Investing in the real world faces a number of challenges, one of which is the human inclination for juicing returns, beating the crowd and (hopefully) delivering results that make for engaging conversation at cocktail parties. In practice, however, stuff happens that alter the best laid plans of mice, men and, yes, even mutual fund managers.
The latter come to mind after reading a story in today’s Wall Street Journal (subscription required), which reports, “Mutual-fund companies are proposing big investment-policy changes this year, with many asking shareholders for permission to put more of their money into foreign stocks and real estate just as those once-hot investments are slowing down.”
Opportunities often appear brighter elsewhere for active managers, particularly those wedded to the relatively efficient world of domestic stocks. It’s getting harder to look good by swimming in mid- and large-cap American equities. The realities of expenses, trading costs, taxes and unexpected events conspire to turn an otherwise impressive paper strategy into something less by the time the net results filter down to the end user–i.e., you and me. The challenge isn’t limited to U.S. stocks, although arguably it burns brightest there.

For those who agree, index funds are an obvious alternative. There is a long list of reasons for using index funds. By our reckoning, the case is overwhelming, or so the real-world results inform us. We won’t revisit the details here, other than to note that today’s Journal article provides one more reason to consider passive investing.
Indeed, one has to step back and ask, Why would a manager want to expand the mandate of the existing policy? A forgiving answer may be that the world of opportunities has expanded and therefore so should the manager’s capacity for exploiting those opportunities. There are, however, competing theories as to what’s behind the motivations. That includes the possibility that the manager’s track record isn’t all that impressive of late and so something new is required.
There are several ways one could potentially improve a lackluster record. One, work harder and/or hire better managers. Two, look to more fertile investment fields. The latter seems to be the preferred route of late, or so the Journal article suggests. Adding the capacity to trade foreign stocks, real estate securities and even commodities are among the favored changes on the docket of late. Franklin Templeton, for instance, reportedly held a meeting last week on proposals for altering fund rules on borrowing, lending and commodities limits in some 30 funds.
Theoretically, we don’t have a problem with such ideas. For all we know, the changes mean that fund companies are poised to enhance the return/reward profiles of their portfolios. Hope springs eternal.
We’re second to none in expanding one’s asset allocation horizons when it comes to incorporating more asset classes in search of superior risk-adjusted returns. That said, our preferred approach to an enlightened mix of low and negatively correlated asset classes is through low-cost index funds that target a broad definition of their respective investment quarry.
For example, owning a low-cost Russell 3000 index fund for tapping U.S. equity returns is eminently reasonable to our way of thinking. There are several reasons, and one that stands out at the moment is the expectation that such a fund will deliver what it claims today, tomorrow, next year and so on. From a strategic, asset allocation-crafting perspective, that’s a plus–a big plus.
A Russell 3000 fund won’t ask shareholders to add commodities to the mandate, or ask for the ability to add long/short strategies next month. We may be in the minority, but we prize the long-term strategic visibility that flows from owning a Russell 3000 fund. Building asset allocation strategies is hard enough with the individual components changing direction with every turn in the investment cycle.
Granted, a Russell 3000 fund may or may not excite at any given time. Fortunately, a Russell 3000 index is but one piece of a broader asset allocation puzzle. It’s the pie overall, not the slices, that engage us. That said, strategic success demands that each one of the slices is robust, consistent and generally effective at delivering the targeted beta.
As readers of this site know, we’re of a mind to own multiple asset classes via broad index funds on a routine basis over time. The crux of the challenge (and potential opportunity) comes from spending time choosing strategic weights among the asset classes and opportunistically rebalancing when the weights move sharply away (up or down) from the targets.
Simple though such a strategy sounds, it’s fairly complex in practice. The point, however, is this: there’s enough opportunity in such an index-based strategy to offer satisfaction for investors of all risk tolerances. And as the financial services industry adds new index funds tapping formerly untapped asset classes, the opportunities continue to improve.
In short, we have our hands full with our preferred strategy. Adding in the active manager factor only makes the job that much tougher and, we suspect, marginally less productive over time. We take no comfort from the possibility that active managers can potentially change strategic directions mid-way through the horse race, as the Journal article reminds.


  1. Bob Shaffer

    I enjoy you comments very much. I look forward to them every day. Thanks for all the hard work that goes into producing your daily letter.
    After many years of ups and downs in investment returns I’m just starting to see the wisdom of the index philosopy. Thanks for driving it home once agin.

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