Indexing – Hugging

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Article by Investment Master Class

“Any program which involves complete investment of all capital at all times is not apt to be the most successful one”  Gerald Loeb

“You can understand why many succumb to the pressure to “hug” the index, so to speak. But we believe if you go down the road of trying to make sure you’ll never do much worse than the index, you’re almost insuring that you’ll never do well enough to justify your compensation as an active manager” Bill Nygren

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"Both closet indexing and shooting for the stars are exposing financial planners’ clients to undue risk. Both are a result of benchmark tyranny.” Jean Marie Elliellard

“Money managers motivated to outperform an index or a peer group of managers may lose sight of whether their investments are attractive or even sensible in an absolute sense” Seth Klarman

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"To us is makes little sense to invest in industries we don't particularly like, or understand well, only to have to find the least bad idea of the group, in order to maintain semblance to a benchmark index"  Allan Mecham

"The pressure for short-term performance versus a benchmark can easily disorient the investment brain of a portfolio manager.  What should matter is capital enhancement in bull markets and capital preservation in bears; in other words absolute, not relative returns"  Barton Biggs

“Passive investors, benchmark huggers and herd followers have a high probability of achieving average performance and little risk of falling far short” Howard Marks

“The pressure to retain clients exerts a stifling influence on institutional investors. Since clients frequently replace the worst-performing managers [and since money managers live with this fear], most managers try to avoid standing apart from the crowd. Those with only average results are considerably less likely to lose accounts than are worst performers. The result is that most money managers consider mediocre performance acceptable” Seth Klarman

“[With] closet indexing….you’re paying a manager a fortune and he has 85% of his assets invested parallel to the indexes. If you have such a system, you’re being played for a sucker.” Charlie Munger

“At the extreme, if everyone practised indexing, stock prices would never change relative to each other because no one would be left to move them” Seth Klarman

“No matter how diverse the companies in an index are, if the indices themselves dominate the market, then all the securities in the index do indeed share one fateful “shadow” correlation. They are all members of the index, and it is the index, not the companies, that the market is trading” Andy Redleaf

“When everybody indexes, the 500 stocks will remain unchanged relative to each other” Gary Helms

“I think the reason why we got into such idiocy in investment management is best illustrated by a story that I tell about the guy who sold fishing tackle. I asked him, “My God, they’re purple and green. Do fish really take these lures?” And he said, “Mister, I don’t sell to fish.” Charlie Munger

“Stocks trade up when they are put in an index. So index buyers are overpaying just because a stock is included in an index. I am much more inclined to buy a stock that has been kicked out of an index because then it may have value characteristics – it has underperformed.” Seth Klarman

“You have to strike the right balance between competency or knowledge on the one hand and gumption on the other. Too much competency and no gumption is no good. And if you don’t know your circle of competence, then too much gumption will get you killed. But the more you know the limits to your knowledge, the more valuable gumption is. For most professional money managers, if you’ve got four children to put through college and you’re earning $400,000 or $1 million or whatever, the last thing in the world you would want to be worried about is having gumption. You care about survival, and the way you survive is just not doing anything that might make you stand out.” Charlie Munger

“The percentage of assets under management with active share less than 60% went from 1.5% in 1980 to 40% today” Michael Maubousssin

"Share prices fluctuate more widely than values.  Therefore, index funds will never produce the best total return performance" Sir John Templeton

"Closet indexing is far more comfortable than being wrong but it is certain to produce subpar returns" Christopher Parvese

"Even indexes can be victims of bubbles.. at certain times, an index is not a conservative investment" Chris Browne

"Trouble comes in all kinds of shapes, sizes and directions. We find it worrisome that to many investment folks, trouble begins and ends with underperforming a benchmark. Although we list stock and bond indices in our performance tables, our benchmark is essentially cash." Paul Singer

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