Indexing vs. Active Management

A comment (or two):

• I'm now at 45% Money Market.
• By month's end I'll be at 65%.
• Methinks we've seen just the tip of the iceberg re the Asian influence.
• I'm the world's worst investor.

cklung. The problem with 'expert' opinion is that at any one moment it is split, with 1/3 of the 'experts' believing the market is overvalued, 1/3 that it is fairly valued, and 1/3 that it is undervalued. If their opinion changes so that there are more 'bulls' than 'bears' the price changes very quickly until the balance returns. (Remember: every share that is sold on the stock exchange must have a seller who thinks the price is not going up and a buyer who thinks the price is not going down.) So if experts did, in general believe, the market would fall until October, they would sell now. This would make it fall now instead of October.

So my advice is hang tight. It might fall or it might rise. No one knows. If this makes you uncomfortable, you should perhaps rethink your allocation: move a great portion of your portfolio into short- and medium-term bonds.

cklung

Your safest bet is to stay in the equity market 100% of the time. Doing so will ensure you don't miss the markets bounce back. Selling now may mean selling at a low and the Random Walk theory leads me to beleive that this move would be unfounded.

Buy, buy and buy more all the way down.

CK:

..................................................................You're too late!

Buy and hold is only a bull market strategy. Waiting for highs to sell is a bear market strategy. If you identify a bear market, wait for highs to sell.

If you choose to hang on, then don't look at the values from now on. Go golfing. Make sure you don't decide to hang on at TSE300 6500 , and then sell at TSE300 5500.

No, no, no!!!!!!

You must buy, buy, buy!!!!! Don't do what the lemmings do and fall off the cliff. Mutual funds are supposed to be for the long haul, so don't get cold feet when the market goes down. You should be anxious and think about what to buy next on sale. Market timing is about as easy as predicting the next great earthquake - an inexact science at best. What is predictable is that the lower the market gets, the deeper the discounts in mutual fund prices become. Buy and Hold is the name of the game.

SELL,SELL,SELL!!!!!!!!! Why wait for the market to correct. You are so much smarter than the analysts and you should bail at a loss and buy in at the next high. Afterall, I cant buy low if noone is selling. NUFF Said!!!!

I wonder what all those who bought index funds R thinking now?

I will be buying soon. I like the Templeton Intl Stock fund if it gets below $15.

I must confess, I rolled my initial investment back into the AIC advantage fund Friday. I could have waited longer I guess, but I bought it at a 12% discount off its highs. I'll wait for it to start again. It may take awhile, but I'm patient. After all, I'm up over 110% since I bought it Jan 2/96. So I can afford to give a few points back. I'm not greedy. :)

I think this is the Bear market we were all waiting for. Only time will tell. When it really gets bad, I plan to leverage a bundle into it. I still have some cash on the sidelines, but I may just keep that as a cushion.

fastwalker,

I was about to say that Buy and Hold is for the lemmings, but I don't know which is the bigger fallacy. Lemmings jumping off cliffs OR buy and holders always winning. Both are 100% false, and it seems both have penetrated the mind of the masses to the same degree.

fastwalker you are right. Look at the Japanese bear market, it tumbles for 9 years and never return. Most canadian mutual funds cannot go short. Plus the MER of 2% a year, holding canadian equity funds is a loser's game in a down market. I will look for hedge funds instead. Buy and hold and wait for the long term is only mutual fund managers' advertisement. They need your money so that that can earn you MER for sure, whether the market is up or down.

A rising market is a casino where most wins, but a falling market is a casino where most loses. The total equity value is falling from day to day. CIBC alone, with its 400 million shares and a drop of $25 from its high, has already wiped out 10 billion dollars in this casino.

Should you stay in a casino where there is less and less money around? It becomes harder and harder to make money, and easier and easier to lose money.

I don't mean to create panic. I am just frustrated that how people are misled. Selling on panic is of course no good, but blindly holding is equally bad.

I mean Dave N you are right.

More, if money can be earned so easily by just BUY AND HOLD irrespective of market conditions, then who else will buy GIC, T-bills, etc?? There ought to be times you have to get out of the market, if you dare not go short.

My attitude is "just don't look down."

There are many bargains out there despite all the growling bears. For example, bank stocks will never be as cheap again--anybody ever heard of a Cdn bank (i.e., big 5) losing money lately?

BUY lo is great if'n y'all got the loot to buy, meanin' they should be some Cash/MoneyMarket available NOW.

So,

"I wonder what all those who bought index funds R thinking now?"

Huh Reg?

Why should indexers think any differently than any other investor?

Gummy,

0% in Cash. Sure wish I had some extra cash to buy those cheap bank stocks now.

JM :)

Hi Bylo,

Sorry I didn't get back to U sooner. Been busy lately. :)

The reason I asked, is that there is no protection. What U see is what U get. At least with a managed fund a person has a bit of a cushion. Depending on the fund management of course.

I ran a three week time period from July 17 - Aug 7 on some funds I follow. The Dow is down 7.9% Nasdaq 8.1%, TSE 10.5% & the Hang 18.7%.

Most of the funds report losses of less than 7.9%.

"The reason I asked, is that there is no protection. What U see is what U get. At least with a managed fund a person has a bit of a cushion. Depending on the fund management of course."

Unless you are referring to the cash component that managers have to play with, I don't know what cushion you are referring to, Reg. By the same token funds like tips-35 and -100 don't have the signficant MERs those big-thinker fund managers demand, dragging them down.

There are many Cdn equity funds down further than the tse right now. Active management is no insurance against market risk.

Reg, like jd, I too assume you mean cash when you say "protection."

FWIW, my portfolio is now at about 10% cash/MMF (earning 4% to 4.5%), 40% in short and medium term bonds/bond funds and the rest is in equities, both indexed and actively-managed. I'm quite comfortable with my degree of "protection."

Now while the TSE300 is down just 2.74% over the last 30 days many well-known Canadian equity funds with large amounts of "protection" are down way more during this same period. The first three I looked up on GlobeFund:

Trimark Canadian with 16% "protection" is down 6.66%
Ivy Canadian with 26% "protection" is down 6.38%
Templeton Canadian Stock with 22% "protection" is down 8.03%

OTOH, an 80/20 blend of TSE300 and cash would have about the same amount of "protection" but would be down a mere 2.2% over 30 days. [I suspect that a TIPs or HIPs blend would be down even less, but I couldn't find the 30-day numbers for them.]

We'll make an index convert out of you yet... ;-)

jdjd:

As the figures have been boasted by indexers that 75% of managed funds underperform the index, this is roughly true in a bull market. In a bear market, it's pretty much the reverse - about 75% of managed funds beat their respective indices. The cash component is the main reason for this difference.

