Index funds: An efficient index in inefficient markets

Sim · 14-04-2009, 11:48 AM

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Given markets are not always efficient, and prices don’t always reflect fair value, this can have a significant impact on traditional index funds.

Traditional index funds link the size of investment to price, which means that as companies become more expensive, an index fund will buy more of these companies.

Similarly, as companies become cheaper, index funds will buy less of these companies. In other words, an index fund overweights the overvalued companies and underweights the undervalued companies, which cause a performance drag as prices revert to fair value.

So, is there a better way of building an index and not linking the portfolio weight to price?

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Johny_come_lately · 03-07-2009, 04:13 PM

I like the concept of index funds. Not ever wanting to be a trader, I will accept a performance that is lower than 30% of fund managers. My question is this. How do they calculate index funds in times of great volativity?

Johny

AsxBroker · 03-07-2009, 08:17 PM

Quote:

Originally Posted by Johny_come_lately

I like the concept of index funds. Not ever wanting to be a trader, I will accept a performance that is lower than 30% of fund managers.

Hi Johny,

What do you classify as being lower than fund managers? Remember that last years winners are usually this years dogs. It is near impossible for a fund manager to be year after year outperforming.

Quote:

My question is this. How do they calculate index funds in times of great volativity?

Johny

The same way they do in times of low volatility? Attached is Vanguard Australia Property Index fund factsheet (it shows the weighted percentages whereas the Aussie and International Shares don't show the weighted percentages) http://www.vanguard.com.au/vnl/factsheet/vapsif.pdf

You can also look at the volatility index (aka VIX) CBOE VOLATILITY INDEX Index Chart - Yahoo! Finance to show the years volatility.

Cheers,

Dan

PS This is general information, before making an investment decision speak to your FPA registered Financial Planner.

Johny_come_lately · 03-07-2009, 08:50 PM

You are correct of course. I have been reading indexing books at uni, and the stats don't say 30% is a rolling average or, whether they were calculated when the book was published.

Do you know of any Idia only index funds or China only index funds?

Johny.

AsxBroker · 03-07-2009, 09:42 PM

Hi Johny,

I do not know of any managed funds like that available. There may be some Exchange Traded Funds (ETF) available.

Cheers,

Dan

PS This is general information. Speak to your FPA registered Financial Planner before making an investment decision.

Johny_come_lately · 03-07-2009, 10:16 PM

Have you heard anything about the Fidelity India Fund?

Johny.

venger0 · 03-07-2009, 10:32 PM

@johnny_comes_lately, there's a couple of ishares ETFs covering that particular region, from memory- IZZ top 25 china index, also IAA for asia and then there is another ishares for Hang Seng (hong kong .. so maybe IHK?).. there are also a couple of emerging markets IEM and IBK (for specifically the BRIC nations.
Oh. and there is also a listed inv company with the ASX code of AGF.

@sim, thanks for the article

i hadn't heard of realindex investments before... sounds like they do a similar thing to DFA?
did a quick google.. loks like they are a part of Colonial First State... wonder that their MERs are like?

ps: i own none of the above china/asia only funds.. just sharing the info. DYOR...

Johny_come_lately · 08-07-2009, 11:53 AM

If indexs' are all market weighted and Realindex is not, does this mean that technically it is not an index?

Johny.

venger0 · 08-07-2009, 05:29 PM

@johny, would imagine that if you designed and published an index by inversely weighting from the last of top 200 company up to the highest, based on market cap (that is, BHP becomes the smallest portion of your index) - you could reasonably call it "Johny's index"..

not all indices are market cap weighted - in the US, there are a few varieties... eg, Vanguard worked with FTSE to develop a high dividend yield stocks index for their high yield stocks fund to track.

from what i've read of the article, realindex has done some R&D and come up with their own "index", based on specific rules and filters and intent to run a fund to track their own index.
So their funds will track separate indices as opposed to vanguard and streettracks; these track the ASX300 and ASX200 respectively.
the ASX200/300 index was designed by S&P and started sometime in 2000 (IIRC).

hope above is helpful and not repeating the obvious for you

Waimate01 · 09-07-2009, 09:00 AM

Quote:

Originally Posted by Sim

Traditional index funds link the size of investment to price, which means that as companies become more expensive, an index fund will buy more of these companies.

That's not correct, but it is a frequently misunderstanding.

Index funds do not have to rush out and buy more BHP shares every time BHP goes up, because they already own them and the ones they already have go up in value.

The only time index funds need to transact are:

1) when new money enters the fund, in which case they buy more of what they already have in exact proportion to what they already have

2) when stocks enter or leave the index. Most index funds, if mirroring the ASX200 for example, would not bother with the bottom 10 or 20 stocks, because they are the ones most likely to drop on and off the index and have little bearing on the overall index, so they try to minimise the number of times entries or exits occur.

If it worked the way you're suggesting, then index funds would have a high transaction rate, whereas their objective is to have a low transaction rate.

When you have a basket of shares that mirrors the ASX200, then as the various stocks flutter up and down, your basket continues to mirror the ASX200 without you having to lift a finger.