how can an index fund also be a value fund?

[mrWinter]

Vanguard has several funds with Index in the name that are listed as value funds (ex. VVIAX, VMVAX). How can an index fund be a value fund? My understanding was that index funds didn't try to actively pick certain stocks at certain times and instead just bought the whole market (or market sector) defined by some index. Whereas value funds pick individual stocks based on price versus some calculation of true value, and sells once they are no longer under-priced. Aren't the two methodologies mutually exclusive? What am I missing here?

 

[GalaxyBoy]

I think your answer is hiding in your question:

... defined by some index.

It all depends on how the index is defined, which should be outlined in the prospectus. They set down criteria for what constitutes a "value stock" then they buy shares to track that index.

 

[clobber]

Vanguard has several funds with Index in the name that are listed as value funds (ex. VVIAX, VMVAX). How can an index fund be a value fund? My understanding was that index funds didn't try to actively pick certain stocks at certain times and instead just bought the whole market (or market sector) defined by some index. Whereas value funds pick individual stocks based on price versus some calculation of true value, and sells once they are no longer under-priced. Aren't the two methodologies mutually exclusive? What am I missing here?

The prospectus should reveal all. From VVIAX it says:

1) "Investment Objective: The Fund seeks to track the performance of a benchmark index that measures the investment return of large-capitalization value stocks"

2) "Principal Investment Strategies: The Fund employs an indexing investment approach designed to track the performance of the CRSP US Large Cap Value Index, a broadly diversified index predominantly made up of value stocks of large U.S. companies. The Fund attempts to replicate the target index by investing all, or substantially all, of its assets in the stocks that make up the Index, holding each stock in approximately the same proportion as its weighting in the Index.

So - it does not track the Dow, or the S&P 500, but rather the CRSP US Large Cap Value Index.

 

[mrWinter]

OK, but isn't that kicking the can down the road? That just means someone other than vanguard is determining what to buy. It still sounds like active management to me, they are just parroting someone else's decisions rather than making their own. CRSP decides what is a large "Value" and they buy the same stuff. Active management via proxy?

 

[Sunset]

So many of their funds have ETF's that are equivalent and charge a lower fee than some of the funds, so I buy the ETF.

 

[easysurfer]

I think your answer is hiding in your question:



It all depends on how the index is defined, which should be outlined in the prospectus. They set down criteria for what constitutes a "value stock" then they buy shares to track that index.

+1. There are indexes besides the common SP 500 and total. Even index value and index growth funds.

 

[clobber]

OK, but isn't that kicking the can down the road? That just means someone other than vanguard is determining what to buy. It still sounds like active management to me, they are just parroting someone else's decisions rather than making their own. CRSP decides what is a large "Value" and they buy the same stuff. Active management via proxy?

But that is kind of the point. If some one else (CRSP) makes the "picks" then you (Vanguard) don't need to be paid to do so. You (Vanguard) just blindly and cheaply follow. I'm sure Warren Buffett spends millions of dollars a year trying to determine which companies to buy and sell. You can buy and sell everything he does and not pay the millions of dollars. The Index fund is just blindly following the Index. It is all computerized and therefore much cheaper than having an active manager.

Unless you are going to buy every single stock in the world, then someone has to pick which ones to buy. Right? Active management means looking at individual stocks or mutual funds and trying to predict whether their share price will go up or down. Most indexes don't do that. They are simply a method to try and track what the market (or a part of the market) are doing. For example, did you know there are roughly 22 companies add/removed from the S&P500 Index every year? There is a company called Standard & Poor's that created the Index and gets to decide which companies are in and which are out.

S&P 500 index constituent turnover - Business Insider

They are not added/removed based on the direction of the share price. Just because a company is added/removed does not mean someone is recommending you buy or sell that stock. Rather, that the new group of 500 stock better represents whatever they are trying to track (overall health of the market?).

So - how are Large Cap Value Stocks doing these days? The CRSP thinks they have they answer with the CRSP US Large Cap Value Index. If you think they are right and you would like your investment performance to be very similar to the performance of large cap value stocks, then get that fund. It will be cheaper than you buying each of the stocks in their Index.

 

[youbet]

OP:

Many folks here, and everywhere really, make the false assumption that when "index investing" is mentioned, it means investing in a fund that tracks a popular, broad-based index like the TSM. But in reality there are hundreds of indexes and funds that track most of them.