Thanks Ont FA,

I seemed to have touched a nerve with the indexers. I agree with the fact of lower MERS for them. That's a big issue with DIYER's. Also that a lot of funds lag behind the indexes in a bull market. But do they lag the markets, say, over a 5-10 year period? I'm interested in long-term results. I see value in having active management in my portfolio. So do my clients.

But, we all have to look at the BIG picture - bottom line. With active management from those who do beat the indexes (those R the funds I'm interested in selling) besides the protection cash gives, U will find the stocks they pick also tend to take the volatility out of their performance. Proper portfolio management gives people a zone of comfort rather than riding the raw indexes. BTW, index funds R a recent phenomenon. Better informed investors coupled with a record Bull run have largely contributed to this. Only a very small percentage of investors buy them. I would love to see some figures comparing them to a well-managed fund for longer periods of time, say 10 years. Perhaps the higher MER may justify itself.?

Does anyone have those statistics available?

Let's be careful! It looks like an ugly papabear , with a TSE that could drop to 3500 to 4000. It will be a trying time for investors as well as their advisors. My advice since January has been to go to minimum stock allocation, maximum cash and short term bonds and to avoid long term canadian bonds as well because of a possible breakdown in the dollar.The stock portfolio should be made of closed end funds trading at a discount such as Templeton Emerging market appreciation fund, First Asia income fund, a sprinkling of Wardley China, Westshore terminals, Newcastle Market neutral, some of the better natural resources income trusts, or Atlas income trust fund run by Bissett, some of the higher quality real estate trust convertible debentures, etc all of the above not household names but reasonable value in an extreme market. That kind of allocation should keep you on the plus side for the next 12 to 18 months. As usual, everyone' situation is different and there is no more important time to consult a trusted advisor. The bear market started without me but I was in France and the good guys won. " On a gagne" Old hand

Old Hand: Add Polar Hedge Income Trust to that list (T:PHT.UN). It has been quite resistant to the drop and along with Newcastle Market Neutral Income Trust (T:NMN.UN) they charge a MER of 1.0% to 1.25% percent but guarantee a return of 8% per year. I like the management fee incentives that are built into these two funds. They make a bonus if you earn over 8%. If you don't, they don't get paid until that guarantee has been made up to the investor. A High Yield Bond Fund sponsored by CI (T:HYB.IR) also has the same incentive built into the management fee. Wouldn't it be nice if all mutual fund MERs had a performance incentive built into the management fee structure.

I have been 100% equity from the very beginning, and I am still 100% equity now and in the future for another 15 years

Reg, according to GlobeFund:

The TSE 300 TR index did 10.53% over 10 years. Of 81 broadly-based Canadian Equity funds only 24 did better than 10.48% (I assume that TIPs 100, with an "MER" of 0.05%, make a reasonably good proxy for the TSE 300.)

When we lower the bar further by 0.50% to allow for an index fund MER, 31 funds beat the index, i.e. only 38% of funds that survived 10 years beat the index plus reasonable expenses.

Now I can't speak for you, but if I'm going to "gamble" on selecting actively-managed funds, i.e. try to guess today which funds will turn out to have beaten the index 10 years from now, I'd want to set as my target a higher bar than just equal to the index. After all I can always get that return with a safe bet like TIPs 100. Well only 5 funds beat the index by more than 200bp over 10 years.

Doesn't sound like good "odds" to me.

South of the border the evidence is even more compelling. The S&P 500 index did 21.06% over 10 years. There were 0 (yes, zero, nil, rien) Canadian-based US Equity funds that even came close. In fact the best 5 funds all did under 19% over 10 years.

Is it any wonder that indexing has become so popular?

Thanks Bylo,

Just got back from the cottage. I'm always learning from U guys. I see your point of view. But I like to think I can pick some of those that beat the indexes. I'm sure U know some of the ones that do also.

The day of the end of commission-based selling is coming closer all the time. I hope with this latest correction and CT advertising 0%, the business gets cleaned out of those who are not career-oriented FP's. The record Bull market has attracted a lot of people into this business. There R too many excesses as a result. They have to be corrected.

I will be going to our annual conference at Whistler, BC next week. It will give me a good feel for what's happening with the fund companies & how the dealers R doing. I expect that a lot of reps R having a tough time. I also hope to get some insight into how deep & long this correction is going to last.

BTW, I am taking some initial steps to move my business over to a pay-for-service one. I think U know I'm listed in Ross's list as a 0% commission FP. I just sent a letter to my client's informing them of this. My only restriction is $25,000 minimum.

Reg,

Do you plan to still collect trailer fees on the funds you sell, or will you be a true 'fee-only' FP like Warren for example, that is, not accepting any trailers from the fund companies you deal with?

Gatekeeper,

For the time being I will collect trailers just like all the other 0% dealers. Is their a problem with that? The reason I can go 0% in the first place IS because of the trailers. Not a lot of reps can do even that,

Reg, I guess this is one of your larger personal risks undertaken. A good businessperson is someone who can anticipate the prevailing winds - but not the markets!! Good Luck!

Gatekeeper, you want him to donate his house and Lexus to the Franciscan Order, too? I have always had more of a problem with the upfront/deferred sales commissions than the trailer fees. If the planner monitors the client's holdings and is providing regular reports it approximates the ongoing fee that the advisors at TE Financial charge. The one fly in the ointment - and it is a rather large fly - is that Reg still won't have an incentive to suggest PH&N or Bissett funds. Based on the growth rate of these fund families, this problem will likely grow over time with planners.

Given the amount they spend on marketing and advertising, I find it utterly amazing the growth rates of these two fund companies (36.6 percent for PH&N, 216.4 percent for Bissett between Jul97-Jul98.)

Hey Bylo, try that analysis when buying just before a weak (or bear) market. I believe that the strength of good actively managed funds may prove more valuable when you consider that many investors actually end up jumping in near a high, or just before a decline. Since funds usually don't fall by as much, fund investors might have a head start by avoiding a big dip. I haven't tried it but it seems like it would make sense. Use Trimark Canadian against the TSE 300 invested at the end of Sept/87 or Dec/89. I'd bet that Trimark will shine brightly in such a scenario.

Reg,

Why would I have a problem with that.....? I simply thought that a clarification was in order when you said you were planning to change to a "pay for service" planner. As you are well aware, planners receive their compensation via many different routes - some charge loads, some don't. Some accept trailers, some don't. Some accept niether but charge a flat fee (or by the hour) for their services. So when you said "pay for service", it was hard to decipher which camp you were in. Some consider trailer fees to be "commissions" under a different name - in fact, wasn't that the case Rob was making re. his support of Dynamic vs. the IFIC and Canada Trust's "0% Commission" claim?

