Value Investing And Indexing

In general, most value investors like indexing.  Warren Buffett and many others agree on this.  But why?

1) Most value investors that I have known want ordinary people to have an option of doing pretty well, without investing with them, because the minimums are too high — investing in index funds fits that.  Further, Vanguard, who acts in the interest of their investors is an excellent institution.  If I could have a fund there and be paid 10-20 basis points, I would do it in a heartbeat.

2) The second reason is less noble.  We like less competition.  Index money is thought-free money with respect to company and sector selection.  The more of a company that is held by index investors, the greater the probability that it is mispriced.

Now, that is not necessarily so crass on our part.  Look, good investing for most people is like holding a second job.  Do you really want to devote that much of your life to seeking out bargains?  Not many will want to do that.  (Note: there is a side benefit to doing value investing, no matter what sort of firm you work for.  You learn to think like an intelligent businessman — most employees don’t do that.  The ability to think like a intelligent businessman sets you up for greater responsibility, because you can not only do your task, but you can consider the deeper questions of business, making you a prime candidate for a promotion.)

But… there is another venue for mispriced stocks.  Some large stocks don’t get into the index because they are foreign, or have a large amount of the stock owned by a control group, which makes them less liquid.  The main idea is that stocks that few people think about are less liquid, and more likely to be mispriced, but the question remains: are they mispriced high or low?

That is the question for the value investor, and not for those that buy stocks as commodities, as many index investors do.

By David Merkel, CFA of Aleph Blog