Check out this list:

https://en.wikipedia.org/wiki/List_of_stock_market_indices

I like the Solactive 3D Printing Index myself.

We all should probably be more carefull on how we phrase things. For example, we should say "my FIRE portfolio is primarily in a domestic TSM index fund" rather than "I like index funds and they make up much of my FIRE portfolio." In the later statement, you could be focusing your investments in Sri Lanka and Botswana and still be correct that index funds make up much of your FIRE portfolio. They do, they're just in very focused international indexes, but indexes just the same.

 

[ERD50]

OP:

Many folks here, and everywhere really, make the false assumption that when "index investing" is mentioned, it means investing in a fund that tracks a popular, broad-based index like the TSM. But in reality there are hundreds of indexes and funds that track most of them. ....

I'd put it a bit differently. It seems to me that, by convention, when people who have been around here a while say 'index fund', they almost always mean investing in a fund that tracks a popular, broad-based index like the TSM.

If they are talking about a market sector, I think they are generally specific about that, and mention the sector.

True, there are lots of indexes out there. I don't pay much attention, unless I'm curious about a specific industry for reasons other than investing. Just like if I get curious about how the corn crop is doing this year (can't take the farm out'a the boy), I'll look at corn futures. But I've never traded them.

-ERD50

 

[youbet]

I'd put it a bit differently. It seems to me that, by convention, when people who have been around here a while say 'index fund', they almost always mean investing in a fund that tracks a popular, broad-based index like the TSM.

If they are talking about a market sector, I think they are generally specific about that, and mention the sector.

True, there are lots of indexes out there. I don't pay much attention, unless I'm curious about a specific industry for reasons other than investing. Just like if I get curious about how the corn crop is doing this year (can't take the farm out'a the boy), I'll look at corn futures. But I've never traded them.

-ERD50

It may seem that way to you, but it's still a sloppiness in expression that sometimes leads to misunderstandings. Indexes have grown tremendously in number and popularity and it's not uncommon for folks to use focused indexes in lieu of focused actively managed funds.

In your case specifically, there have been several times where your interpretation of what an index fund is has mislead me for a moment and I've had to stop and think "oh, he must be assuming the market cap weighted TSM index."

It's easy and important to be clear in these matters, so why not?

 

[mrWinter]

Thanks for the clarification all, this is jiving more for me now. I was interpreting "index" to always mean TSM index or something similar, which I now see is not the only usage of the term.

 

[OldShooter]

Not that anyone cares, but I think the word "index" has been so hijacked and corrupted that it has become almost useless for communication.

The original published paper on active vs passive investing is from 1991: https://www.google.com/search?q=sharpe+active+manatemen&ie=utf-8&oe=utf-8 In it, William Sharpe (Nobel laureate) explains why actively managed funds must always underperform passively managed funds by the amount of their fee difference. The paper is an easy 3-page read, but if you like videos, Kenneth French (of Fama/French fame) explains it here: https://famafrench.dimensional.com/videos/is-this-a-good-time-for-active-investing.aspx

The key to Sharpe's arithmetic working exactly is that the universe of stocks in the average must also be the universe of funds that the active managers are trading. If the two are not the same, the arithmetic argument is no longer perfect.

But we know that when we talk about a "large cap index" being compared to the performance of large cap funds, we can be pretty sure that not everything that the active managers are trading is included in the index. So where does that leave us?

Fortunately, the S&P SPIVA results give us the answer. Even where the indices do not exactly comprise the stocks being traded, Sharpe's analysis is close enough to describe the outcome. Actively managed funds, on average, underperform in all Morningstar categories that S&P surveys.

As the indices get narrower and narrower, like maybe the "South China Sea Small Cap Index," the mismatch becomes larger and larger and makes fund comparisons to the index meaningless. More importantly, investing based on narrow indices is really a form of stock-picking, aka active management. Even investing based on a broad index, like the CRSP US Large Cap Value Index is really at the top of a slippery slope that leads to active management.

