inception, the CAGRs were: 6.11% for DFUSX, 6.02% for the S&P 500 index itself, and 6.00% for VFIAX.

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The most direct comparison that would show the benefit of "accepting a little tracking error" would be, I think, the DFA US Large-Cap Equity Portfolio, DUSQX. Would you suggest something else as the most suitable comparison to an S&P 500 index fund? They say it benchmarks to the Russell 1000.

P.S. To avoid any issues about DFUSX benchmarking to the Russell 1000 instead of the S&P 500, I added a Russell 1000 pure index ETF, Vanguard's Russell 1000 ETF, VONE, in green, to the comparison.

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Blue, DFA Large-Cap Equity Portfolio
Orange, Vanguard 500 Index Fund
Green, Vanguard Russell 1000 ETF
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For something that covers a longer period of time, we can compare the DFA US Core Equity 1 Portfolio, which benchmarks to the Russell 3000 (i.e. DFA says it should be compared to a total market index), to the Vanguard Total Stock Market Index Fund.

Blue, DFA US Core Equity 1 Portfolio
Orange, Vanguard Total Stock Market Index Fund

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In the DFA counterparts to an S&P 500 index fund or a total market index fund, "accepting a little tracking error" did not lead to huge performance improvements.

Footnote: Furthermore, although the DFA total market fund, indeed outperformed the true index fund, it also had a higher standard deviation, and according to PortfolioVisualizer, the Vanguard Total Market Index Fund had a (microscopically! negligibly!) higher Sharpe ratio than the DFA fund. Small differences in risk usually aren't evident to the eye, not as evident as differences in return; but very often when you take them into account, outperformance fades or vanishes completely.

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Re: Rob Arnott:index Investors Buy High, Sell Low

Post by matjen » Fri May 18, 2018 3:16 pm

nisiprius wrote:
Fri May 18, 2018 10:27 am
It's more important to keep your CVS ExtraBucks coupons organized.
Hilarious! Perhaps that should be a factor? :-)
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Re: Rob Arnott:index Investors Buy High, Sell Low

Post by Zhen » Fri May 18, 2018 6:36 pm

If you believe the stock market is efficient or roughly efficient, his point can not be valid. With thousands of institutional & professional investors keep keen eyes on S&P500 stocks, I wonder why anyone of those stocks will be purposely priced over or under their values?

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Re: Rob Arnott:index Investors Buy High, Sell Low

Post by galeno » Fri May 18, 2018 7:25 pm

False. When I rebalance our portfolio I buy low and sell high. Automatically.

It's true that some people are able to "front run" a stock that's about to be added to an index.
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Re: Rob Arnott:index Investors Buy High, Sell Low

Post by nisiprius » Fri May 18, 2018 8:04 pm

galeno wrote:
Fri May 18, 2018 7:25 pm
False. When I rebalance our portfolio I buy low and sell high. Automatically.

It's true that some people are able to "front run" a stock that's about to be added to an index.
Except that modern indexes make this hard to do. Index providers have been doing things like this since at least the year 2000.

For example, Vanguard's index provider, CRSP, says:
CRSP uses the closing price for all eligible securities on a “random price day” to determine the company’s total market capitalization used at ranking. The random price day is selected algorithmically from the seven trading days immediately prior to the ranking day according to the following convention:
▪ The two days with the highest aggregate absolute price moves (using the CRSP US Total Market Index as the point of reference) are excluded.
▪ The two days with the lowest aggregate trading volume (using the CRSP US Total Market Index as the point of reference) are excluded.
▪ The excluded days above may overlap.
▪ The remaining days will be used to randomly select the random price day.
I think what this means is that people know what day new stocks will be added, but do not know exactly which stocks will be added, because their market capitalization is calculated on a randomized day.
Last edited by nisiprius on Fri May 18, 2018 8:18 pm, edited 2 times in total.
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Re: Rob Arnott:index Investors Buy High, Sell Low

Post by AlohaJoe » Fri May 18, 2018 8:13 pm

nisiprius wrote:
Fri May 18, 2018 2:31 pm
Would you be thinking of "passive funds that are willing to accept a little tracking error" in general, or would you be thinking specifically of Dimensional Fund Advisors (DFA?) I ask because DFA is the only fund family I personally am aware of that does this.
FWIW, Vanguard does this, too. Their new factor funds are "active but passive, non-index funds" specifically to add flexibility around tracking an index. I'm not positive but I think Goldman Sachs also lets themselves have a lot of tracking error relative to the indexes they follow. (I can't imagine their actually that bad at tracking an index accidentally.....)