DO NOT dump equity funds now. Do make sure that your'e equity funds are spread out properly, can./u.s./europe etc . Far east funds are tough to take right now but represent bargains for the forseeable future. europe is booming along, canada is as usual under performing. usa sways to & fro but always settles to business. Big Bear may be coming but I'am in for long and will outlast him no problem.

Doesn't look good in the international market scene...

The following is taken from AIC's 1997 Annual Report.

"Thirty years ago, no one could have foreseen the huge expansion of the Vietnam war,wage and price control, two oil shocks, the resignation of a president, the dissolution of the Soviet Union, a one-day drop in the Dow of 508 points, or treasury bill yields fluctuating between 2.8% and 17.4%. But surprise! - none of these events made the slightest dent in Ben Graham's investment principles. Nor did they render unsound the negotiated purchases of fine businesses at sensible prices. Imagine the cost to us,if we had let fear of the unknowns cause us to defer or alter the deployment of capital. Indeed, we have usually made our best purchases when apprehensions about some macro event were at a peak. Fear is the foe of the faddist, but friend to the fundamentalist. A different set of major shocks is sure to occur in the next 30 years. We will neither try to predict these nor profit from them. If we can identify businesses similar to those we have purchased in the past,external surprises will have little effect on our long-term results."

glennn, nice quote, Thanks.

I can also only surmise that stats are just that.

Bylo quoted #'s that made active managers look bad, and yet I just read an article that made some of the dogs like Trimark look good recently that Bylo mentioned. I guess it depends on the day that you look. I'm not sure that I get it, as the dates don't seem far apart. There is an article at http://retirecanada.miningco.com/library/weekly/aa081998.htm that has very different results from Bylo's so it is all very confusing.

Reg, and Ont FA may have more than a leg to stand on here.

JJ4, that article is misleading. Bylo's information is correct. The reason behind is that an index fund always have a smaller cash position(they have to match the index, so they can't afford to reserve too many cash). So in a down market, it is more than sure that index funds will be hit more severely than managed funds. The reverse is also true, in an up market, index funds, generally outperform managed funds.

That article snapshot a typical down period and that explains all.

Well, you may say that the ability to reserve cash before a major market turndown is the advantage of using a fund manager. But, how many times did thy do it right? Remeber a famous fund that sell the bank stocks last year? How many funds have been holding BXM ?

IF YOU BELIEVE IF A FUND MANAGER. Close end funds are the place to go. They can participate 100% (sometimes more than 100%) in the market. I like hedge funds more. At least the managers of these funds are doing more work that worth your MER. In a down market a mutual fund that cannot go short is a sure loser.

Actually index funds "neve time the market". They also adopt a "buy and hold" principle.

These are what those fund managers tell us to do, right? It is embrassing that their propaganda points to eliminating their jobs.

If you invest on broad based, I see no point to pay the MER.

If you go for a special fund like AIC, that is stock picking. You can do it better off by right out stock purchases. By the way, has anybody do a research what is the comparison between AIC advnatge and the TSE financial sub-index? I have no data, but I will say that the financial sub-index "index fund" has a good chance to beat AIC during last year's record run. By the way, anybody knows if AIC have unloaded their bank stocks recently AND SUCCESSFULLY?

I think that you're kinda cynical stockstock. Perhaps you have a reason to be, but I don't see the article at Retirement Plannning as being misleading. In fact, all biases were put forward. I also didn't see it as contradicting Bylo, but, I asked a simple question as to the difference in numbers. I didn't question one being right or wrong. Are you saying that the numbers at the retirement planning site are incorrect and that Bylo's are correct?

The author also spoke of the cash position quite forwardly. Gee,... did you read it? You also started rambling, and I didn't understand your prose. Perhaps you could enlighted us when you are more lucid.

With your second posting, regarding market timing, you also lead me to believe that you do not understand value investing. I could be wrong, as I often am, but....are you for AIC or against. Hard to tell from my point of view.

I'm with JJ4 here stockstock. It seems that you have your own biases. There was another article that was quite similar to the Retirement Canda one this weekend in the Financial Post. I'll see if I can post it here, but regardless, I think you need to lighten up, and perhaps open up. Gee, ... I don't see where anyone one trying to mislead.

OK, I may be cynical. But I insists that article is misleading, or at least, incomplete.

That article just states that managed funds outperform index funds in a typical down market, right?

I don't think that article ever reveals any up market comparison. THAT IS WHY IT IS MISLEADING.

Bylo's figures are on a much wider time basis.

I have said that as index funds have to remain almost fully invested in order to match the index, in a down market more than likely they will underperform all managed funds with cash position. Assume a managed fund has 40% cash(never that much , of course), it is only 60% invested. When an index drops by 10%, that managed fund should, on the average, only down by 6%. Only when the mangaged fund is down by less than 6% can we say that its physical holdings outperform the index.

I am not an index fund fan. I am just frustrated that those managed fund did so bad.

Your comments welcome.

JaneS, your post comes up when I am writing. So I have to answer that in a second post.

It seems that you have never been misled in your life before, congratulations. Watch out, traps are elsewhere . Sometimes, though, somebody mislead you without any conspiracy. They just miss the whole picture.

Secondly, may I have your attention to the funds that quoted in your article. High income funds cannot be compared to the TSE 300, they are REITS, high-yield bonds etc. Most funds in that article that "outperform" the TSE300 are dividend funds. These are defensive funds which offer dividend support and always outperform a down market when interest rates are not rising. You should broaden your comparisons to growth funds which mimic the general market better.

Sorry all fund managers, I will shut up.

I'd forgotten about this thread. Hmmm...interesting debate. I've read Keitha's article and also the one in the FP. It certainly looks like in recent weeks -- even taking their cash components into account -- some actively-managed funds have indeed beaten the TSE300 index. However, I don't think a few weeks of "relative underperformance" is enough time to condemn indexing. The jury is still out.

But let's assume for the purposes of this debate that active funds do indeed perform better in down markets and that index funds perform better in rising markets. Now we all agree (don't we?) that over long periods of time markets go up a lot more than they go down, i.e. ignoring the "bumps" along the way, on average stock markets return 8% or 10% each year? So if you're a long-term buy-and-hold investor -- and you can put up with those bumps -- which asset class will provide higher total returns:

(a) the asset class that drops least during bear markets?
(b) the asset class that outperforms in bull markets?

Caveat: indexing is not a panacea¹. Even in the most efficient markets (e.g. large caps, US, Canada, Europe) index funds don't beat all actively-mananged funds all of the time. But, they do beat the average actively-managed fund most of the time. Also because they are highly tax efficient, in non-registered accounts index funds provide close to 100% tax-sheltered compounding.

