AAII Journal Editor
How Various Indexes Are Weighted
The advantages and disadvantages of index weighting strategies.
Stock Price Movements Are Unpredictable
Burton Malkiel explains why stock price movements can’t be predicted.
AAII Discussion Boards
What do you think of Vanguard’s changes?
This week’s AAII Sentiment Survey results:
Bullish: 33.9%, down 2.2 points
Neutral: 32.9%, up 5.5 points
Bearish: 33.2%, down 3.2 points
September 27, 2012
September 20, 2012
September 13, 2012
September 6, 2012
August 30, 2012
August 23, 2012
August 16, 2012
August 9, 2012
August 2, 2012
July 26, 2012
July 19, 2012
July 12, 2012
July 5, 2012
June 28, 2012
June 21, 2012
June 14, 2012
June 7, 2012
May 31, 2012
May 24, 2012
May 17, 2012
May 10, 2012
May 3, 2012
April 26, 2012
April 19, 2012
April 12, 2012
April 5, 2012
March 29, 2012
March 22, 2012
March 15, 2012
March 8, 2012
March 1, 2012
February 23, 2012
February 16, 2012
February 9, 2012
February 2, 2012
January 26, 2012
January 19, 2012
Vanguard announced this week that it is changing the benchmark indexes used for 22 of its funds. A full listing of the affected funds can be found on Vanguard’s website. Even if you don’t own Vanguard funds, the change is worth noting.
Fund companies pay an index provider for the rights to use their index. The composition of an index is actually owned by the parent company of that index. This means you cannot simply create a portfolio that mimics the performance of the S&P 500 index and offer it to clients without paying a licensing fee. Creating and maintaining an index requires work, and index companies want to be compensated for their efforts.
Vanguard is citing the costs of these licensing fees as the reason for the change. The company is switching from MSCI indexes to established FTSE benchmarks and newly created CRSP benchmarks. For those of you unfamiliar with the initials “CRSP,” it stands for the University of Chicago’s Center for Research in Security Prices. CRSP data is often used in academic studies about market performance and asset price returns.
Vanguard further believes that costs will be saved by the manner in which a stock is transitioned from one index to another. The CRSP benchmarks will use a “packeting” methodology. This means two indexes will be allowed to hold onto the stock during the transition period. The idea is that this will reduce costs relative to a commonly used strategy of completely removing a stock from one index and adding it to another index.
Although the intention is good, we will have to see how this works in practice. Shareholders of the affected Vanguard funds, including me, will incur different return characteristics than they would have had no change been made. The question is will the change be noticeable and how much positive impact will it really have? Costs should be reduced, but how much these costs will be offset by any reduction in return is unknown. Ideally, the impact on realized performance will be nominal, but we’ll know more several years from now.
If you hold one of the affected funds or are considering investing in one of them, should you have concerns? Given Vanguard’s track record, I would say no unless you are truly intent on following a specific index.
Know What Index Your Fund Follows
When using an index fund from any fund family, make sure you understand what index it is designed to follow. With the growth of exchange-traded funds, there has also been growth in indexes for those funds to follow. Similarly sounding funds may follow different indexes.
Read the prospectus, understand the methodology used and make sure you are comfortable with the level of volatility.
More on AAII.com
- A Question of Proportions: How Various Indexes Are Weighted – James Cloonan discusses the advantages and disadvantages of various index weighting strategies.
- Stock Price Movements Are Unpredictable – It’s difficult to discuss index investing without mentioning Burton Malkiel. Malkiel is a big proponent of index funds. Here is a transcript of my interview with him.
- Index Funds and the Balance Between Active and Passive Investing – While going through our archives on AAII.com, I found this interesting 1996 article. (PDF format)
- What Do You Think of Vanguard’s Changes? – Tell us on the AAII Discussion Boards.
The Week Ahead
The U.S. bond markets and most banks will be closed on Monday in observance of Columbus Day.
Alcoa (AA) will “officially” kick off third-quarter earnings season when it reports on Tuesday. Fellow Dow component JPMorgan Chase (JPM) will report on Friday. Joining them will be fellow S&P 500 members Yum! Brands (YUM) on Tuesday, Costco Wholesale (COST) on Wednesday, Fastenal Company (FAST) and Safeway (SWY) on Thursday and Wells Fargo & Company (WFC) on Friday.
The first economic reports of note will be the Federal Reserve’s periodic Beige Book and August wholesale trade, both of which will be published on Wednesday. Thursday will feature August international trade data and September import and export prices. The September Producer Price Index and the preliminary October University of Michigan consumer confidence survey will be published on Friday.