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Re: Rob Arnott:index Investors Buy High, Sell Low

Post by nisiprius » Fri May 18, 2018 8:15 pm

AlohaJoe wrote:
Fri May 18, 2018 8:13 pm
nisiprius wrote:
Fri May 18, 2018 2:31 pm
Would you be thinking of "passive funds that are willing to accept a little tracking error" in general, or would you be thinking specifically of Dimensional Fund Advisors (DFA?) I ask because DFA is the only fund family I personally am aware of that does this.
FWIW, Vanguard does this, too. Their new factor funds are "active but passive, non-index funds" specifically to add flexibility around tracking an index. I'm not positive but I think Goldman Sachs also lets themselves have a lot of tracking error relative to the indexes they follow. (I can't imagine their actually that bad at tracking an index accidentally.....)
Thanks.
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Re: Rob Arnott:index Investors Buy High, Sell Low

Post by stlutz » Fri May 18, 2018 8:18 pm

One can also run a factor regression to see to what extent their chosen index fund has "unexplained" returns--a.k.a. negative or positive alpha.

Here I compare the VG Smallcap index fund, the iShares Russell 2000 ETF, and the DFA Smallcap fund:

https://www.portfoliovisualizer.com/fac ... sion=false

The results are what I would expect. There was some performance leak for the R-2000 ETF. The VG and DFA funds look just fine.

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Re: Rob Arnott:index Investors Buy High, Sell Low

Post by dumbmoney » Fri May 18, 2018 9:00 pm

To me the ideal passive stock market fund would be one that never, ever trades. That's even better than an index fund that trades smartly. The only downside is a gradual loss of diversification, which is meaningless over a human lifetime.
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Re: Rob Arnott:index Investors Buy High, Sell Low

Post by AlohaJoe » Fri May 18, 2018 9:23 pm

dumbmoney wrote:
Fri May 18, 2018 9:00 pm
To me the ideal passive stock market fund would be one that never, ever trades. That's even better than an index fund that trades smartly. The only downside is a gradual loss of diversification, which is meaningless over a human lifetime.
Why is that ideal?

So it never bought Amazon or Facebook when they IPOed? Or Apple or Microsoft or Lowe's or Dominos or Southwest Air or....? I don't see how that is ideal to never buy new stocks and add them to the fund. Instead you have only the public companies that were already public when Vanguard's Total Stock Market Fund was created in 1992.

If you think that doesn't have a meaningful impact on your returns, you are wrong.

Oh, also you can't buy shares of it. Because if you send them money, they aren't allowed to trade and buy more shares of the underlying companies. You also aren't allowed to take money out, because that would require them to trade.

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Re: Rob Arnott:index Investors Buy High, Sell Low

Post by dumbmoney » Fri May 18, 2018 9:35 pm

AlohaJoe wrote:
Fri May 18, 2018 9:23 pm
dumbmoney wrote:
Fri May 18, 2018 9:00 pm
To me the ideal passive stock market fund would be one that never, ever trades. That's even better than an index fund that trades smartly. The only downside is a gradual loss of diversification, which is meaningless over a human lifetime.
Why is that ideal?
Lowest cost.
AlohaJoe wrote:
Fri May 18, 2018 9:23 pm
So it never bought Amazon or Facebook when they IPOed? Or Apple or Microsoft or Lowe's or Dominos or Southwest Air or....? I don't see how that is ideal to never buy new stocks and add them to the fund. Instead you have only the public companies that were already public when Vanguard's Total Stock Market Fund was created in 1992.
That's fine. You also miss the losers.
AlohaJoe wrote:
Fri May 18, 2018 9:23 pm
If you think that doesn't have a meaningful impact on your returns, you are wrong.
Well, it will have some effect, but not a predictable one.
AlohaJoe wrote:
Fri May 18, 2018 9:23 pm
Oh, also you can't buy shares of it. Because if you send them money, they aren't allowed to trade and buy more shares of the underlying companies. You also aren't allowed to take money out, because that would require them to trade.
Not true of ETFs (that use in-kind creation/redemption).
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Re: Rob Arnott:index Investors Buy High, Sell Low

