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What Does Research Have To Do With Stock Index Performance? Everything…

What Does Research have to do with Stock Index Performance? Everything…

Some thirty-seven years ago, John Bogle launched the first passive index based on the S&P 500 as a mutual fund. In the process, he democratized the investment process by offering access to a universe of stocks used by many of the largest institutional money managers in the world as their performance benchmark without the cost of active management. Fast forward to today and the managed fund terrain is awash in new index products, some even derivative based, traded as ETFs. The old adage that investors used for years: buy and hold seems to have disappeared especially when looking at daily ETF trading volumes. Yet, some still do invest in ETF indices for the long haul.

One thing is certain, however. Investors now look at investment expenses with a different eye. What if a stock index fund could be bought as a buy and hold but also factored in re-balancing as part of the equation. Is there room in the equity index world for an index that combines low expense ratios with passive / active management that is equally weighted and outperforms a widely accepted benchmark?

MarketGrader thinks so and to prove its point developed the Barron's 400 Index for Dow Jones along with 14 proprietary indices of its own. In the case of the Barron's 400, the Index was designed to outperform the S&P 500 doing so handily over the last ten years.

Key to the Barron's 400 outperformance of the S&P 500 has been the use of MarketGrader's research to optimize portfolio holdings. Twice a year, the Barron's 400 Index is rebalanced in accordance with strict portfolio construction rules that use ratings derived from MarketGrader's fundamental research. As a result the portfolio is optimized with approximately 45-50% annual turnover and meets the time proven test that successful investing is about taking intelligent risk, diversification, and keeping costs to a minimum. A similar discipline is applied to the construction of proprietary portfolios that are core, market cap, and sector based.

The Role of Re-balancing in an Index

William Smead in his recent blog on SA referenced Jason Zweig of the Wall Street Journal who wrote "Simple Index Funds May Be Complicating the Stock Market". Smead explains how passive investments have risen to 33% of the money in equity mutual funds and says that Zweig theorizes that all these agnostic investments might be adding to the volatility and the high correlations in the marketplace.

To quote Zweig: "Recently, leading investing experts-including Rodney Sullivan, editor of the Financial Analysts Journal, consultant James Xiong of Morningstar Investment Management and Jeffrey Wurgler, a finance professor at New York University-have been warning that index funds could destabilize the financial markets. The rise of trading in index funds, these researchers say, is causing stocks to move more tightly together than ever before-as if they "have joined a new school of fish," as Prof. Wurgler puts it. That is reducing the power of diversification and could make booms and busts more likely and more extreme. Unlike conventional funds run by highly paid stock-pickers who seek to buy the best securities and avoid the worst, index funds-including most exchange-traded funds, or ETFs-effectively buy and hold all the securities in a market benchmark such as the Standard & Poor's 500-stock index."

This assumes, of course, that only highly paid stock pickers can sort out which stocks to buy to avoid the worst. What about unconventional indices that rebalance? Stock picking does not need to have legions of highly paid analysts to be effective. Fundamental analysis that is automated and cost effective has proven otherwise.

Index providers owe a debt of gratitude to John Bogle. The investment landscape we have today has been shaped by his vision. The buy - hold market cap weighted investment strategy he espoused Vs the buy - hold & re- balance equal weighted investment strategy both have merit. In short, as markets evolve in time, investors will see that there are viable and prudent alternatives to straight passive index investing as long as expense ratios are controlled & methodologies are transparent. Such stock picking inherent in those indices that are cost efficient in their rebalancing will help also to mute the boom or bust cycles that others worry about coming from markets over reliant on passive investing. In the end, only performance will matter.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.