¹pan·a·cea a remedy for all ills or difficulties; a cure-all

It is not clear to me that the indexing panacea of today is a long term trend. Based on the chart produced by Doug Fabian in the link below, a case can be made that average active management can outperform passive indexing over extended periods of time, e.g. 1977-1983. However, this chart ignores the tax efficiency of index funds which may tilt the scales weighed by the jury in favour of passive management for non-RRSP accounts.

Excellent link to Keitha's retirecanada site posted in error. Trying mutual funds interactive link again...

The diversity of views and the useful links at these discussion forums are greatly appreciated by this reader. There is ample fodder for both thought and learning. Thanks.

In general I'm in the low cost MER - Index Fund camp at this point in time. The exception is when I think I know (I mean really "know" – and this is very rarely the case) something about the market or a sector of the market or a particular company that I'm willing to bet on with direct stock purchases.

But I do wonder if the current advantages of passive management (low MER Index Funds or TIPS) over active management (high MER Funds) may not disappear if the markets should become dominated by passive investors.

Consider the extreme case where 100% of the market is invested passively. This is of course unlikely but it illustrates a point. Who or what would then determine which stocks go up and which go down? Nobody. The first active investor would have a strange market where he/she could play all sorts of games and reap benefits.

OK what if the passive number is 80% and not 100%. Then the 20%-active-market transactions would determine 100% of the market valuation. It makes you wonder.

I think my conclusion is that Index investing is of maximum benefit when most of the market is being churned (in a random walk?) by active investments. But if the roles should become reversed, where most of the market is involved in passive index type investing, then I'm not sure what to think anymore. It's not clear that the views I have today would stay the same.

George,

As I recall even if the US -- where indexing has become extremely popular (Vanguard is the #2 fund company behind Fidelity, Vanguard's S&P 500 index fund is #2 behind Fidelity Magellan, and something like 20% of pension fund money is indexed, etc.) -- nevertheless index funds represent only 6% of all mutual fund assets. I imagine that elsewhere indexing represents an even smaller percentage. So there's a long way to go before this becomes a real concern.

For the time being those of us who invest in index funds ought to be grateful to (a) the active managers whose quest to "outperform the index" helps to keep markets efficient and (b) the investors in actively-managed funds whose higher MERs pay for this "service."

Is it possible that index (passive) managers could employ certain techniques to enhance (outperform) an index? Some data exists that managers have negative MERs in mid and micro-cap index funds primarily because they are market makers in some of the securities.

But what about the S&P500?

Can techniques such as arbitrage, futures plus cash enhancement, option overwriting, security-level and sector/style optimization enhance returns in large cap stock index funds?

Is the jury still out?

Enhanced indexing sounds like a "free lunch" oxymoron to me, but that may be too rash a denouncement since I know so little about them.

The Ibbotson reference is interesting but does not say much. In their abstract they do admit that the funds that did better than the S&P 500 in their study could have done as a result of chance rather than management. I would think that this conclusion must almost always will be the case with empirical data mining of past performance data.

Mike, you refer to micro-cap index funds that are also market makers in some securities. My take on this is that such stocks would not behave like an efficient market stock would and so the fund is not what I call a "real index" fund. It sounds more like a great opportunity for insider trading and a conflict of interest if the fund also buys shares in a stock that they make. Perhaps one should beware of non-index funds that masquerade under the index label.

I believe that there are some Index Funds in the US based on derivatives that have outperformed the Index they follow but again I think that this is done at the expense of a higher volatility (risk) factor.

I have shares in the Vanguard 500 Index Fund and I must admit that I have some concerns about it. It has done so well in the last 5 years that perhaps the large cap companies the 500 index represents are overvalued at present relative to the non-500 companies – and the latter may do better in the future to re-balance things. The current "popularity" of the 500 stocks must at some point "correct".

The Vanguard 500 discussion group at the Morningstar website has some good debates about the index vs non-index issues and the relative pros and cons. I will try to provide a live link to that discussion group, which is at -

http://www.morningstar.net/nd/ndNSAPI.nd/Bbs/ConvAll?forumId=1100109700

*******************************************************Fact(no bias):-

I read the Fabian site and do a overly simple calculation. I add up the % numbers and divide them by 20, that is below 45%. (I already use 79% for 1997) *******************************************************

MERs difference may play a key role, though. But as an investor I am only interested in the overall return.

Moreover is 1977-1983 a overall depressed market that favour a stock called "CASH" ? I have no data. Will appreciate if anyone can supply the data.

I am not an index fan, but I am not happy with fund managers that do not do their homework. I am cynical again, which fund owns Livent now? I may need some lighten up, but will the MER lighten up?

Amendment : it is 46.15% if you use 79% for 1997.--- I am lucid enough to admit any mistakes.

That makes no significant difference. Remember that site is from an index-burster. How he count the mutual funds is highly questionable. Have he excluded special funds, etc, so many question marks. Just interesting that even material from this index-burster favours indexing Vs active management.

Final comment---Why Fabian omit the 1987 figure? Anyone know how managed funds are doing in that horrible year when compared to indexing? It is a down market, which should favour managed funds!

Mikale and George,

Following up on the "joke" of active management....here's one from Nobel laureate, Merton Miller.

"I choose a few stocks myself. But I do it strictly for entertainment."

It seems that some of the leading academics invest with Dimensional Fund Advisors, who are strictly in the index camp.

Again thanks for the interesting links, Bylo and Mikale. Will read them carefully.

Yes I have had the same thought about VTSMX(5000) versus VFINX(500) as you mention Bylo but one reason for not moving the Vanguard 500 assets is the good fortune of having appreciable unrealized capital gains in this index fund. I don't want to pay the taxman until I need the money. As Warren Buffet says, unrealized capital gains is one of the great freebies of all time - an interest free loan with no call date. But I think I will try to find some new $ to put into the Wilshire 5000.

I have two US "brokers". My original Vanguard investment is with Vanguard. I also have a Waterhouse account now but have not made any purchases there yet. [I opened the Waterhouse account as a result of the information I found at the this Forum site.]

Bylo, the Waterhouse information package says I should be receiving a US credit card. Mine has not arrived. Did you get one? Is it the good deal it looks to be?

George,

1. My US allocation at Waterhouse in roughly equal amounts is, VIVAX (which is the value half of the S&P 500), VTSMX, and Berkshire Hathaway shares (for "growth"). The BRK.b shares are still up some 23% from when I bought them in the spring.

2. I presume your Vanguard account is a legacy of US residency. Will they service you from Canada? They now have online account access, so that may be an option.

