Journal of Financial Planning : the irony

[walkinwood]

I found the juxtaposition of these two articles in the contents of this month's JFP to be quite ironic.

Slow-Timing the Market, an Alternative Portfolio-Allocation Approach
by D. Allen Cohen, Ph.D.
The author proposes a method to help clients take advantage of intermediate-term statistical market trends and make better adjustments to their portfolio allocations.

Is Buy and Hold Dead? Exploring the Costs of Tactical Reallocation
by David M. Blanchett, CFP®, CLU, AIFA®, QPA, CFA
This research shows that a long-term static allocation strategy will likely lead to higher risk-adjusted performance for most investors than a tactical allocation strategy, especially considering additional costs incurred by tactical investors.

I only skimmed through the articles. I think that beating the market consistently is very, very difficult, so I found the second article quite obvious.

 

[walkinwood]

The issue also has this interview with Rob Arnott, the guy who developed the RAFI indexes (Fundamental Indexes). Whether you agree with him or not (and I don't know where I stand yet), it is an interesting interview that covers his view on why fundamental indexes are better than cap-weighted indexes.

I can't quite figure out how his approach differs from having a Value Index fund (like VG's Value Index VIVAX).

http://www.fpanet.org/docs/assets/B9103FE0-1D09-67A1-7A9A65A9D36175F5/10Q.pdf

 

[kyounge1956]

The issue also has this interview with Rob Arnott, the guy who developed the RAFI indexes (Fundamental Indexes). Whether you agree with him or not (and I don't know where I stand yet), it is an interesting interview that covers his view on why fundamental indexes are better than cap-weighted indexes.

I can't quite figure out how his approach differs from having a Value Index fund (like VG's Value Index VIVAX).

http://www.fpanet.org/docs/assets/B9103FE0-1D09-67A1-7A9A65A9D36175F5/10Q.pdf

I think the difference is in the weighting. VIVAX "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."(emphasis added) I think this means that VIVAX is made up of stocks with value characteristics, weighted by market capitalization. The stocks in a fundamental index are held in amounts according to their economic weight, which is a score based on, IIRC, four fundamental characteristics of the stock. A fundamental index would probably include many of the same stocks as a value index, but would hold more of a stock that scores well in all four characteristics but has low market cap, than there would be of a stock with higher market cap but poorer scores. I read a book about fundamental indexing last year, and it makes sense to me that fundamental indexes would outperform cap-weighted ones, but I don't have access to the RAFI funds with my current 457 plan custodians, so I haven't bothered to look up the charts and see whether the theoretical out-performance actually shows up in practice. It may turn out that for all practical purposes, a fundamental fund and a value fund are interchangeable.

 

[walkinwood]

Thanks kyounge. Do you remember the name of the book? Would your recommend it as a good primer for Fundamental Indexing?

 

[kyounge1956]

Thanks kyounge. Do you remember the name of the book? Would your recommend it as a good primer for Fundamental Indexing?

The book is called The Fundamental Index. I started a thread about it last year. I don't know about calling it a primer, it's perhaps not simplified enough to be called one, but it was a clear explanation of what fundamental indexing is and why the authors advocate it.

 

[walkinwood]

I can't remember when I first got the link to this article, but it explores performance & volatility differences between ETFs based on cap-weighted, equal weight and fundamental indexes over the last 5 years

WSJ: Index Funds Get a Makeover
http://online.wsj.com/article/SB10001424052748703555804576101812395730494.html

Bottom line : cap weighted indexes had the least volatility & lowest returns. Fundamental indexes had the most volatility & best returns.
And ...

And what about when market bubbles burst?
Turns out, both Rydex S&P Equal Weight and PowerShares FTSE RAFI US 1000 underperformed the market in the most recent crash. From Dec. 31, 2007 to the March 9, 2009 market bottom, the Rydex fund lost 56.4% and the PowerShares fund lost 57.9%, versus the 53.9% loss for the S&P 500.
The market may be irrational, but it is devilishly hard to beat consistently.