Jared Dillian is editor and publisher of The Daily Dirtnap, a market newsletter for investment professionals, and the author of “Street Freak: Money and Madness at Lehman Brothers.” and “All the Evil of This World.”
Unless you have been trapped under something heavy, you know by now about the rise of indexing. You’ve heard about the assets fleeing actively managed funds for index funds, under the idea that you can’t be the market, so why try?
The thing is—people are still trying the beat the market.
Imagine this scenario: Retail Investor A goes in to meet Financial Advisor B. Financial Advisor B is a convert to indexing, and wants to act in the best interests of his client—so he wants funds with low fees. ETFs!
So what ETFs does Financial Advisor B pick?
- He likes utilities, so he picks the Utilities Select Sector SPDR Fund (XLU).
- He likes health care, so he picks the Health Care Select Sector SPDR Fund (XLV).
- For a little international exposure, he picks Germany, via the iShares MSCI Germany ETF (EWG).
- For a little emerging market exposure, he picks India, via the WisdomTree India Earnings Fund (EPI).
- For a little fixed-income exposure, he picks the iShares iBoxx $ Investment Grade Corporate Bond ETF (LQD).
- And finally, he likes defense stocks under Trump, so he picks the iShares U.S. Aerospace & Defense ETF (ITA).
He then constructs the following portfolio:
You Won’t Be Getting Market Returns
It goes without saying that the return of this portfolio is going to be very different than “the market.” It could be higher, it could be lower, but this portfolio of index ETFs looks nothing like the market.
Well, how do we define “the market?” If you really want to be a true indexer—you want to own a perfect slice of every asset in the world. U.S. stocks, international stocks, emerging and frontier stocks, U.S. bonds, international bonds, corporate, municipal, mortgage—everything. And that’s just tradable assets. Theoretically, you would also want to own real estate and commodities.
You would earn:
Economic growth + a risk premium.
That is indexing.