3. When I opened the Waterhouse account they sent me a credit card application form. I filled it out with a Canadian address, Canadian employer, SIN etc. and within a month they sent me a gold MC with US$10K limit.

Is the card a good deal? I think so, especially if you make purchases in the US and you pay off the balance each month (both of which I do.) The card is better than free¹ which beats all US$ cards available in Canada. Not only that but they give you a choice of either "classic" or "gold", VISA or MC. I don't know why anyone would want the "classic" version since you get all the "gold" features like car rental CDW at no extra cost.

As an added "bonus" the familiar green TD logo appears on the front of the card, so one can have the distinction of owning a genuine TD Mastercard! (Makes a great conversation item at cocktail parties...)

¹ Yup, they actually pay me to use it. :-) At the end of the year they're supposed to rebate 1% of all card purchases to my Waterhouse brokerage account.

Bylo,

I am curious as to your estate planning situation with the Waterhouse account. It seems to me that if the account exceeds $60K U.S. and the great maker in the sky calls your number, your estate would have to file U.S. estate tax returns (and potentially) pay U.S. estate taxes. Based on my experience, the "clearance certificates" seem to take a long time to be issued leaving the account in limbo. But the tax liability may not be an issue based on the 1995 Protocol.

Your thoughts on any mitigation techniques would be appreciated.

mikale,

Bylo,

On the issue of enhanced index funds, take a look at the offshore Global Manager funds. They are leveraged index funds that bear the names Geared (for the bullish) and Bear. Each will turn in stellar results if the market direction matches the strategy. But Bear fund investors will get hurt badly if the market keeps on sailing upward. So there is no free lunch at this picnick. You either make lots of money or you lose.

mikale,

Bylo,

I did access (after some trouble) the archived September '97 mail bag article you cited originally. Still curious as to your specific mitigation strategy and rationale though as I contemplate taking the Waterhouse type step. You can e-mail if you prefer. The credit card story is highly amusing. Thanks.

Can you access the Dimensional Fund Advisor MF accounts via Waterhouse?

Further, you may want to consider the Merton Miller "joke" for your Aphorisms page.

Bylo, your earlier note (10:44 AM), regarding your own US $ allocation, nudged me into thinking more about re-balancing some of our own assets. The result is that I have some more questions and comments.

I am a bit puzzled as to why you chose VIVAX to complement VTSMX. It seems the assets of both these Vanguard funds are dominated by large-cap companies, albeit the VTSMX portfolio holds some 3,000 stocks. The top 10 holdings in VTSMX (13% of assets) are essentially the same top 10 as in the S&P 500 fund (VFINX where they constitute 20% of assets). Am I correct in thinking that your total exposure to small-cap US companies is somewhat minimal via both VIVAX and VTSMX?

Given that the gurus have convinced me that "small cap stocks produce a higher return than big ones over long periods" – I am inclined to add the Vanguard Index Small Cap Stock fund, NAESX, to complement my current S&P 500, VFINX, holdings, rather than your VTSMX. NAESX has about 1850 stock holdings and a turnover of about 29% (unavoidable I guess at the small-cap end of the stock spectrum where issues die and are born on an ongoing basis). Any comments on my intentions?

Strange, but it pleases me to see that NAESX has underperformed the S&P 500 over the last 5 years and the return YTD is -9.6%. With those numbers on the board it surely must be bargain !? ):

Mikale's interesting link ("How the Really Smart Money Invests" by Shawn Tully) talks about the DFA 9-10 Small Company Fund, DFSCX. It seems to be very similar to Vanguard's NAESX. Any comments?

You own some Berkshire Hathaway shares. Any reason you purchased these via Waterhouse – as I presume you could have done the same via any US account at a Canadian Broker? As an aside, at the moment we (my wife and I) do not own any Berkshire shares but we do have some General Re. Corp shares. Since the two are in the process of merging we should end up owning about a dozen New Berkshire-B shares.

mikale,

"I did access (after some trouble) the archived September '97 mail bag article you cited originally."

See the revised link above.

"Still curious as to your specific mitigation strategy and rationale though as I contemplate taking the Waterhouse type step."

Not sure what is the question. I'm not at the US$1.2M level yet, and with current markets it looks like it'll happen later rather than sooner. If/when I have that problem, plan B is to set up a holding company.

"Can you access the Dimensional Fund Advisor MF accounts via Waterhouse? "

No. (I thought the "How the Really Smart Money Invests" decribes the road blocks and toll collectors that DFA uses to deter impecunious clients.)

"Further, you may want to consider the Merton Miller "joke" for your Aphorisms page."

Your merest wish is my command. As of 5 minutes ago it's there. Thanks.

George,

"total exposure to small-cap US companies is somewhat minimal"

Yes that's true, but I also have Canadian US mutual funds (PH&N US Equity and Spectrum United American Growth) from my pre-indexing days. The latter is a US small cap fund (with lots of technology holdings last time I looked.) Both of these are in a non-registered account, have been 1Q performers for the past 10 years or more, and have considerable built-up capital gains, so I'm in no hurry to "convert" them to index funds.

Re NAESX, did you know that Vanguard recently introduced some new small cap funds that are more focused. (I haven't looked at them in any detail and I don't know if Waterhouse carries them yet.)

You can get some comparative info on DFSCX vs NAESX in the "How to Beat the Benchmark - Indexing's Ultimate Irony" article.

I bought the BRK through Waterhouse partly because the brokerage fees are US$12 per transaction and there is no odd-lot surcharge (I can't afford 100 BRK.b let alone 100 BRK.a -- ouch US$7M for a board lot!)

BTW, the BRK/GRE merger package arrived in yesterday's mail. (and no I'm not even going to try to read it.) Welcome to BRK. You'll love reading Buffett's reports to shareholders almost as much as counting your paper profits. :-)

Anyone know if RevCan allows BRK shareholders to deduct the cost of travelling to Omaha to attend the annual meetings? (My guess is no.)

Interesting discussion folks.

Re. U.S. Index funds / Actively-Managed funds: Personally, I prefer deciding what portfolio weight I want to allocate to the U.S. stock market outside an RRSP, and simply investing this portion in a Wilshire 5000 index fund. The market cap mix (large vs. small cap) is just about right for me, and the entire spectrum of U.S. market caps is conveniently held in a single fund, with no stock overlap that inevitably occurs when one invests in an assortment of U.S. Equity funds (though I hear ya Bylo when you say that the sale of your existing funds wouldn't be worth the tax hit).

