Living in fantasy land care of property and share indexes

[urbanista]

Read more: http://www.smh.com.au/national/living-in-fantasy-land-care-of-property-and-share-indexes-20140822-107636.html#ixzz3BLp4qxLD

This article has heavy Australian focus, but surely applies to any investors worldwide.

Basically, the author mocks any sort of index investing, be it shares (stocks) or residential real estate.

This guy writes the column in a Saturday's edition of a  well respected daily Melbourne paper, i.e. his audience is your mum&dad's investors. I drives me nuts as every single weekly article by him is basically the marketing pitch in favour of active fund managers and against any sorts of index investing. For example:

"The whole index marketing thing is simply an attempt by every industry to dumb you down into thinking an asset class is reliable over long periods and therefore safe so you invest. But property or shares, it's just marketing."

So, just marketing, no less. But look who's talking! The active trader (active fund manager!).

I am sick and tired and want to write back to the paper to protest. But I don't really have any concrete evidence. Two things:

1. Residential real estate index: does it really ignore the value of renovations?

2. Stock index funds: do they really suffer from the survivorship bias and if yes, what is the magnitude of that?

Appreciate everyone's help.

[superannuationfreak]

Stock index funds don't suffer from survivorship any more than actively managed funds.  There's a long track record for basic indices at least, so look at how well an ASX200 index ETF (STW) has tracked the index.  Maybe a 40 b.p. lag due to expenses, trading costs, etc.  Then look at the SPIVA scorecard: http://au.spindices.com/resource-center/thought-leadership/spiva/

While some years active management of large caps does well, over the five years to 2013 for example almost 70% of large cap funds underperform the index.  Over longer time periods and in more efficient markets the story is an even stronger one.  There's also research to show that when active management underperforms then the average underperformance is more than the average outperformance (here's a non-Australian example http://www.rickferri.com/WhitePaper.pdf ).

I don't know much about real estate indices.  There's a lot of heterogeneity in real estate as it is [it's not possible to actually invest in the index directly].

[hodedofome]

In a way buying and holding anything is essentially making a bet that it will be worth more in the future than today. That goes for indexes as well. It's why we have to diversify, because a concentrated buy and hold portfolio is pretty risky. Diversifying globally and across various asset classes increases the odds that your portfolio won't get killed in the event of an asset class underperforming for decades.

[bigchrisb]

I've been fairly skeptical of residential property indices.  Mainly because there is such a poor match between the different data sources (be it the ABS, or the property spruikers such as RP data).  Its also an illiquid market, with at best a guess as to the amount of capex spent between one sale and the next.  So I reckon he is rightly skeptical about residential real estate indices.  There is a somewhat useful paper put out by the reserve bank (http://www.rba.gov.au/publications/rdp/2014/pdf/rdp2014-06.pdf) which tried to put some estimates to items like this, in its assessment of potential over-valuation in the housing market.

As for stock indices, I'm pretty sure that the indices account for this on re-balancing - i.e. periodically the index will add/remove constituents.  In effect, this is like buying the new entrant, and selling the existing security.  This may be due to de-listing, or having such a crash that it falls out of the index basket, with an associated loss.   The main difference with the indices is that they are friction less - no brokerage,  no tax issues etc. 

If you want an example of how close trackers get to indices, look up the chart for the oldest ETF I can find (the US SPY, since 1993).  Plot that against the s&p 500, and the price has tracked perfectly (on a price basis).  Anyone clever enough to be able to plot the total return (with dividends) comparison for this?

[urbanista]

Thanks, everyone, the advice is very helpful. Will process and come back with further questions.

[misterhorsey]

LOL.  I knew it was Marcus Padley before I clicked on the article.

He's actually a stock broker. Without churn he'd not be able to put any bread on his table.