If something cannot go on forever, well then, it will eventually stop. So said economist Herbert Stein when he made this obvious but insightful observation. Trees do not grow to the sky, and matters that are truly unsustainable eventually come to an end.
The most recent example of something that can’t go on forever has been the inflows into low-cost, passive index funds, primarily to the detriment of higher-cost, actively managed funds. As the Wall Street Journal reported:
For the first six months of 2018 the amount of money going into all U.S. passive mutual funds and exchange-traded funds was down 44 per cent from the same period a year earlier.
The decade after the financial crisis saw rivers of money gushing into the three biggest indexers - Vanguard Group, BlackRock Inc. and State Street Corp. These firms now manage almost US$15-trillion in equities and fixed-income funds. All three are many times larger than they were in the mid-2000s.
During the fat part of the inflows, many fearful explanations were cited as a reason. Some were simply silly: indexing was Marxist, or nonprofit or Socialist, a bubble soon to burst, dangerous to the economy, and so on. Others were less histrionic, but just as misinformed and wrong.
A more factual explanation for the shift toward indexing is: 1) Changing business models in the money-management business with the move away from commission brokerage accounts and toward fee-based advisory; 2) investors were not getting the promised gains from many active managers, especially hedge funds and other alternative investments; 3) investors became disillusioned by a series of accounting frauds, analyst scandals, scams and Ponzi schemes in the 2000s; 4) a sense that markets were rigged against the little guy sent them looking for other options; 5) the broad acceptance of behavioral economics led many people to recognize that they lack the skills and temperament to actively manage their own money; and 6) repeated crashes and volatility in equities, commodities and housing finally exhausted the patience of a generation of investors.
There are many more reasons, but those intellectually and mathematically supportable explanations suffice for the purposes of today’s discussion on sustainable trends.
Now that the unsustainable is no longer being sustained, we already see similarly misguided explanations for the flow slowdown.
Yes, the inflow slowdown was correlated with a period of market swings tied to concern about trade wars and rising interest rates. But what about all of the prior market swings? We have had flash crashes, nuclear saber-rattling, special prosecutors, surprising election results here and abroad, even a downgrade of the U.S.’s credit rating, none of which slowed inflows. Finding a correlation, then implying that is the causation, is simply sloppy reasoning.
Nor are there good reasons to think that a reduction of inflows into cheap indexers represents - as some seem to think it does - a test of investors’ comfort with passively managed funds.
Try this better explanation: About US$10-trillion in assets have completed their move from pricey and actively managed funds to cheaper and passively managed ones. It has slowed down because the first phase of transition to indexing has been completed. The low-hanging fruit has been picked. If my thesis is correct, after this, inflows will likely be steady but somewhat slower.
I speak regularly with senior management at Vanguard, Dimensional Fund Advisors and another index providers. For years they have had to cope with a deluge of inflows, and I suspect they welcome the opportunity to digest these gains, allowing their systems to catch up to the huge increase in assets under management.
Despite the slowdown in inflows to passive funds, indexing is still giving active funds plenty of competition. The Journal reports that “US$29 billion in client money left those [active] funds during the first half of this year.” Any fund manager presented with the choice of slower inflows versus outflows is going to choose the former.
Why must we complicate what is otherwise a simple explanation? Investors have become a little more financially literate; indexing is maturing as an investment style. Those who are hoping for a major reversal of a trend that has been 40 years in the making are very likely to be disappointed.
-- By Barry Ritholtz, Bloomberg news
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The Rundown
BMO’s run in 2018 marks another win for our winning bank picking strategy
Analysts at RBC Dominion Securities have upgraded their recommendation on Bank of Montreal to “outperform” from “sector perform,” and investors who follow our strategy of buying laggard bank stocks will no doubt applaud the move.
Our strategy at the start of this year identified BMO as the best Canadian bank stock for 2018. And look at BMO now: Midway through the year, the stock has emerged as the sector’s top performer, edging past Toronto-Dominion Bank. David Berman reports (for subscribers)
Five solid stocks with dividends above 5 per cent
Summer is the perfect time to grab a cold beverage, put out the lawn chair – and start picking some great dividend stocks.
Even though many dividend payers have started to recover from the interest rate-related sell-off earlier this year, plenty of companies still offer attractive valuations, above-average yields and solid prospects for dividend growth.
In this column, John Heinzl chooses five companies from his Yield Hog Model Dividend Growth Portfolio whose share prices are still well below their 52-week highs. That means you’ll be getting more dividends for every dollar you invest.
So pour yourself a lemonade (picking stocks while drinking beer is not recommended) and let’s get busy. (for subscribers)
The feared bond massacre of 2018 never happened – and there’s a lesson in it for all investors
So much for the hysteria over bond ETFs getting massacred. There was a point in mid-May when it looked as if bonds were going to be a big problem for investors in 2018.
And then it passed. Let this be a lesson to all the investors who lost faith in bond exchange-traded funds – you never know what’s ahead in today’s ever-unpredictable financial markets. Stop trying to guess and just hold your bond ETFs, individual bonds, guaranteed investment certificates or whatever you use for exposure to fixed income. Rob Carrick shares his thoughts (for subscribers)
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Ask Globe Investor
Question: I am 57 years young and have never set up an RRSP, mainly due to having a DBPP from my army career which I am currently receiving. I am working at a job since leaving the army, which I plan to do for a few more years. My unused RRSP room is quite a lot but is it too late or a waste to catch up all that unused contribution room? I recently sold my home and am starting to rent in the fall.
My income will be lower in retirement than I get currently, by about $13,000 yearly. I have maxed out my TFSA. My wife is retired and does not have a TFSA or an RRSP either, she is 69. -Paul O.
Answer: If your income is going to be lower in retirement, opening an RRSP may make sense. The reason is that you will get a tax deduction now, when your income is higher, but the money will be taxed at your lower income rate when it comes out of the plan. However, the $13,000 difference may not put you into a different tax bracket. It depends on your province of residence and income level.
For example, the marginal rate for an Ontario resident with $65,000 taxable income is the same as for someone making $52,000 – 29.65 per cent according to EY’s 2018 Personal Tax Calculator. But if your current income is $50,000 and you expect it to drop to $32,000, your marginal rate at that level would be 20.05 per cent – almost ten percentage points less. It would stay at that rate up to $42,000, which gives you plenty of room to withdraw some of the RRSP/RRIF savings without moving into a higher bracket.
You can do your own calculation by going to www.ey.com/ca/en/services/tax/tax-calculators-2018-personal-tax.
If the tax calculations don’t work in your favour, a TFSA for your wife would be a good alternative. – G.P.
- Gordon Pape
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