So, personally, I like the "total market" funds, like funds that track the ACWI All Cap index. This is closest to Sharpe's model and guarantees that I am passively holding what Fama calls "The market portfolio." A worthwhile 30 minutes can be spent here: INVESTORS FROM THE MOON: FAMA | Top1000Funds.com

Some people speak of "tilt" where a broad passive portfolio is modified by inclusion of broad based funds that emphasize, for example, value or small-cap stocks. The argument is that these categories have outperformed over time and may be expected to outperform in the future. DFA has a huge array of passively invested funds, each holding thousands of stocks with 5-10% portfolio turnover, that include some tilt. They also offer 100% tilted funds that are intended to be secondary holdings of investors who want to manage their own tilt. (DFA does not use the word "index," which I like. Theirs are passive funds.)

So, back to our regularly scheduled program: Holding only a specialist index fund like a value fund or a small cap fund is good in the sense that one is not in the mode of using expensive stock pickers, but it is not so good in terms of diversification, as over any period of time the chosen category may underperform or outperform the market just as any other sector might. The key to successful passive investing, the academics will argue (and I am a believer), is to invest in everything and just ride the tides with confidence that the long term trend will be favorable.

Whew! Lots of typing. Sorry.

 

[bw5972]

Thanks for the clarification all, this is jiving more for me now. I was interpreting "index" to always mean TSM index or something similar, which I now see is not the only usage of the term.

Even a sector or market based index fund should have less turnover of stocks than an actively managed fund.

.i.e.

An "Energy Sector" fund not likely to have to drop Exxon because it switched to a restaurant business.

 

[ERD50]

It may seem that way to you, but it's still a sloppiness in expression that sometimes leads to misunderstandings. Indexes have grown tremendously in number and popularity and it's not uncommon for folks to use focused indexes in lieu of focused actively managed funds.

In your case specifically, there have been several times where your interpretation of what an index fund is has mislead me for a moment and I've had to stop and think "oh, he must be assuming the market cap weighted TSM index."

It's easy and important to be clear in these matters, so why not?

Not that anyone cares, but I think the word "index" has been so hijacked and corrupted that it has become almost useless for communication.
....

Well OK, but I'm kinda surprised that there is any confusion when these terms are used in context. To me, it's like reading a recipe in the local paper that lists:

1 Cup Whole Milk
1 Tablespoon Sugar​

in the ingredient list. I assume that to be Cow's milk, not goat's milk or Almond Milk or Soy Milk, or they would have specified. Same with the sugar, just regular old "Table Sugar", not powdered sugar, not brown sugar, etc.

So if I'm talking about a simple portfolio and suggest keeping it simple with "index funds", and say I think one Stock fund and a Bond fund are enough, and heck, you can throw in some REIT or International if you want. You think that for the stock and bond portion that people might be confused and think I'm talking about some sector of each (like only Telcomm, or only Pharma, or only Petroleum)? Or Bonds are only grade such and such from a single industry?

Maybe if the poster is a new and unfamiliar with the terms, some specificity is in order, but that's usually clear, and probably provided? But otherwise?

OK, if this bothers you, what terms should I use? How specific when I'm just talking general AA and index funds. To be honest, I'd have to look up TSM, I really don't know how "total" total is (5000? and is that "total"?). I personally don't get into even differentiating much between a S&P 500 fund versus Russell 2000 for my own investment purposes, and don't consider it a big deal unless the conversation is getting into those specifics (then people should specify, small cap, or whatever). Do we need to throw "US" in there, so nobody thinks we are talking International stocks? I'm not trying to be a smarta$$, I honestly don't know how far you two think this should go.

So, back to our regularly scheduled program: Holding only a specialist index fund like a value fund or a small cap fund is good in the sense that one is not in the mode of using expensive stock pickers, but it is not so good in terms of diversification, as over any period of time the chosen category may underperform or outperform the market just as any other sector might. The key to successful passive investing, the academics will argue (and I am a believer), is to invest in everything and just ride the tides with confidence that the long term trend will be favorable.

Sounds good to me!

-ERD50

 

[OldShooter]

... Maybe if the poster is a new and unfamiliar with the terms, some specificity is in order, but that's usually clear, and probably provided? But otherwise? ...

The problem I see is that the hucksters have hijacked the word. In The Beginning, there were the major indices like the Dow Industrials and the S&P. Then we got Russell and Wilshire. But all of these were pretty broad. Not total market broad, but still a decent surrogate and useful for passive strategies.