There is a case to be made for manager-added value in the area of small cap funds and emerging markets funds, but if the price is right (read Wilshire 5000 index fund MER), the simplicity and peace of mind that simply owning a single U.S. equity fund that 'owns' the entire U.S. stock market outweighs any potential 'outperfromance' that a given fund manager MAY be able to achieve over the long term.

Re. the performance of the Wilshire 5000 vs. S&P 500: I had a chart that compared the performance of these two indexes (can't seem to find the thing at the moment). From what I recall, the S&P 500 has in fact outperformed the Wilshire 5000 over the past few years, which is not surprising since large caps have certainly been the 'cap of choice' for the last while. However, I believe that investing in the Wilshire will likely produce slightly better results with less volatility over the long term. Therefore, it is my index of choice.

Bylo,

I bet you invested in the Spectrum fund when Barry Firestein (sp?) was running the show. He certainly racked up some big numbers before his departure, and the Spectrum and PH&N funds you own are among the top performers over the past 10 years, so it looks like you've done alright for yourself!

Bylo, I wouldn't exactly describe ourselves as impecunious because we can't ante up the $2M U.S. for the privilege of investing with some Nobel laureate economists (and laureates-to-be) in the Dimensional Fund MF Group. Maybe we should put together a unit trust of 20 investors with $100K U.S. and go for it:-)

Gatekeeper, here's a 7 year chart of the

Gatekeeper,

1. I don't regret buying PH&N US or SU Am Gr, but if I had it to do again, I'd stick to the W5000 index. PH&N US has done fine -- almost matching the S&P 500 -- but the distributions have been rather large (10%+ over the past few years.) I just don't like having to share any of that with RevCan unless and until absolutely necessary. (SU Am Gr has been rather tax efficient as I recall.)

2. John Bogle is a big proponent of the W5000 index over the S&P500 for essentially the same reasons you give.

3. I agree that if one believes in reversion-to-the-mean, then bright days lie ahead for small cap investors. And soon, I hope ;-)

A couple of observations about fund selection:

1. Both PH&N US and SU Am Gr (neé Bullock American) were 1Q performers 10 years ago. Interestingly -- especially for those of us who (claim to) believe that past performance is no predictor of future performance -- they both somehow managed to maintain that record over most of the last decade. Was it merely luck, or was there some skill involved? I dunno.

2. After Barry left, SU/BA went through 2 or 3 years of mediocre performance. Pundits (e.g. Pape) began to urge unitholders to sell and move on. SU changed fund manager at least one more time. Ultimately those of us who exercised patience (or was it inertia?) saw performance recover and the fund's long-term record maintained despite the temporary slump. Was this luck on our part or another example of the virtue of patient, long-term investing? (Ahem, is there a lesson there for Trimark Canadian unitholders?)

As I've said before, indexing may not be a panacea, but it sure is an important tool for low-cost, low-risk portfolio diversification.

Yes I too agree, all other things being equal, that the Vanguard Wilshire 5000 Index fund probably makes the most sense as the best general purpose investment for the long term in the whole US economy. As I recall, Malkiel, in his book "Random Walk Down Wallstreet", has the same recommendation. It makes a good as an "index of choice".

But often enough all things are not always equal.

In my case: (1) I'm sitting on substantial capital gains in the S&P 500 fund and cashing in would reduce my investment capital due to taxes, (2) I do think that relative to the rest of the US market that the 500 stocks may be overvalued at present (but not enough to sell and take the tax hit?). That is, non-500 stocks (read small-caps) may be a better value today than the 500 stocks. Or in Bylo's words that we should expect a "reversion-to-the-mean" for the small-caps (and also for the large-caps from the other side of the mean). (3) I want to believe Rolf Banz's research conclusion that "small-cap stocks produce higher return than big ones over long periods". For all these reasons I'm inclined to complement my current S&P 500 holdings with the Vanguard Small Cap Index Fund, NAESX, rather than the total market index fund.

I have some reservations about NAESX however.

Morningstar reports the NAESX fund stock-turnover at 29%. (By comparison, the Vanguard Total Stock Index Fund (Wilshire 5000), VTSMX, has a turnover of a paltry 2%.) I'm assuming that the 29% turnover for NAESX is unavoidable and goes with the territory of the small-cap market. The corresponding turnover number for the similar DFA small-cap fund is 28% and so reassures me. But there will undoubtedly be more taxes to pay annually if the small-cap market raises. (I hope that Rolf Banz took this negative tax-efficiency factor into account in his comparative study – and noting that he was Eugene Fama's graduate student, he probably did.)

My second reservation with picking NAESX is that I think I probably agree with Gatekeeper: - that perhaps a case can be made for manager-added value (read non-index funds) in the area of small cap funds and emerging market funds". Morningstar lists a whole host of small-cap funds with a better 3-year return than Vanguard's 11.6% for NAESX. But are they likely to do better tomorrow? How does one find the fund that really is better and is not simply one with a lucky past? I dunno. I would also think that in the small-cap market just a few great choices, say stocks that quickly become 10-baggers, like Amazon, are much more likely to happen than in the large-cap market, and will result in a misleading past-performance profile for the lucky ones. Thus I'm inclined to go with a broadly based Vangurd small-cap index fund like NAESX.

The two other small-cap Vanguard funds, VISVX and VISGX, that Bylo mentions, are quite new (5/21/1998 inception date) to Vanguard. As I understand it, one focuses on small-cap Value and the other on small-cap Growth stocks. The older NAESX (inception 10/3/1960) is a small-cap Blend, a mix of Value and Growth. Together all three form the bottom line in Morningstar's 3 x 3 Investment Stylebox Summary.

This may all seem ho-hum to some readers. Sorry about that.

George,

You might be interested in...

mikale,

Thanks for the link.

George,

Your post was far from ho-hum. You seem to be a person who does his homework and I find your logic very sound indeed.

Re. your dilemma concerning your S&P 500 holdings and your desire to get some U.S. Small Cap exposure without getting nailed with a huge capital gains tax bill: One option to consider is to simply sit tight with your current S&P 500 holdings and invest any future money you wish to sink into the U.S. Equity Market in Vanguard's Wilshire 5000 index.

Re. the "added value" that fund managers may provide in the small cap and emerging market areas: It seems apparent to me that, in the area of Canadian Small Caps, your average fund manager does seem to be able to beat the benchmark (ie, Nesbitt Burns Canadian Small Cap Index) by a significant amount. For example, for the 10 year period ended June 30, 1998, the median and mean of the Canadian Small Cap fund category (11.2%, 10.2%) beat the Nesbitt Burns Index (8.6%) by a significant amount. The same was true for all compound periods up to the 10 year numbers, so there does seem to be value added potential here. However, such a result may be due to the inability of Nesbitt Burns to truly reflect the direction and magnitude of return that the Canadian small cap market as a whole generates (ie. maybe some fine-tuning of the index is needed...?).

