Thursday, October 13, 2011

If It Bleeds (an Investor) It Leads

Zig Ziglar quips that hurricanes and earthquakes get the headlines but termites do more damage than hurricanes and earthquakes combined.

The number of car accident fatalities in Texas in an average month is the equivalent loss of life as the crash each month of a full commercial airliner with the loss of all aboard.  Who doubts that if a full commercial airliner crashed in Texas monthly there would be a public outcry for immediate improved aviation safety?  But where’s the public outcry about the tragedies on the state’s roads?

News coverage of a billionaire often is solely about his or her wealth.*  A billionaire has one hundred times the wealth of a person with a net worth of ten million dollars.**  However, press coverage about the billionaire's wealth is orders of magnitude greater than the ratio difference in wealth between the two people.

The point: visibility distorts proportionality in public attention. So do precipitousness and conflict.

Reading business and financial news can leave the impression that nearly everyone and their brother -- especially if perceived as sophisticated -- are investing in private equity, hedge funds, commodities, other “alternatives,” and complicated trading strategies.  And frequently stock picking and trading, selecting the "best" investment managers, playing the IPO market, and the like. For example, the NYT’s “Dealbook” -- which has excellent content, by the way -- has the latest and greatest on these topics: private equity, hedge funds, M&A, securities offerings, investment banking, and venture capital. There’s drama with these topics: triumph, failure, redemption, and other sagas.  And adrenaline rushes.  Heat; smoke; sizzle.

So-called passive investing -- low cost, index fund investing -- by contrast is boring. Losing or making a fortune quickly with index investing is difficult.*** Where’s the excitement -- the news -- in that?  A typical person perusing mass-market financial publications would think that index investing isn't in the game.

But it is.  $6 trillion is invested in indexed assets, representing a value increase of almost 25% last year.  And the trend for indexing is good, especially for institutional investors seeking worldwide equity exposure.  Reasons for the trend include lower risk, a desire for liquidity, the avoidance of subpar active performance, and, of course, the cost advantage.  "Nothing is cheaper than beta exposure, delivered through index funds."

The more attention an investment class receives from the financial press the more lucrative that class is for "financial services industry professionals" (or, to use Warren Buffett's word, "helpers").  And the less likely the class is to produce acceptable, risk-adjusted returns in the long term.

A prediction:  in not too many years the great debate about active management versus indexing will have evolved.  The two opposing viewpoints will then be whether investment return optimization is achieved via indexing as the core strategy, complemented by other investment strategies, or whether indexing is the only strategy.

*"Famous for being rich" is a variant of today's "famous for being famous."

**The common reference to a natural person's "net worth" is unfortunate. It's as if a person's character or value can be expressed in a single dimension by a single measurement. How about substituting the term “balance sheet net worth”?

*** The word “quickly” in this sentence makes all the difference:  it’s easier to make a fortune, over the long haul, with low-cost indexing than with alternatives.

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