But now, we have literally thousands of stock lists being called "indexes." Look at https://www.msci.com/acwi, for example. Most of these so-called indexes are designed to be sold to ETF hucksters who are creating, effectively, sector funds. Wolves in sheeps' clothing.

A new investor and many more experienced investors have been sold on the soundness of passive investing but they do not understand that the strategy depends on, as Fama says, "holding the market portfolio." i.e., everything. So they get sold a bunch of sector funds with "index" in their name and they are not passive investors at all. They are trying to pick winners and the hucksters are picking their pockets. Grrr ...

So that's why I think the concept of "index investing" is no longer very useful. I try to stick to the word "passive." But I am a curmudgeon.

.... and I hold primarily one US total market fund and one international total market fund at about a 60/40 ratio. I do not hold the "South China Sea Small Cap Index" fund or any of its ilk. (Yes, I made that one up but it is not at all far-fetched.)

 

[ERD50]

The problem I see is that the hucksters have hijacked the word. In The Beginning, there were the major indices ....

But now, we have literally thousands of stock lists being called "indexes." ....

A new investor and many more experienced investors have been sold on the soundness of passive investing but they do not understand that the strategy depends on, as Fama says, "holding the market portfolio." i.e., everything. So they get sold a bunch of sector funds with "index" in their name and they are not passive investors at all. They are trying to pick winners and the hucksters are picking their pockets. Grrr ...

OK, I guess I've been around long enough that the 'old' indexes are what come to mind unless someone specifically calls out a 'sector'.

It might have been on another forum (not financial focused), where a side discussion came up about investing, and I think I used the term "broad-based index fund", to try to be clearer in a group that didn't normally use these terms. I probably threw in 'low cost' as well.

But around here, when someone says, 'Nah, I don't buy individual stocks anymore, I just buy the index', I assume they are talking a broad-based stock index like S&P500, Russell 2000, etc. Unless the discussion was about pharma or some other sector, then maybe they are talking a sector 'index'.

Not sure what is required for clear communication, but "U.S. equity market Index, including small-, mid-, and large-cap growth and value stocks, comprising approximately 3600 different stocks for diversification (it's actually 3606, had to look it up!)" is quite a mouthful!

Could give a ticker, but then I sound like I'm favoring one fund company over another.

-ERD50

 

[OldShooter]

... Not sure what is required for clear communication, but "U.S. equity market Index, including small-, mid-, and large-cap growth and value stocks, comprising approximately 3600 different stocks for diversification (it's actually 3606, had to look it up!)" is quite a mouthful!

Could give a ticker, but then I sound like I'm favoring one fund company over another.

Well, Einstein said “Everything should be made as simple as possible, but not simpler.”

Maybe it is necessary to say your mouthful or to give a ticker.

The funny thing about the 3600 stocks is that mutual funds outnumber them about three to one. Not sure what conclusion to draw from that except that the hucksters are very industrious people.

 

[RobLJ]

I've thought for years the Dow 30 was a pretty narrow "index" of stocks further flawed by price weighting, so I started paying attention to the S&P, but even that has a pronounced large cap capitalization bias.

 

[OldShooter]

I've thought for years the Dow 30 was a pretty narrow "index" of stocks further flawed by price weighting, so I started paying attention to the S&P, but even that has a pronounced large cap capitalization bias.

Yes. Like ... all large cap.

IMO all the naive enthusiasm for anything called "indexing" has also driven S&P 500 prices up -- another reason to avoid it. That's why I stick with "total market" funds. The effect of the S&P can't be avoided even there but it can be reduced.

 

[mrWinter]

A couple articles I found interesting regarding some indexes, that unlike what I may have thought an index was, are not diversified and are not really all that passive:

When Is A P/E Not A P/E: How To Turn Nasdaq's 90x Into 22x In 3 Easy Steps | Zero Hedge

What Is The PE Of The iShares Biotech ETF? It Depends On Whether You Read The Fine Print | Zero Hedge

Looks like P/E numbers can't really be trusted. Shame there isn't a standard mandatory way of calculating so everyone is talking about the same thing.

 

[target2019]

When discussion includes a very broad term like index, I try to find an example or definition:

Index Investing

This article helps to answer the initial question:

Index Investing: What Is An Index?