Post by Taylor Larimore » Fri May 18, 2018 9:58 pm

Bogleheads:
‘I wish I was as sure of anything as he is of everything.’ —Vanguard founder John C. Bogle, speaking of Rob Arnott
I hope this link to today's The Wall Street Journal article works:

Rob Arnott, ‘Godfather of Smart Beta,’ Tells Investors: You’re Doing It Wrong

Best wishes.
Taylor
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Re: Rob Arnott:index Investors Buy High, Sell Low

Post by Grogs » Fri May 18, 2018 10:44 pm

Aren't VG and the other large fund companies allowed to swap stocks between funds? Seems like that would take most of the wind out of the sails of people trying to front run the S&P500 index. When company number 500 drops out of the index, they can transfer most of it to a completion index. Likewise, when company 501 moves up, they can transfer it from the completion index fund to the S&P 500 fund. Most likely they hold the S&P stocks overweight relative to the total market, but it would seriously reduce the number of additional shares they would need to buy.

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Re: Rob Arnott:index Investors Buy High, Sell Low

Post by JoMoney » Fri May 18, 2018 11:49 pm

Grogs wrote:
Fri May 18, 2018 10:44 pm
Aren't VG and the other large fund companies allowed to swap stocks between funds? Seems like that would take most of the wind out of the sails of people trying to front run the S&P500 index. When company number 500 drops out of the index, they can transfer most of it to a completion index. Likewise, when company 501 moves up, they can transfer it from the completion index fund to the S&P 500 fund. Most likely they hold the S&P stocks overweight relative to the total market, but it would seriously reduce the number of additional shares they would need to buy.
I believe what you're talking about is called "cross trading", it does happen at a lot of fund companies , and does theoretically reduce commission costs of trading , but the funds participating in it do need to make sure the transaction is occurring at the fair market price, which may be elevated or reduced if there is a change in volume/liquidity in that stock due to supply and demand of the market which can be impacted by changes to an index.
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Re: Rob Arnott:index Investors Buy High, Sell Low

Post by AlohaJoe » Sat May 19, 2018 12:04 am

Grogs wrote:
Fri May 18, 2018 10:44 pm
Aren't VG and the other large fund companies allowed to swap stocks between funds? Seems like that would take most of the wind out of the sails of people trying to front run the S&P500 index.
Fair point. I don't know how much of an effect that has. Just looking at the most recent iShares Core MSCI Emerging Markets semi-annual report they cross-traded

$33 million in purchases out of a total of $6.3 billion (one half of 1%)
$87 million in sales out of a total of $774 million (11%)

So they seem to do way more cross trading on sales than purchases. I don't know what that really means though :happy

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Re: Rob Arnott:index Investors Buy High, Sell Low

Post by Lauretta » Sat May 19, 2018 3:30 am

AlohaJoe wrote:
Sat May 19, 2018 12:04 am

Fair point. I don't know how much of an effect that has. Just looking at the most recent iShares Core MSCI Emerging Markets semi-annual report they cross-traded

$33 million in purchases out of a total of $6.3 billion (one half of 1%)
$87 million in sales out of a total of $774 million (11%)

So they seem to do way more cross trading on sales than purchases. I don't know what that really means though :happy
Well it seems to me that if that ETF has done way more cross trading on sales than purchases, then there must be other iShares ETFs that have done way more cross trading on purchasing, to acquire the stocks that exited from the Core MSCI Emerging Markets ETF. Overall it must be a zero sum game, unless I am missing something.
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Re: Rob Arnott:index Investors Buy High, Sell Low

Post by JoMoney » Sat May 19, 2018 3:51 am

Lauretta wrote:
Sat May 19, 2018 3:30 am
AlohaJoe wrote:
Sat May 19, 2018 12:04 am

