Investing

Index Funds Have Jumped the Shark

By John Del Vecchio  |  September 25, 2019

If you don’t know, “jumping the shark” is the moment when something that was once popular no longer warrants the attention it previously received and attempts a publicity stunt, which only serves to highlight its irrelevance.

The idea goes back to Happy Days, when Fonzie jumped an electronic shark. That was the beginning of the end of the show’s run.

Hopefully, we are at the beginning of the end of the index craze.

Michael Burry, famous for making a mint shorting the housing bubble, and a main figure in The Big Short, recently made a lot of news comparing index funds to subprime derivatives. He argues that their rising popularity is creating a ticking timebomb in the market.

I wouldn’t go that far.

The process of trading ETFs runs relatively smooth. The market is about a quarter century old. Plenty of kinks have been worked out. There are still hiccups. But I think concerns are overblown.

Though indexes are not without risk…

The Risk of Indexes

What isn’t mentioned in Burry’s article is that today there are more indexes than actual stocks.

Think about that for a moment… The number of indexes that track investable areas of the market exceed the actual stocks used to fulfill the objective of those indexes.

If ever there was a sign of a bubble, that’s it.

It’s getting to the point of being a joke; indexes have jumped the shark.

An ETF was recently launched that tracks a vegan index. It might be noble to be a vegan. Animals’ lives are spared. It’s better for the environment. Eating less animal meat has some health benefits, too.

That doesn’t make it a good investment strategy.

What’s worse is the details.

The largest holdings in the vegan ETF’s portfolio: Apple (Nasdaq: AAPL), Microsoft (Nasdaq: MSFT), Facebook (Nasdaq: FB), and JP Morgan (NYSE: JP Morgan).

That’s just plain ridiculous. These companies have little, if anything, to do with veganism. They might be environmentally responsible. So what? You can get exposure to these companies many other ways.

This is simply a marketing scheme to use a trendy topic like veganism to get people to invest. While ETFs disclose their holdings daily, few people know what they own. And there are thousands of examples of indexes that make little sense to own — a vegan index isn’t the only one.

The Upside to Actively Managed ETFs

Don’t get me wrong, ETF’s are wonderful investment vehicles.

In 2011, I cofounded one of the first actively managed ETFs on the market. It’s traded on the New York Stock Exchange. The difference with an active ETF is that it doesn’t track an index.

Active management is a great tool for complex strategies such as short selling and high-yield bonds. There are many advantages of active management in these areas of the market.

For example, it’s virtually impossible for an individual investor to buy high-yield bonds here and there for their portfolio. The indexes have thousands of holdings. There’s plenty of crappy bonds in those portfolios. Active management can provide higher yield at less risk.

Indexes are also great for getting access to large asset classes.

Want to own the entire market? Indexes are great.

Want to own emerging markets? There’s no better way to do it than through index funds.

Many indexes are also cheap, too. The combination of low prices and broad market exposure can do wonders for your investment returns.

But slicing the market too thin is very dangerous.

Once you start buying indexes based on hair-brained ideas and indexes that don’t contain stocks that make strategic sense, then you’ve entered a zone of complete nuttiness.

In my upcoming book, Unbounded Wealth, I present a simple strategy far from the nuttiness of the index-mania we find ourselves in today.

The strategy simply uses a small handful of ETFs that provide access to the market in an easy fashion. And, with a little twist here and there, return as much as the stock market over the last 45 years, but with a quarter of the risk.

The book’s release date will be announced soon. So, stay tuned to learn more…

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John Del Vecchio

John Del Vecchio is the author of the bestselling book, Rule of 72: Compound Your Money and Uncover Hidden Stock Profits and What’s Behind The Numbers: A Guide To Exposing Financial Chicanery And Avoiding Huge Losses In Your Portfolio.

As the in-house stock market guru and forensic accountant for Dent Research, John stood on the shoulders of the great David Tice, James O’Shaughnessy and Dr. Howard Schilit, and built a framework of algorithms and a multi-factor grading system that has made him one of the more successful short-sellers around.

John is also the executive editor of our Hidden Fortunes newsletter and our trading service Small Cap All-Stars.

He graduated Summa Cum Laude from Bryant College with a B.S. in Finance and was awarded Beta Gamma Sigma honors. He earned the right to use the Chartered Financial Analyst designation in September 2001.MORE FROM AUTHOR