I'd like to see similar numbers for U.S. Small Cap funds vs. the Russell 2000, and Global Small Cap funds vs. the new MSCI Global Small Cap index that was apparently introduced not long ago. Incidentally, I myself am content to simply invest in the TSE 35 and/or TSE 300 indexes, so no flashy Canadian small caps to speak of in my own portfolio.

In the Emerging Markets area, the verdict appears to be less decisive than in the realm of Canadian Small Cap funds. The problem is that the Globe and Mail (my source for the numbers) mixes Latin American funds into the same category as Emerging Markets. However, the 5 year return numbers are not subject to such contamination, as all funds available in Canada with a 5 year record as at June 30, 1998 are 'classic' Emerging Markets funds. Anyway, the 5 year numbers are:

Median and Mean of the Emerging Markets fund category: 4.8%, 3.7%

MSCI Emerging Markets Index: 3.3%

Thus it seems that the 'typical' actively-managed EM fund has a decent chance ofbeating the benchmark. Personally, I'm of the opinion that country selection in Emerging Markets is important, since I do not believe that all developing nations will 'make it' in their effort to produce stable, well-run economies with all the political, economic, and fiscal responsibility and regulation necessary to provide investors with long term growth of capital. Thus, I think there is room for a good fund manager to have a better than average shot at outperforming the MSCI EM Index over time, but hey, that's just me.....

Gatekeeper. Thank you for the kind words. Some hasty comments …

My reason for not investing future money now in Vanguard's Wilshire 5000 Index fund (although we all seem to agree that it probably is the single best one index fund for investing in the whole US equity market) is that the S&P 500 companies (in which I am already heavily into via the Vanguard 500 fund) is a significant sub-set of the Wilshire 5000 index. Thus I would be re-investing a large fraction of my new money in the already "overvalued (?)" 500. Thus my current choice is either the older Vanguard small cap blend (NAESX) or the new small cap value (VISVX)

Over the last 20 years I have made small investments in Canadian small-cap companies that were "recommendations" from my brokers and much to my dismay every single one of them has turned out to be a bust. Thus my attention these days is on US small caps. I feel a bit ashamed about this.

You ask where to find numbers on US Small Cap funds. I have found the www.indexinvesting.com website a most useful website, with a wealth of historical data. It may not have exactly the data you ask about but it is worth looking at I think. For example they give a table with 25 years of returns, year by year, for eight different asset class. I will try to prove a link to it. Cheers.

Hmmm. must have omitted the intended link in the above. Sorry.

My mutual funds with the Royal Bank consist of some of their new index funds.I admit they are down at this point but so are my load funds with Trimark and AGF.I do feel that the advisor to the Royal bank,Jim O'SHAUGHENESSY is a little different in his approach but I think in the long run he will perform.The wealthy barbour is losing some of my confidence in his Royal Fund.Anyone hold the ROYAL BANK INDEX FUNDS and have comments?

George,

Thanks for posting the link.

For what it's worth, before I decided on the Wilshire 5000 index, I did consider investing in an actively-managed U.S. Small Cap fund (Franklin U.S. Small-Cap Growth). The original is sold in the U.S., and Templeton brought a clone of the fund to sell in Canada just over a year ago. The manager (Ed Jamieson) has a very good track record, and I liked his investment style (bottom-up, blend of growth and value from what I recall...). So if you are skeptical re. the ability of a passive U.S. Small Cap index fund to provide acceptable long-term results, you might wanna check this fund out.

Having said that, the reasons you gave for your reluctance to invest in an actively-mananged U.S. small cap fund are certainly legitimate ones. Even if the fund manager is a genuinely good small cap stock picker (i.e., returns are no fluke), that manager could quit, retire, change jobs, or (heaven forbid) drop dead at any given point in time, thus leaving you with the difficult choice (or should I say, 'guess') of whether to sell your fund units, take the tax hit, and begin your search anew, OR stay invested in the fund and hope the new guy/gal doesn't screw things up.

Papasan: I went to your os funds website link [knowing zero about the O'Shaughenessy funds before I did this] and here is a chronology of my reaction and final take on it.

My eyes popped when I first saw the "Cornerstone growth strategy vs S&P 500' graph [see link below http://www.osfunds.com/mutual/growth/growth.htm– I dunno how to imbed a link]. Unbelievable results from 1952 to 1997 – a 19.1% average annual compound return [relative to 12.4% for S&P 500]

But I now think the following (a) The graph is totally misleading because it seems to imply the results of a real fund whereas it really is a hypothetical or theoretical fund (b) It is based on "45 years of stock market data". Thus I think his projections are probably rubbish. I say "probably" because I have not read any of his works and so am assuming a fair bit. But he uses "data mining" methodology to project! I would liken this to using the past winning lottery numbers to develop a winning prescription for projecting the next lotto winner number. Rubbish! Bah!

Morningstar tells me that the total Management Expense Ratios for the three OS funds are 1.56% [OSCGX], 1.85% [OSCVX], 1.98% [OSAGX]. These are extremely high by my and by Vanguard standards. The three funds have existed only since 1996 and their performance relative to the S&P 500 returns are negative. Not at all like the above projection would indicate.

I must also confess that I have a negative bias against any author of a book with titles like "How to Retire Rich", or "Invest Like the Best", etc. To me these are code words for: - "If you are greedy and gullible, I will become rich selling you nonsense."

Besides, Jim O'Shaughnessy has written three investment books and he looks quite young. How can he possibly know enough that is worthwhile to fill three books? More marketing hype than substance I suspect.

Sorry, it's thumbs down from me for any O'Shaughnessy fund.

I've just come across another great Bogle article [from June 1997] that I somehow missed seeing before.

It is Bogle's "The Implications of Style Analysis on Mutual Fund Performance Evaluation" [see link below]. He looks at ALL nine boxes in the Morningstar Category Rating System and makes, I think, a compelling case that low-cost indexing is the wisest choice for all nine Morningstar sectors, including the small-cap fund sector. [He, of course, only looks at US funds, not Canadian funds. But can anybody make a compelling case that different investment rules should apply in Canada?]

Three days ago in this thread I said: - "perhaps a case can be made for manager-added value (read non-index funds) in the area of small cap funds and emerging market funds". I don't think so anymore. [Can't help being less than correst at times, I'm learning as I go.]

http://www.vanguard.com/educ/lib/bogle/tictactoe.html

I'm also willing to change my mind re. my stance on U.S. Small Cap funds vs. a relevant benchmark - provided that I see hard data that contradicts my current position (as they say, the proof is in the pudding).

