Valuation-Informed Indexing #136
by Rob Bennett
There’s now 30 years of academic research showing that investors need to be willing to change their stock allocations in response to big valuation shifts to have any hope of keeping their risk profiles roughly constant over time. Valuation-Informed Indexing always offers much higher long-term returns than Buy-and-Hold at greatly reduced risk. It’s investor heaven. So why does Wall Street continue to relentlessly push Buy-and-Hold?
Quant ESG With PanAgora Asset Management’s George Mussalli
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Many have concluded that it’s a profit-enhancement thing.
There’s more money to be made in commissions on stock purchases than there is in the purchase of most alternative investment choices. The Buy-and-Hold Model posits that stocks are always the best investment choice. It’s no coincidence, the cynics among us argue. Wall Street will always push Buy-and-Hold regardless of what the academic research shows re its dangers. Wall Street will always look out for its own and will never feel much concern for the investors hurt by its self-interested marketing campaigns. There’s nothing we can do.
I’m not a cynic. I don’t buy it.
I wish that I could say that money plays no role whatsoever in the continued promotion of Buy-and-Hold. I cannot go that far. To go that far would be naive. But I view it as excessively mistrusting to conclude that the money is the only factor here or even the primary factor.
First of all, people really believe in Buy-and-Hold. I know. I have been making the case in opposition to Buy-and-Hold strategies for 10 years now. Buy-and-Holders are not shy about telling me that I am off my rocker. It’s not just industry professionals who do this. Millions of ordinary investors believe strongly that Buy-and-Hold is the answer. They believe what Wall Street tells them. They revere the industry professionals who make the case for Buy-and-Hold.
I think that’s the real money angle here.
It’s not so much that Wall Street wants people always to buy stocks. It’s that Buy-and-Hold possesses a powerful intuitive appeal, especially during bull markets. Valuation-Informed Indexing is the first true research-based strategy and there is now a mountain of evidence showing that it is superior to Buy-and-Hold in every possible way. But investors don’t take to it easily. So it is a hard sell. Wall Street wants to please its customers. So it pretends not to know about the mountain of research pointing the other way and continues to make the easy pitch for Buy-and-Hold.
The distinction is important. If Shiller’s investing ideas prove out, we are going to see another stock crash sometime over the next few years. Investors are going to be angry. They are going to be looking for people to blame for their losses. If the idea takes hold that Wall Street continued to push Buy-and-Hold for purely financial reasons, things could get ugly. To the extent that it is possible to offer explanations for what has happened that will help to diffuse that anger, we should be doing that.
The history here contains a lot of positives for Wall Street.
People forget that Jack Bogle, the King of Buy-and-Hold, was once the renegade. The Wall Street Journal once ran a full-page advertisement making the claim that indexing was “UnAmerican.” Bogle changed how Wall Street operates in a fundamental way by making popular the idea that investment analysis should be rooted in academic research. That was a big step, a step that I believe will be paying big dividends as we make the transition from Buy-and-Hold to Valuation-Informed Indexing.
Buy-and-Hold was a legitimate strategy prior to the publication of Robert Shiller’s revolutionary research showing that valuations affect long-term returns (and that the market is thus not efficient). Shiller himself acknowledges in his book Irrational Exuberance that the research that was once thought to support the Buy-and-Hold strategy was research of “the highest quality.”
What Bogle did was to at least partially move the onus for poorly performing investing strategies from Wall Street to the academics and the economists. The academics and the economists are not entirely disinterested parties. They are influenced by financial considerations. But they are less influenced than those working on Wall Street. Moving the core responsibility for the efficacy of investing strategies from Wall Street to the academics and the economists was a smart and positive move.
Our problem today is that we are living through a transition period. Moving control to the academics and the economists was a good thing. But it did not produce instant results. It has taken a few decades for the academics to work through some early ideas, identify the flaws in them, and move on to the Version 2.0 ideas that really work. It’s scary living in the times in which financial ruin rains down on us all because of the mistakes made. But, once we put those mistakes behind us — and the signs are that those days are not too distant anymore — we will be a lot better off for a long time to come.
Wall Street will get behind Valuation-Informed Indexing when it becomes easier to make the marketing pitch for it. I have seen a big change since the 2008 price crash. The next crash will greatly accelerate the process. Once investors are open to hearing about new ideas, Wall Street will be there to make a buck through the promotion of them (I intend no sarcasm in this observation — effective marketing of good ideas is a wonderful thing!).
Will the shift to Valuation-Informed Indexing put a crimp in Wall Street profit dreams? Not at all!
Valuation-Informed Indexing will make stock investing safer and more simple and more profitable for millions. Stocks will be more popular among unsophisticated investors after the shift. Wall Street will make more money promoting Valuation-Informed Indexing strategies than it ever did promoting Buy-and-Hold strategies.
Rob Bennett has recorded a podcast titled “Bogle and Valuations.” His bio is here.