Fair point. I don't know how much of an effect that has. Just looking at the most recent iShares Core MSCI Emerging Markets semi-annual report they cross-traded

$33 million in purchases out of a total of $6.3 billion (one half of 1%)
$87 million in sales out of a total of $774 million (11%)

So they seem to do way more cross trading on sales than purchases. I don't know what that really means though :happy
Well it seems to me that if that ETF has done way more cross trading on sales than purchases, then there must be other iShares ETFs that have done way more cross trading on purchasing, to acquire the stocks that exited from the Core MSCI Emerging Markets ETF. Overall it must be a zero sum game, unless I am missing something.
Well, it could include securities owned in the companies inventory, which could be for reasons of liquidity and market making and have beneficial purposes but also raise questions.
http://www.biz.uiowa.edu/faculty/atiwar ... rading.pdf
...we find that different measures of cross trading (total, principal, and agency cross trading) are significantly negatively related to the performance of adviser fund portfolios...
...The insensitivity of flows to different TCT measures may in part reflect a lack of investor attention to, or appreciation for, the adverse impact of such conflicts on client fund performance...
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Re: Rob Arnott:index Investors Buy High, Sell Low

Post by Lauretta » Sat May 19, 2018 4:20 am

JoMoney wrote:
Sat May 19, 2018 3:51 am
Lauretta wrote:
Sat May 19, 2018 3:30 am
AlohaJoe wrote:
Sat May 19, 2018 12:04 am

Fair point. I don't know how much of an effect that has. Just looking at the most recent iShares Core MSCI Emerging Markets semi-annual report they cross-traded

$33 million in purchases out of a total of $6.3 billion (one half of 1%)
$87 million in sales out of a total of $774 million (11%)

So they seem to do way more cross trading on sales than purchases. I don't know what that really means though :happy
Well it seems to me that if that ETF has done way more cross trading on sales than purchases, then there must be other iShares ETFs that have done way more cross trading on purchasing, to acquire the stocks that exited from the Core MSCI Emerging Markets ETF. Overall it must be a zero sum game, unless I am missing something.
Well, it could include securities owned in the companies inventory, which could be for reasons of liquidity and market making and have beneficial purposes but also raise questions.
http://www.biz.uiowa.edu/faculty/atiwar ... rading.pdf
...we find that different measures of cross trading (total, principal, and agency cross trading) are significantly negatively related to the performance of adviser fund portfolios...
...The insensitivity of flows to different TCT measures may in part reflect a lack of investor attention to, or appreciation for, the adverse impact of such conflicts on client fund performance...
Thanks for the feedback! However, please correct me if I am wrong; in this thread I understood cross trading to mean that a company like Vanguard or BlackRock will not buy or sell new stocks that need to enter an ETF (let's call it ETF1); instead, they will transfer them from another ETF (say ETF2). So a stock exits from ETF2 and enters ETF1, with no trading costs. Is that so?
In the article you gave a link to, cross trading is instead defined as follows
Cross trading refers to transactions
between the fund adviser or its affiliated broker, and one or more client funds, or transactions among
multiple client funds in which the adviser acts as an intermediary.
So this seems to refer to a different context altogether.
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Re: Rob Arnott:index Investors Buy High, Sell Low

Post by JoMoney » Sat May 19, 2018 5:56 am

Lauretta wrote:
Sat May 19, 2018 4:20 am
...
Thanks for the feedback! However, please correct me if I am wrong; in this thread I understood cross trading to mean that a company like Vanguard or BlackRock will not buy or sell new stocks that need to enter an ETF (let's call it ETF1); instead, they will transfer them from another ETF (say ETF2). So a stock exits from ETF2 and enters ETF1, with no trading costs. Is that so?
In the article you gave a link to, cross trading is instead defined as follows
Cross trading refers to transactions
between the fund adviser or its affiliated broker, and one or more client funds, or transactions among
multiple client funds in which the adviser acts as an intermediary.
So this seems to refer to a different context altogether.
You would have to find out from the company facilitating the transaction whether or not there is a fee involved. It might have a benefit of not creating a market impact, and might have no or lower commission fees for facilitating it, but you would have to dig into the weeds to find out.
I was just pointing out that cross-trading could involve other types of transactions where the defining factor seems to be that the transaction isn't occurring on the open market but is being kept in-house.
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Re: Rob Arnott:index Investors Buy High, Sell Low

