Fuzzy Math Quandary

February 21, 2008

As an editor once told me after reviewing similar odd numbers: Mutual funds are sold, not bought.

Stong-armed commissioned salespeople aren't the only headaches connected to figuring out so-called enhanced index funds.

Common logic would seem to dictate that markets don't act logically. How many millions of trades are transacted a day (or, depending on the exchange, billions)? There's no way of tracking all of that and figuring out any real pattern.

So conspiracy theories persist. And that's what active managers seem to thrive on. Let's face it, if you're trying to beat markets, you're a trader, not an investor. The most honest and successful active strategists I've met refer to themselves as traders. It's certainly a viable option, but one that requires intense discipline and I'd argue just as intense research.

Few people can do it consistently over long periods. And from the results of enhanced index fund managers, most pros can't do it well, either. But to be fair, most don't even try. They're stuck trying to actively manage big baskets of stocks using some sort of long-term investing strategy. Good luck.

Another factor all of this brings up is how quantitative-based hedge funds got battered last summer when the sub-prime fiasco came to light. As an IU report on quant ETFs pointed out earlier this year, the less-exotic portfolios did the best in 2007. That's no doubt largely due to higher fees and turnover (i.e., more market-timing type of bets?).

But as market volatility picks up, aren't these sort of quant and enhanced indexing models going to really face stiff challenges? It's going to be interesting to see which ones in the ETF world hold up better than others, won't it?

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