Malkiel’s 11th ‘Random Walk’ To Mine ETFs

October 16, 2014

Indexing legend will explore ETFs more thoroughly in the latest edition of his classic tome.

Burton Malkiel, the Princeton economics professor who 41 years ago helped popularize indexing with his tome “A Random Walk Down Wall Street,” is updating the classic this year, in part to reflect the growing importance of exchange-traded funds to indexing and to investing in general.

“ETFs certainly figure much more prominently in this 11th edition,” Malkiel told in a recent telephone interview. “In the appendix of earlier editions of ‘A Random Walk,’ I had the ‘Random Walkers Address Book,’ which had mutual fund addresses, and what 800-number you would call. And now that address book is full of not only mutual funds, but ETFs.”

“Why is the book different if the thesis hasn’t changed? The instruments have changed and the opportunities for investors have changed,” Malkiel said, noting that among those changed opportunities is international investing. Investing outside the U.S. has blossomed into being a meaningful diversifier of risks associated with investing.

Focusing a bit more on ETFs is an appropriate addition to the 11th edition of “Random Walk—a book that did so much to influence the way investors and advisors think about investing. It was Malkiel, with his accessible turns of phrase in the book, who created the entertaining-but-true image of a chimp randomly throwing darts at the Wall Street Journal stock pages—and outperforming active managers.

The book first came out in 1973—two years before Vanguard’s first retail index fund came to market. But now, 41 years later, ETFs—the vast majority of them index funds—are slowly moving to center stage in financial markets.

Almost 22 years after the first U.S.-listed exchange-traded fund was launched, total assets in U.S.-listed ETFs are on the verge of reaching $2 trillion in assets. To put that asset number in perspective, hedge funds now manage about $3 trillion, and open-end mutual funds have a total of about $13 trillion in assets, according to various industry sources. Assets continue to pour into ETFs at record levels.

‘Beta’ Not A Bad Word

To put into perspective what “A Random Walk Down Wall Street” helped create, today there are about 40 percent of institutional assets being indexed, and about 15 percent of individual assets are. Both those percentages were barely above zero at the time Malkiel’s book was first published.

Those percentages are growing every year as investors get wise to the cheaper costs of indexing relative to active management, and as they grasp the probabilistic realities of investing.


Indeed, roughly two-thirds of active managers underperform their indexes every year, as Malkiel and other pioneers of indexing argued early on. Worse yet, a successful manager’s capacity to sustain a streak of outperformance is lower than those odds, suggesting that success in active management conforms to some of the simple mathematics of chance.

The SPIVA data series—the twice-yearly Standard & Poor’s Index Versus Active report—tells that tale reliably, and we recount it here at each time it’s published.

Beta, The New Alpha

To be sure, the world of index investing Malkiel helped create is shifting. While more than 99 percent of all ETF assets are invested in index funds, ETFs are increasingly being used for alpha generation, or the indexed version of alpha.

“Enhanced beta” funds that systematically tilt portfolios for greater exposure to various factors that affect returns, such size, value, momentum or quality have become all the rage in the contemporary ETF market. Interpreting what constitutes a “smart beta” ETF as liberally as possible means such ETFs now make up $380 billion, or a fifth, of total U.S.-listed ETF assets.

And even though these strategies are bona-fide rules-based indexes, they are poaching market share from the true active managers plying their trades. Worse yet for active managers, pure-beta, capitalization-weighted index ETFs are increasingly being arranged in alpha-seeking constellations.

Even Vanguard, the pioneer of such pure-beta index funds, talked about creating alpha-seeking investment strategies using its ETFs in a webinar on Of course, Vanguard is hardly alone in using index ETFs to deliver outperformance.

More than $100 billion of ETF assets are now managed by so-called ETF strategists. That’s 5 percent of the ETF market.

The new edition is likely to appear by the end of the year, and, again, will contain, among other ETF features, a  section with addresses and contact information for ETF sponsors.



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