Post by Lauretta » Sat May 19, 2018 6:11 am

Taylor Larimore wrote:
Fri May 18, 2018 9:58 pm
Bogleheads:
‘I wish I was as sure of anything as he is of everything.’ —Vanguard founder John C. Bogle, speaking of Rob Arnott
I do agree that excessive confidence in investing, which is an area inherently riddled with uncertainty, is unhealthy.
However, it seems to me that those who advocate a market cap based allocation and think that any deviation from it is speculation (which would make, say, the Larry Swedroe portfolio a speculation) might also be excessively confident in their views.
I have not been able to find a satisfactory reason why indexing based on market cap should have some sort of pre-eminence on other strategies (except that it's scalable and it's cheaper because of lower turnover).
I found a reply to one of my comments on this subject in another thread quite revealing; it said:
Cap-weighted total market indexing is not just a strategy like any other. (Sea level is not just "a level like any other.") It may not be the best strategy by some criterion, it may not have an inherent "pre-eminence," but it does have an inherent special status because of mathematical theorems in financial economics about the market portfolio.
It seems to me that those who are not familiar with science and the scientific method, simply feel that the use of some maths makes financial economists more trustworthy. Mathematics and scientific jargon provide some appearance of rigor to the subject (the same has been the case for other academic subjects in the humanities that have been treated 'scientifically' to make them seem more rigorous), unless one realizes the truth of Shiller's statement that passive investment (and much of the theory behind it) is really a pseudo-science.
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Re: Rob Arnott:index Investors Buy High, Sell Low

Post by JoMoney » Sat May 19, 2018 6:50 am

^ The 'math' of the total market, has the advantage that it starts with a unity. We can add up an entire market and describe the whole consistently across time. We can make statements about the aggregate even if we don't really know much about the individual pieces and how their risks, returns, etc... will form together to create that aggregate result across time, but we know as a whole they will. We don't know all the risks in stocks, we don't know what the future returns will be, but we do know if there is a portfolio that out-performs the whole, it has to be matched by one that is under-performing, and that fees absolutely subtract from the aggregate.
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Re: Rob Arnott:index Investors Buy High, Sell Low

Post by Lauretta » Sat May 19, 2018 7:09 am

JoMoney wrote:
Sat May 19, 2018 6:50 am
We don't know all the risks in stocks, we don't know what the future returns will be, but we do know if there is a portfolio that out-performs the whole, it has to be matched by one that is under-performing, and that fees absolutely subtract from the aggregate.
Yes this very basic arithmetic is undeniable. But since empirically we find that small, value, momentum and quality stocks have outperformed over the long haul; one can suppose that if they invest in those, they will likely have higher than market resutls, because the stocks having the opposite characteristic will likely have lower than market results.
Also if an active manager beats the marker (e.g. by taking advantage of unsophisticated individual investors) by an amount which is superior to the fund's fees, they will have higher than market returns. So that simple arithmetic doesn't tell me that much.

The same person who made that very simple and down to earth argument also made other proofs, suchs as the market portfolio being on the efficient frontier. This appears to be more debateable as you surely know. Indeed a number of academics have voiced some doubts on CAPM:
https://papers.ssrn.com/sol3/papers.cfm ... id=2980847
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Re: Rob Arnott:index Investors Buy High, Sell Low

Post by JoMoney » Sat May 19, 2018 7:22 am

Lauretta wrote:
Sat May 19, 2018 7:09 am
... Yes this very basic arithmetic is undeniable. But since empirically we find that small, value, momentum and quality stocks have outperformed over the long haul; one can suppose that if they invest in those, they will likely have higher than market resutls, because the stocks having the opposite characteristic will likely have lower than market results.
Also if an active manager beats the marker (e.g. by taking advantage of unsophisticated individual investors) by an amount which is superior to the fund's fees, they will have higher than market returns. So that simple arithmetic doesn't tell me that much.