The Treasury Department will auction $32 billion of three-year notes of Tuesday, $21 billion of 10-year notes on Wednesday and $13 billion of 30-year notes on Thursday.
AAII Sentiment Survey
Both bullish and bearish sentiment fell, leaving the difference between optimism and pessimism very narrow in the latest AAII Sentiment Survey. This is the first time that the bull-bear spread—the difference between bullish and bearish sentiment—has been less than 1% in consecutive weeks since November 4 and November 11, 1993.
Bullish sentiment, expectations that stock prices will rise over the next six months, declined 2.2 percentage points to 33.9%. The drop brought optimism down to a four-week low. This is the 26th out of 27 weeks that bullish sentiment is below its historical average of 39%.
Neutral sentiment, expectations that stock prices will stay essentially unchanged over the next six months, rose 5.5 percentage points to 32.9%. This is a four-week high for neutral sentiment. The historical average is 31%.
Bearish sentiment, expectations that stock prices will fall over the next six months, fell 3.2 percentage points to 33.2%. This is the sixth consecutive week and the 22nd time in 26 weeks that pessimism has been above its historical average of 30%.
The continued narrow bull-bear spread is indicative of the ongoing uncertainty about where stock prices are headed. Splitting the moods of AAII members are higher stock prices, improved economic data, slowing global economic growth, Washington politics and the European sovereign debt crisis. Nonetheless, even though bullish sentiment remains below average and bearish sentiment is staying above average, optimism among individual investors is higher than what was registered throughout spring and much of the summer.
This week’s special question asked AAII members how worried they are, if worried at all, that stocks could correct (a decline of 10% or more) before the end of 2012. The largest number of respondents (about 35% of all respondents) described themselves as being somewhat worried that a correction could occur. Another 30% of respondents, however, said they were not worried about a correction. A small group of AAII members described themselves as being very worried. A few said they looked forward to a correction creating a buying opportunity. Many members pointed to the elections as either a potential hurdle or catalyst for stocks, while others cited unresolved budget and tax issues as reasons for worry.
Here is a sampling of the responses:
- “I am worried there will be a big correction if Congress does not reach an agreement with the president on a budget deal.”
- “I think the elections will have an impact. The fiscal cliff looms large.”
- “I am somewhat worried that the market could correct because of the fiscal cliff and the European financial crisis.”
- “Somewhat worried, depending on the presidential election results.”
- “Yes, I’m worried that as the fiscal cliff approaches, the lame duck politicians might become rational or irrational.”
- “Not worried. Pullbacks and corrections provide buying opportunities.”
- “Actually, I wish the markets would drop soon and quick so I can buy more stocks.”
AAII Asset Allocation Survey
September Asset Allocation Survey
60.1%, down 0.4 points
21.9%, up 0.5 points
18.0%, down 0.1 points
Asset Allocation details:
30.2%, down 1.3 points
29.9%, up 0.9 points
5.3%, up 0.9 points
16.6% down 0.4 points
Fixed-income allocations rose to a seven-month high last month, as equity and cash allocations declined, according to the September AAII Asset Allocation Survey.
Stock and stock fund allocations declined 0.4 percentage points to 60.1%. The drop puts the September’s equity allocation near the historical average of 60%.
Bond and bond allocations rose 0.5 percentage points to 21.9%. This is the largest allocation to fixed income since February 2012. It is also the 39th consecutive month that fixed-income allocations are above their historical average of 16%.
Cash allocations slipped 0.1 percentage points to 18.0%. The decline leaves cash allocations at their lowest level since May 2011. It also makes September the 10th consecutive month that cash allocations are below their historical average of 24%.
A rise in interest rates during the first half of the month may have made bonds more attractive to individual investors. At the same time, however, many AAII members remain frustrated over the low level of interest rates. Many also continue to be concerned about the pace of economic growth, Washington politics and the European sovereign debt crisis. These concerns dampened enthusiasm for stocks, even as stock prices rose further during September.
This month’s special question asked AAII members what changes, if any, they made to their portfolios in response to this summer’s rise in stock prices. Responses were mixed. The largest number of respondents said they did not make any changes. The second largest group said they increased their cash allocation, primarily by selling stocks. The third largest group, conversely, said they added to their stock holdings. A small group of individual investors said they simply rebalanced their portfolio.
Wishing you prosperity,
Charles Rotblut, CFA
AAII Journal Editor