The Shakedown

September 10, 2007

It kind of feels like that seminal moment in every market cycle, when the pretenders begin to be weeded out by reality.

Am I talking about the market or ETF product issuers? Well, both I guess ... because frankly they tend to run together. It never ceases to amaze me that for all the talk of pure indexing—market exposure at lowest cost and all that—by and large, the index industry chases performance and demand with product launches as much as anyone else, and flows into index funds look just about as buy-high and sell-low as those of flows in other parts of the financial services markets.

Actually, can I quote myself from about three years ago?

I have always found it ironic that indexing—like most everything else in the world of finance—comes in waves. Hedge fund indexes, microcap indexes, dividend indexes, commodities indexes, China indexes and "enhanced" indexes are all flavors of the month. And I'll give you three guesses as to what all these indexes have in common: (1) chasing returns, (2) chasing returns, or (3) chasing returns. "If you believe in indexing, then you know that there is no free money. Ultimately, the push toward enhanced indexing is about enhancing the bottom line for managers. ... But it's important for us to keep our eyes on the ball and remember what makes indexing, well, indexing: Low fees, broad diversification, hold hold hold. Don't believe the hype. Try to beat the market—in any manner—and you're likely to get beat ... by about the cost of doing it."

So now we'll see how things begin to shake out. I guess ultimately you need to step back. If you're investing for the long run, and are in an area because it is a long-term part of your asset allocation plan (which is in line with your risk tolerance and investing time horizon) the odds are going to be a lot better that you are on the right track than if you're chasing around the last trends in vogue.

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