The same person who made that very simple and down to earth argument also made other proofs, suchs as the market portfolio being on the efficient frontier. This appears to be more debateable as you surely know. Indeed a number of academics have voiced some doubts on CAPM:
https://papers.ssrn.com/sol3/papers.cfm ... id=2980847
Personally, I'm skeptical of most of it, including the strong forms of the "Efficient Market Hypothesis". I'm actually more concerned about actors in the market that do act on asymmetric information, whether about the securities themselves, or about human behavior, and selling people stories convincing them to pay for things they don't need, or take on risks they don't really understand.
But low-cost broad-market passive investing is appealing whether the market is efficient or not:
The Inefficient Market Argument for Passive Investing
... the argument for indexing is even stronger for individual investors if the stock market is not efficient. The game of poker provides, in some respects, an instructive analogy. Poker is a zero sum game, similar to active investing compared to indexing, and poker combines luck and skill, consistent with the assumption of a less than perfectly efficient market. An old adage among professional poker players applies to those deciding to participate in the active investing game. "If you don't know who the mark is, get up and leave the table, because it's you."
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Re: Rob Arnott:index Investors Buy High, Sell Low

Post by Lauretta » Sat May 19, 2018 7:39 am

JoMoney wrote:
Sat May 19, 2018 7:22 am

But low-cost broad-market passive investing is appealing whether the market is efficient or not:
The Inefficient Market Argument for Passive Investing
... the argument for indexing is even stronger for individual investors if the stock market is not efficient. The game of poker provides, in some respects, an instructive analogy. Poker is a zero sum game, similar to active investing compared to indexing, and poker combines luck and skill, consistent with the assumption of a less than perfectly efficient market. An old adage among professional poker players applies to those deciding to participate in the active investing game. "If you don't know who the mark is, get up and leave the table, because it's you."
I agree. That's a good point.
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Re: Rob Arnott:index Investors Buy High, Sell Low

Post by Lauretta » Tue May 22, 2018 3:27 pm

Just came across an interesting Credit Suisse report, whose conclusions echo some of the points raised in the piece by Arnott. Mauboussin et al. conclude:
Using historical numbers, investors who bought the stocks that the committee removed from the S&P 500
(that still traded) and who sold short the stocks entering the S&P 500 would have earned a tidy excess return. It appears the S&P 500 committee
behaves in a way that many investors do: It buys high and sells low.
Here's the link
https://research-doc.credit-suisse.com/ ... Muuz0FI%3D
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Re: Rob Arnott:index Investors Buy High, Sell Low

Post by JoMoney » Tue May 22, 2018 5:01 pm

Lauretta wrote:
Tue May 22, 2018 3:27 pm
Just came across an interesting Credit Suisse report, whose conclusions echo some of the points raised in the piece by Arnott. Mauboussin et al. conclude:
Using historical numbers, investors who bought the stocks that the committee removed from the S&P 500
(that still traded) and who sold short the stocks entering the S&P 500 would have earned a tidy excess return. It appears the S&P 500 committee
behaves in a way that many investors do: It buys high and sells low.
Here's the link
https://research-doc.credit-suisse.com/ ... Muuz0FI%3D
...and yet, over roughly the same period, the S&P 500 outperformed 92% of other U.S. Large-Cap equity funds (15 year period 2001-2016).
https://us.spindices.com/documents/spiv ... d-2017.pdf
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Re: Rob Arnott:index Investors Buy High, Sell Low

Post by jalbert » Tue May 22, 2018 5:07 pm

And keep in mind that Rob Arnott’s research and company products are predicated on his view expressed in that article being correct.
Risk is not a guarantor of return.

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Re: Rob Arnott:index Investors Buy High, Sell Low

Post by willthrill81 » Tue May 22, 2018 5:10 pm

Rick Ferri wrote:
Fri May 18, 2018 9:36 am
If Rob is right, and this buy-high sell-low phenomenon in the markets is so easy to avoid, where is the outperformance by active managers?
For one, the number of potential investment strategies is infinite, whereas there are only a finite number of active managers. Every potential strategy cannot be followed by someone.

Second, just because a strategy has worked in the past does not necessarily mean that an investor purportedly employing that strategy has been equally successful (e.g. failure to consistently follow that strategy). On one level, strategies should be evaluated independently of those who purport to follow them.

