Poor investment advice on the internet
“When investing the details matter, so it’s important you fully understand what you are buying…”
While I was still working in Investment Banking full time (as you’ll see, I’m a part time hustler now) I used to irregularly write and distribute Market Research reports. It wasn’t part of my formal job description as a Vice President of Global Risk Management, it was something I enjoyed doing and besides, I’ve got lots of opinions and ideas I’d often be invited to the pub to discuss my views . Which really meant going on the piss, as The British say, but that’s ok. When I moved from Deutsche to ABN AMRO I was soon contacted by one of my old colleagues, asking for my research. When I told him
and would only distribute it at my new employer he immediately offered to pay. Well, I do like money so that was an immediate deal, doubly so as Investment Banks pay over the top for proprietary research. Same thing happened when I left ABN AMRO (the first time) for Moody’s. And again when I returned to ABN AMRO a few years later (yes, there is a story there I’ll write up someday). As we’d say now, a side hustle was born. Fast forward some twenty two years later and I’m distributing my research to six financial services firms (combination of Tier 1 Investment Banks and Hedge Funds) and, best of all, getting paid for it. I purposely limit this to six clients, as not only do I write and distribute Market Research (sidenote: much of my Medium writing is based on short form excerpts from these long form research notes, each note I author for banking clients is typically 5K to 8K words with a large number of tables and graphs), but I also present my views several times each quarter to banks trading and research desks. I’ll tell you there is nothing more exciting than presenting on a trading floor at 0630 to an engaged and sometimes cynical audience, Q&A is a blast. I’m
and regularly attend calls with clients. Yesterday morning I was on a call with a bank that shall go unnamed (don’t even ask, strict bilateral NDAs are the norm in this very obscure niche) with twelve professional money managers, responsible for roughly $20B in assets. The topic was markets in 2023, and I was invited because of a particularly provocative research note I published two weeks ago. And suddenly the subject of holding the S&P 500 in an index came up. A question was put to the panel, for 2023 would you prefer to hold on
Not one of those managers, all trying to generate alpha and beat the competition, selected the Market Cap Weight index fund option. Not a single manager. So,
After all, an index fund is an index fund, yes? No. And this is remarkably poor advice I often see on the internet, where anyone can write an article pitching investments, without consequence. Everyone says “buy and hold an index tracker”, and often name an Exchange Traded Fund (ETF) they “recommend”, without seeming to understand that not all index trackers are the same. I’ve also seen this with REITS, when folks casually suggest people invest in these assets but don’t clearly understand there are different types of REITS, and it’s also a common mistake with fixed income and FX ETFs. Well,
An index tracker is a financial product, most often an Exchange Traded Fund, which is designed to do one thing: track the performance of a market index. The index most commonly cited by professionals is, of course, The S&P 500. While The Dow is perhaps more widely known, it is a highly deficient index and, compared to The S&P 500, relatively easy to manipulate for two reasons: 1) it is a price weighted index and2) it consists of only 30 stocks.
The S&P 500 is commonly said to consist of 500 stocks, but there are actually 503 (now you know why I’m called The Master of Arcane Financial Knowledge) because some components have dual classes of common stock. For example Alphabet issued Class A (GOOGL) and Class C (GOOG) shares, and both are included in the index. Regardless, the S&P 500 is a market capitalization weighted index. And that
When the value of the S&P 500 index, ticker SPX, is calculated we first calculate the sum of the market capitalization of all the stocks in the index. We can then calculate the weight — you can call it importance — of each stock as a percentage of its market capitalisation, compared to the market capitalization of the entire index. The final step is to multiply the share price of each stock by its weight and sum to arrive at the current value of the S&P 500. If you’re detailed oriented (and what investor isn’t?) the methodology is all spelled out here .
Now we can understand the nuance of the “Equal Weight or Market Cap Weight index fund?” question. A Market Cap Weight index fund faithfully reproduces the weights of each stock in the S&P 500. An Equal Weight assigns a uniform distribution to all components. Let’s look deeper at two S&P 500 index funds, SPDR, The S&P 500 ETF Trust, ticker SPY, and Invesco S&P 500 Equal Weight ETF, RSP. Both of these are S&P 500 index funds, but from a Financial Engineer’s perspective (we’re commonly called Quants) very very different. The chart below shows the top 25 components of SPY
And this chart shows the top 25 components of RSP
(Note most positions held by RSP should be weighted at 0.23%, but differences manifest as prices are changed each trading day, and the fund adjusts at discrete intervals, NOT at the end of each trading day). Both of these funds are S&P 500 index trackers, but structured differently from the Financial Engineering perspective. For each fund costs are different; specifically, SPY charges 0.09% while RSP charges 0.20%, simply because it is more actively managed. These differences manifest in performance, as the chart below shows
Over the past one year The S&P 500 was down -9.67%, SPY tracked closer at a drop of -8.15% while RSP was down only -1.91%. Conclusion: an index fund is not always an index fund. Details matter. In other words,
as you might otherwise think. After all, looking at the holdings data presented earlier, we see over 13% of SPY’s holdings are concentrated in three stocks — Apple, Microsoft and Amazon. Simply put, those holding SPY are overweight. So entering
to hold a market cap weighted index. These are professional money managers, aka, Smart Money, so you have to ask why? There is a manifest change happening, one many people haven’t caught onto yet, but I have featured in several of my research notes since Q3 of last year. We discussed it briefly here
and I presented on this topic recently at a banking event. The era of free money is over. Interest rates are normalising. This favors value over growth. In other words
and things will never be the same again. Or, more precisely, they will be the same as they were before The US entered The Era of Free Money. And there is no option; the current debt debacle in Washington (subject of a Research Note I’ll be distributing to my clients Monday AM) proves this. We are
and speaking from my book (aka, portfolio) I can’t wait.
Structure your portfolio accordingly.
