Interesting to know

In the footsteps of index investors (part 1)

Who are they – index investors of the new generation? What do these people bring to the world, what credits do they hold and what areas do they succeed in?

Let's sort it out!

Unprecedented commercial success was reserved for such stock strategy as indexing (which included investments into managed, cost-effective, diversified stocks and bonds' funds) since the first index fund was created. It happened far back in 1975 of the XX century. This business didn't have any example back then but nowadays the success in the indexing sphere doesn't surprise anyone.

Today the major part of indexed capital is lodged with index funds which work with U.S. Stock Market quotes (for example, S&P 500 and Dow Jones Wilshire 5000), as well as with the funds of global fund market (Morgan Stanley EAFE for Europe, Australia and Far East). The growth at an exponential rate was observed among the assets of the traditional indexed funds' stocks. They increased from 16 million dollars in 1976 to 445 million dollars in 1986 and up to 68 billion dollars in 1996 and to 369 billion dollars in 2006. In the years since, there was positive dynamic at the stock market.

According to the John Bogle's research, whose experience was shared in Little Book of Common Sense Investing: The Only Way to Guarantee Your Fair Share of Stock Market Returns, high competitiveness is observed at the indexing area. The world leading index funds start price fights with each other from time to time. It helps them to increase investments but the index funds' managers observe a profit decrease.

If the market gains 10% the investors are able to earn about 10%, unadjusted for expenses. On the whole, minimization of expenses gives the market participants higher revenue. John Bogle says that this is the only investment approach which guarantees high performance. He sees only one method to outperform the market portfolio – switch the focus. Many active managers were going this way, however they often lose. The analyst says the reason for this phenomenon is the mindless change of the shares' holder. As a result only financial intermediaries win.

Nevertheless, the entrepreneurs who believe in creation of new index funds which can outperform the market have entered the financial arena. They develop new methods to evaluate the content of an investment portfolio. However, John Bogle has expressed some concerns that businessmen will “reinvent the wheel” and won't win anything.

On the whole, the situation is benign for the new generation of index investors. The entrepreneurs focus on the portfolio evaluation based on certain fundamental factors. Market capitalization evaluation is substituted by group of factors: corporate income, cash flow and dividends. Their argument is based on the fact that if in the portfolio evaluated by market capitalization 50% of shares are overestimated to a greater or lesser degree then the other 50% are underestimated. John Bogle considers these conclusions legitimate.

We will keep discussing index investors – new heroes of our time, masters of the stock market, and soldiers of forex luck - in our next article.


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