Third, the question assumes that active managers are aware of any and all possible means of effective outperforming the market. This is obviously impossible for human beings with finite minds to achieve.
Last edited by willthrill81 on Tue May 22, 2018 5:14 pm, edited 1 time in total.
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Re: Rob Arnott:index Investors Buy High, Sell Low

Post by willthrill81 » Tue May 22, 2018 5:13 pm

jalbert wrote:
Tue May 22, 2018 5:07 pm
And keep in mind that Rob Arnott’s research and company products are predicated on his view expressed in that article being correct.
The same could be said of anyone with any vested interest in their advice, including every financial advisor out there.
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Re: Rob Arnott:index Investors Buy High, Sell Low

Post by david1082b » Tue May 22, 2018 5:36 pm

Lauretta wrote:
Tue May 22, 2018 3:27 pm
Just came across an interesting Credit Suisse report, whose conclusions echo some of the points raised in the piece by Arnott. Mauboussin et al. conclude:
Using historical numbers, investors who bought the stocks that the committee removed from the S&P 500
(that still traded) and who sold short the stocks entering the S&P 500 would have earned a tidy excess return. It appears the S&P 500 committee
behaves in a way that many investors do: It buys high and sells low.
Here's the link
https://research-doc.credit-suisse.com/ ... Muuz0FI%3D
Plain total US market indexes have performed almost identically to the S&P 500 over the long haul. The criticisms of the "S&P committee" don't seem to add up to much to me.

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Re: Rob Arnott:index Investors Buy High, Sell Low

Post by DVMResident » Tue May 22, 2018 5:47 pm

Rick Ferri wrote:
Fri May 18, 2018 9:36 am
Don't listen to the arguments. Look at the data. If Rob is right, and this buy-high sell-low phenomenon in the markets is so easy to avoid, where is the outperformance by active managers?
Can we call this question the Ferri paradox?

The Fermi paradox of the investing world :wink:

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Re: Rob Arnott:index Investors Buy High, Sell Low

Post by jalbert » Tue May 22, 2018 6:50 pm

willthrill81 wrote:
Tue May 22, 2018 5:13 pm
jalbert wrote:
Tue May 22, 2018 5:07 pm
And keep in mind that Rob Arnott’s research and company products are predicated on his view expressed in that article being correct.
The same could be said of anyone with any vested interest in their advice, including every financial advisor out there.
Yes, when someone profits from acceptance of their position, particularly when it cuts against conventional wisdom, one should approach with caution.
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Re: Rob Arnott:index Investors Buy High, Sell Low

Post by Artsdoctor » Tue May 22, 2018 7:33 pm

nisiprius wrote:
Fri May 18, 2018 10:27 am

"the icky-poo S&P 500" . . .




Do NOT tell my mother that I mismanaged her money by tax-loss harvesting into Vanguard's "icky-poo S&P 500" fund . . .

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Re: Rob Arnott:index Investors Buy High, Sell Low

Post by nisiprius » Tue May 22, 2018 8:30 pm

dumbmoney wrote:
Fri May 18, 2018 9:35 pm
AlohaJoe wrote:
Fri May 18, 2018 9:23 pm
dumbmoney wrote:
Fri May 18, 2018 9:00 pm
To me the ideal passive stock market fund would be one that never, ever trades. That's even better than an index fund that trades smartly. The only downside is a gradual loss of diversification, which is meaningless over a human lifetime.
Why is that ideal?
Lowest cost.
You mean like the Voya Corporate Leaders Trust, LEXCX, the only fund I know of that does that... which has an expense ratio of 0.59%? "In theory, there is no difference between theory and practice, but in practice, there is."

(And, incidentally, LEXCX has experienced style drift from large value to large blend during a "human lifetime," which is not very important, but not totally "meaningless.")

LEXCX has done well. (It is hard to know what to compare it with. It has beaten S&P 500 and total market index funds, but it has basically tied the Dow Jones tracking ETF, DIA, since inception of DIA).