Still, some can use the terms to suit their viewpoint or purpose.

Many around here will use index as short name for S&P500. The S&P500 can be divided into value or growth companies. You can go further in segmenting (as in sectors).

Since companies succeed and fail over time, the lineups change as companies rise and fall in ranking.

 

[ERD50]

A couple articles I found interesting regarding some indexes, that unlike what I may have thought an index was, are not diversified and are not really all that passive:

When Is A P/E Not A P/E: How To Turn Nasdaq's 90x Into 22x In 3 Easy Steps | Zero Hedge

What Is The PE Of The iShares Biotech ETF? It Depends On Whether You Read The Fine Print | Zero Hedge

Looks like P/E numbers can't really be trusted. Shame there isn't a standard mandatory way of calculating so everyone is talking about the same thing.

I do find that odd. Seems to me that the P/E of ANY basket of stocks is the price of a share of that basket divided by the net earnings that the stocks contributed to a share of that basket. No adjustments needed.

So if a share of the basket held 100 shares of a stock with a $1/share earnings, and another 500 shares of a stock with a $0.01 loss, and all other stocks had exactly zero earnings, the P/E is (Price of the basket)/ ($100-$5).

Why should it be anything else?

When discussion includes a very broad term like index, I try to find an example or definition:

Index Investing

This article helps to answer the initial question:

Index Investing: What Is An Index?

Still, some can use the terms to suit their viewpoint or purpose.

Many around here will use index as short name for S&P500. The S&P500 can be divided into value or growth companies. You can go further in segmenting (as in sectors).

Since companies succeed and fail over time, the lineups change as companies rise and fall in ranking.

Sure, and this is literally semantics, but I do think context makes it clear in most cases. Just because there are lots of sub-classes of a word, doesn't mean we are referring to any of those sub-classes in general use, and we would normally specify that.

Example:

If you say "I drove my car to the store to get some groceries, and drove home", people picture a typical passenger car. But there are all sorts of cars. Yet, no one would think you drove a NASCAR race car to the store, or a kids toy electric car - but those are both 'cars'.

If you did anything like that, you would specify: "I got to drive a Race Car to the store, man, I had to avoid the cops, and did I ever get the looks! But I made it there in record time!", or "I drove the grand-kid's toy electric car to the store, took a long time, and I sure got the looks!".

If I'm talking about a fund that does a 3x leverage short on precious metals, I'm going to specify that, and not just say "I think a 60/40 AA is good, and just invest in index funds".

-ERD50

 

[Rianne]

Well OK, but I'm kinda surprised that there is any confusion when these terms are used in context. To me, it's like reading a recipe in the local paper that lists:

1 Cup Whole Milk
1 Tablespoon Sugar​

in the ingredient list. I assume that to be Cow's milk, not goat's milk or Almond Milk or Soy Milk, or they would have specified. Same with the sugar, just regular old "Table Sugar", not powdered sugar, not brown sugar, etc.

So if I'm talking about a simple portfolio and suggest keeping it simple with "index funds", and say I think one Stock fund and a Bond fund are enough, and heck, you can throw in some REIT or International if you want. You think that for the stock and bond portion that people might be confused and think I'm talking about some sector of each (like only Telcomm, or only Pharma, or only Petroleum)? Or Bonds are only grade such and such from a single industry?

Maybe if the poster is a new and unfamiliar with the terms, some specificity is in order, but that's usually clear, and probably provided? But otherwise?

OK, if this bothers you, what terms should I use? How specific when I'm just talking general AA and index funds. To be honest, I'd have to look up TSM, I really don't know how "total" total is (5000? and is that "total"?). I personally don't get into even differentiating much between a S&P 500 fund versus Russell 2000 for my own investment purposes, and don't consider it a big deal unless the conversation is getting into those specifics (then people should specify, small cap, or whatever). Do we need to throw "US" in there, so nobody thinks we are talking International stocks? I'm not trying to be a smarta$$, I honestly don't know how far you two think this should go.



Sounds good to me!

-ERD50

Hahaha! That was brilliant. I just thank Jack Bogle. Send the $$ in, pick a place to put it and watch it grow. We were so naive, ummm, this fund looks good, there's a bunch of stuff in there, let's try it.