INDEXATION IN BULL MARKETS AND IN BEAR MARKETS
Over the years, I’ve often been asked for investment advice, and in the process of answering I’ve learned a good deal about human behavior. My regular recommendation has been a low-cost S&P 500 index fund. -Warren Buffett 2016 Annual Report
You might have come across the above-mentioned statement before and even discussed it with others, whether it be with investment professionals in the industry or a friend or family member. Do you make use of indexation? Actions speak louder than words. It is clear that indexation has well defined benefits over active alternatives and when the most successful active investor of all time advocates the use of indexation, we all need to listen up!
Data source: Profile Media
Red bars: Underperforming funds
Green bars: Outperforming funds
Black bar: Market return
From the above graph we can see that for the 5 years ending 31 October 2018 an indexation-based fund (purple bar) outperformed 80.39% of all other funds (red bars) in the General Equity sector of South Africa – net of fees – simply by replicating the market return. You could have too!
Indexation outperforms throughout the cycle
There is a perception that prevails in the market that index funds do not outperform during bear markets. We do not disagree with this and the data actually supports this... but that is not the whole story. Index managers always try to keep cash holdings to a minimum which means that active managers are at an advantage when the downturn happens. The more important question is what happens over the longer term? Are active managers able to outperform throughout
the cycle – that is from the top to the bottom…and back up again?
Let’s look at some performance numbers:
Period 1: 78.95% of managers underperform the market. Passive outperforms. Period 2: 4.94% of managers underperform the market. Passive underperforms.
Period 3: 88.37% of managers underperform the market. Passive outperforms.
Period 4: 57.97% of managers underperform the market over the horizontal period. Passive outperforms.
Period 5: 68.42% of managers underperform the market over the full period. Passive outperforms.
Further, the data only reflects funds that still exist today; it is during bear markets that funds close down due to poor performance (survivorship bias). Investors should be cautious in trying to pick the bottom of a market; rather rely on indexation.
Our counsel resonates with Warren Buffett’s: Make use of a low-cost, indexation-based product and stick to your choice throughout the cycle.
CL Treurnicht – Portfolio Manager – Gryphon Asset Management