Monday, July 6, 2015

Latest Horizon Kinetics On Indexing

They're talking about [pdf] how the S&P 500 used to be market cap weighted, but is now float weighted, which means that it will own smaller amounts of the "owner-operator" companies that have historically contributed a significant part of the index return:

"When added to the S&P 500, the share price [of Microsoft] was about $2.41. At January 1999, when the stock was $44.75, insiders still owned 31% of the shares. By September 1999, near the peak of the Great Technology Bubble, when the shares were $47.50 (when Microsoft’s weight in the S&P 500 exceeded 4%), inside ownership had been reduced to 26%, and by early September 2000, the very threshold of the collapse of that bubble, when the stock was $35, inside ownership had dropped to 19%. Today, 15 years later, the shares are only $44.37–a 1.6% annualized return –and were quite a bit lower than $35 only two years ago. Whether by fortune or perception, insiders were dramatically reducing their holdings going into a decade-plus period of decline and stagnation. What did outsiders do? Had the float-adjusted index weighting method been in place at the time, then as insiders sold, such that the float increased, the Index rules would have increased the Microsoft weighting, and mutual funds and other index investors would have been buying more—more of what the insiders were selling."
Index investing has all the signs of an investing fad that will be remembered as an embarrassing flop: nearly universal adulation, unthinking adoption, regulatory blessing.


CP said...

"Index funds will be permanent owners who can never sell. That will give them power they are not likely to use well."

CP said...

Good comment on that post:

"It's simply not possible to go from a world where equities are predominantly held by a relatively sophisticated sliver of society to one where the marginal investor is an indiscriminate buyer / seller, effectively timing transactions around their life cycle, and expect returns to be the same."

whydibuy said...

I thought Buffett endorsed index funds on the basis that nearly none of the managed funds ever beat the indexes so why fight it? Ditto for Mr Bogle who went a step further and advised total market funds on the same logic as Buffett.
And why not index funds? Today, many big winners come out of hard to understand technology or technology that catches you off guard as it blooms into a big business. Fund mgrs are just like you and I and don't always pick up on whats new and on the rise. If they don't invest in it then you, dear shareholder, miss out on that wonderful wealth creation.

innerscorecard said...

Index funds now have the ultimate appeal from authority - people can say that Buffett recommended them!

Anonymous said...

I like reading the Horizon papers, but they tend to simplify things too much.

I don't have a link, but I remember them writing about (and buying) Sears Canada based on the sale of 5-10 properties. They extrapolated the sales price out to all of Sears Canada's stores and concluded that it was cheap.

Wal-Mart's weighting wouldn't have been reduced 38% because the other 499 stocks in the S&P 500 also presumably had shares held by insiders. Just to make a point...if the average S&P stock had insider ownership of 40%, WMT's weighting would have actually increased.

Revenue growth in 2014 was also impacted by the stronger dollar and lower oil prices...which they fail to mention.

All that being said, the point about indexes buying more of a stock that insiders are selling is a good one.

CP said...

The average S&P stock does not have insider ownership of 40%. Not even close.

Anonymous said...

I know that. My point was that saying WMT's weighting went down 38% is wrong...unless every other stock had 0 insider ownership.

Anonymous said...

I totally agree about the fad of passive investing. But what do you think the catalyst will be to break it? In 2000, we had not only a giant tech bubble obviously, but also a mega-cap bubble. The outcome for S&P 500 investors for the next 5-10 years was terrible compared to just about any other asset class. It was the easiest stretch in history to "beat" the market. Now the big mega caps don't look out of line compared to anything else and might even been better than a lot of stuff I see. If the S&P 500 goes down 40-50% from here, I don't think "active" investors are going to do a lot better. Only the cash holders will be okay and that was true of the financial crisis. If the post-2000 period didn't break passive investing, and the financial crisis didn't break passive investing, what will?