For example, Vaguard's three U.S. Small Cap Index funds (VISGX, NAESX, VISVX) apparently seek to track the Growth component of the S&P SmallCap 600 index, the Russell 2000 index, and the Value component of the S&P SmallCap 600 index, respectively (oddly enough, Vanguard doesn't state this in the objective of these three funds on their web site, but I assume this is the respective goals of these three funds). What I'd like to see is a year over year comparison of the mean and median return generated by the group of (actively-managed) U.S. Small Cap mutual funds offered for sale in the United States VS. the return generated by each of the three benchmarks.

I have a great deal of respect for John Bogle, and I agree with his position on indexing re. the S&P 500 and Wilshire 5000 indexes, as the statistical proof here is quite convincing. However, I'd like to see similar 'hard data' proof in the area of U.S. Small Cap stocks before jumping to the same conclusion.

Gatekeeper: I found the above Bogle article quite convincing. He concludes that low-cost mutual funds (read index funds) outperform the managed funds in each of the nine Morningstar style sectors, including the three Small-Cap sectors. Did he not persuade you? His data is bases on the 1992-97 period I think, - and so includes two not-so-good years and thus may be fairly representative.

John Bogle bends over backward to be objective in his analysis I think. In my view he has more credibility than any other mutual fund person I know.

You mention the different small cap indexes. This is an area that confuses me a bit. It seems one has to be very careful about comparing and using different indexes. It seems the "Managers of an Index" can have quite an effect on ones investment in an index fund. Here is a note on another discussion forum [see link] that raised my eyebrows:

" … Russell on the other hand reconstitutes its indexes once a year on June 30, and with respect to the Russell 2000, every stock that is at that point in time between the one thousandth largest and the three thousandth largest in cap size is put into the index, and every stock that ceases to so qualify is booted. As a result, funds that track the Russell have to do a mad game of musical chairs every June 30th, buying and selling stocks, which can hurt performance a bit. For example, NAESX lagged the index in June and July by a tad even though it usually beats the index for the rest of the year … " Steve Dunn - http://www.indexfundsonline.com/forms/wwwboard/messages/327.html

"oddly enough, Vanguard doesn't state this in the objective of these three funds on their web site"

Bylo, thanks again for another good link.

I'm still struggling to find a personal "comfort" level about indexes - about how they function and how they affect the market they are supposed to measure [and the index funds that use them].

I think I know what they are supposed to do - provide an unbiased reference marker for the investment class they represent. But is the "unbiased" part possible? And while I think I know the technical definitions, or can look them up, - I am not sure how they really work and how they affect things in the market place and in index mutual funds? For example, someday, if the securities markets are dominated by index funds, can the marketplace still be "efficient"? There seems to be little discussion of this on the web that I can find.

I am reminded that in physics one of the foundation stones at the atomic level is something called the "uncertainty principle". It in effect says that the actual process of measuring something will have a fundamental effect on the thing being measured. In other words there is no such thing as an "unbiased" or totally objective measurement. [Of course this is an insignificant effect at the larger, human scale of happenings.]

Likewise I am not sure that "indexes" can be "unbiased" observers of the investment class they represent. Their composition changes and the funds following them affect the market as they change their holdings. They of course do provide an important service. But we should try to be well informed about their limitations and how following them blindly via an index fund may handicap that investment.

George,

In one of Bogle's articles (I think the one on the history of indexing) he points out that even today in the US, index funds represent only some 6% of mutual fund assets. Methinks we have a long way to go before the active fund managers are no longer able to keep (at least the large, regulated) markets efficient.

Perhaps one way to resolve the issue of bias in index construction is to invest only in the most broadly-based index funds like the Wilshire 5000. The benefits are (a) minimal bias because one owns a piece of everything and (b) near 100% tax efficiency. For me the crux is, assuming the W5000's ratio of large vs small cap is not what the individual investor would consider to be "ideal", does the added cost, complexity and taxation involved in creating a custom blend sufficiently offset the higher (expected) returns? Needless to say (but I will anyway!), I don't know how to answer that.

BTW Vanguard also has an international fund-of-index-funds that invests in Vanguard's Europe, Pacific and Emerging index funds -- split roughly 90% EAFA and 10 emerging markets -- Vanguard Star Fund Total International Portfolio, VGTSX. The two sets of funds (i.e. VGTSX and VTSMX) collectively invest in 1,000s of issues that are effectively a proxy for the whole world's stock markets. Regrettably VGTSX is not available from Waterhouse or Jack White.

ooops...wrong User Name!

Geez Bylo...and I thought Moonman may have multiple personalities.

I understand that certain advisors "traffic" in rumours about which stocks are to be added to the Russell 2000 (and by implication any other index) every June (I believe) when the index is reconstituted and then suggest buying them because the liquidity flows from the index MF and pension funds "spike" the price.

Have you come across any data on such price spikes which may be of interest to active traders?

Yes I do agree that today index funds are a small component of the market today. But I would guess that the 6% Bogle mentions may be increasing rapidly – and it is the rate of increase itself that I believe is increasing. In the US the index funds are catching on in a really big way (unlike in Canada). So what today is a hypothetical fear (market domination by index funds) tomorrow (ok, say 5 years from now) could be a real fear.

The point about the Wilshire 5000 is interesting. Because it includes the "whole US market", Vanguard does not have to worry about some "index custodian" jigging the index at the next review. This is borne out by the facts it seems.

The Vanguard Total Market Index (VTSMX) has a turnover of 2% while having 2,994 stock holdings. In comparison the Vanguard Small Cap Stock Index Fund (NAESX), which follows the Russell 2000, has a turnover of an astounding (for Vanguard?) 29% (!!!) while having 1,849 stock holdings.

I think the main difference is that when the custodian for the Russell 2000 Index redefine this Index, the Vanguard NAESX fund is forced to sell the dropped stocks and buy the new ones. Their prospectus statement must be honoured. A 29% turnover is not insignificant (compared to 2%).

It does like the Russell 2000 Index itself is the tail wagging (to some degree) the corresponding Vanguard fund. In this case there is a "real Index effec"t on the fund. It is not hypothetical.

Another reason to go with the Total Stock Index.

We should ask Waterhouse why it discriminates against VGTSX.

Mikale: My earlier post refers to another discussion forum post where this Russell-2000-June-effect is mentioned.

And a bit more on turnovers in index funds.

I just came across the attached Vanguard link to "Why Stock Index Funds Have Turnover". This article has another interesting link to "Indexing with Small-Cap and Medium-Cap Stocks".

It seems one should expect at least 35% to 40% turnover in small-cap index funds. At this level it is primarily due to annual changes in the underlying index.