Added: See JoMoney's post immediately below. But the goal of passive investing is not passivity in the sense of no transactions, the goal is to replicate the "market portfolio." In the case of a total market index fund, transaction costs are not zero but are very low because stocks only need to be bought or sold at times when their market capitalization is very low.
Last edited by nisiprius on Wed May 23, 2018 6:01 am, edited 1 time in total.
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Re: Rob Arnott:index Investors Buy High, Sell Low

Post by JoMoney » Tue May 22, 2018 9:37 pm

nisiprius wrote:
Tue May 22, 2018 8:30 pm
...But the goal of passive investing is not passivity in the sense of no transactions, the goal is to replicate the "market portfolio."...
I'm not sure if I agree with that or not :-?
Something about that definition rubs a little bit funny.
The idea of "passive investing" has been around long before one could actually replicate the "market portfolio", and seems to me the passivity was in not making frequent decisions
Benjamin Graham in The Intelligent Investor wrote:... The defensive (or passive) investor will place his chief emphasis on the avoidance of serious mistakes or losses. His second aim will be freedom from effort, annoyance, and the need for making frequent decisions. ..
But at the same time, the expectation for a passive investor was to garner average returns and not taking unusual risks, and it's hard to argue against the "market portfolio" being the embodiment of that.
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Re: Rob Arnott:index Investors Buy High, Sell Low

Post by Epsilon Delta » Tue May 22, 2018 9:51 pm

nisiprius wrote:
Fri May 18, 2018 8:04 pm
galeno wrote:
Fri May 18, 2018 7:25 pm
False. When I rebalance our portfolio I buy low and sell high. Automatically.

It's true that some people are able to "front run" a stock that's about to be added to an index.
Except that modern indexes make this hard to do. Index providers have been doing things like this since at least the year 2000.

For example, Vanguard's index provider, CRSP, says:
CRSP uses the closing price for all eligible securities on a “random price day” to determine the company’s total market capitalization used at ranking. The random price day is selected algorithmically from the seven trading days immediately prior to the ranking day according to the following convention:
▪ The two days with the highest aggregate absolute price moves (using the CRSP US Total Market Index as the point of reference) are excluded.
▪ The two days with the lowest aggregate trading volume (using the CRSP US Total Market Index as the point of reference) are excluded.
▪ The excluded days above may overlap.
▪ The remaining days will be used to randomly select the random price day.
I think what this means is that people know what day new stocks will be added, but do not know exactly which stocks will be added, because their market capitalization is calculated on a randomized day.
It's hard to believe that that prevents front running. There really isn't a lot of random here. The final result is selected from three to five possibilities, and there is likely to be a lot of overlap between them, at least sometimes.

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Re: Rob Arnott:index Investors Buy High, Sell Low

Post by heyyou » Tue May 22, 2018 10:23 pm

Yes, perhaps there will always be a theoretical more optimal way, but is anyone complaining that their old-fashioned index funds have not done well enough, that they couldn't afford to retire just due to missing both of those basis points? This would be a pretty slow board if we just accepted what we have, without greedily wishing we had more due to some new, special procedure. Folks, current indexing is more than good enough (thank you Jack) even if it possibly has some hidden minute imperfections, such as mentioned in this topic.

How much extra should be saved to overcome the drag of those missing basis points? A dollar a day or a dollar a week, for thirty years prior to retiring with a two comma portfolio?

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Re: Rob Arnott:index Investors Buy High, Sell Low

Post by Lauretta » Wed May 23, 2018 5:24 am

JoMoney wrote:
Tue May 22, 2018 9:37 pm
Benjamin Graham in The Intelligent Investor wrote:... The defensive (or passive) investor will place his chief emphasis on the avoidance of serious mistakes or losses. His second aim will be freedom from effort, annoyance, and the need for making frequent decisions. ..
But at the same time, the expectation for a passive investor was to garner average returns and not taking unusual risks, and it's hard to argue against the "market portfolio" being the embodiment of that.
I like the Graham quote a lot. To me having a barbell portofolio (in the spirit of the Larry Swedroe portfolio) with one part in very safe assets (like TIPS for US investors or CDs at the moment for us in Europe) and one part with a strong tilt to those parts of the market with higher expected returns (like EM or SCV) fulfils the role of avoiding effort, annoyance and serious mistakes, and protects more from black swan events than a traditional stock bonds portfolio.
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