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Quarterly Client Newsletter

Passive Aggressive

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Client Newsletter Volume XXIII Number 4 May 1, 2018

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Passive Aggressive:

From ​Th​e Economist, November 18, 2017 edition, subtitle: “Criticism of index-tracking funds is ill directed:”

“Index funds were devised in the 1970s as a way of giving investors cheap, diversified portfolios. But they have only become very popular in the last decade. Last year [2016] more money flowed into ‘passive’ funds (those tracking a benchmark like the S&P 500) than into ‘active’ funds that try to pick the best stocks.

In any other industry, this would be universally welcomed as a sign that innovation was coming up with cheaper products to the benefit of ordinary citizens. But the rise of index funds has provoked some fierce criticism.

Two stand out. One argues that passive investing is, in the phrase of analysts at Sanford C. Bernstein, ‘worse than Marxism.’ A key role of the financial markets is to allocate capital to the most efficient companies. But index funds do not do this: they simply buy all the stocks that qualify for inclusion in a benchmark. Nor can index funds sell their stocks if they dislike the actions of the management.

The long-term result will be bad for capitalism, the opponents argue.

A second argument is that index funds pose a threat to competition. The asset-management industry used to be remarkable diverse. It was hard for any active manager to keep gaining market share; eventually, their performance took a hit. But passive managers benefit from economies of scale. The more funds they manage, the lower their fees become, and the more attractive the product.

Since passive managers like BlackRock and Vanguard own the shares of every company in an industry, the fear is that they might play a role reminiscent of the monopoly ‘trusts’ of the late 19th century. Studies have argued that the concentrated ownership of shares is associated with higher fares in the airline industry and fees in the banking sector.

These criticisms cannot surely both be true. They require index funds simultaneously to be uncritical sheep-like investors and ruthless top-hatted capitalists devoted to gouging consumers. Furthermore, passive investors, in the form of mutual funds and exchange-traded funds, own only 12.4% of the American equity market. It seems remarkable that they can have such a big impact on the corporate sector with such a small stake.

It is worth examining the criticisms in detail. The Marxist criticism implicitly assumes that the investment community is divided into two—passive investors and active managers devoted to combating corporate excess and ferreting out exciting new bets. But a lot of ‘active’ investors run portfolios that cling closely to a benchmark index for fear of getting fired if they underperform. So they, too, own shares in the biggest firms. A few ‘activist’ investors do try to change corporate strategy but most fund managers don’t have the time to campaign. They may be active but they are not activist.

When it comes to voting at annual general meetings, moreover, passive managers can and do get involved. In one 12-month period, BlackRock says it voted in support of proposals from activists 39% of the time, compared with 33% of occasions where it backed existing management…

Even if you concede the potential for a small group of fund managers to exert baleful influence on a few sectors through their cross-holdings, passive managers are surely the least likely participants in such a conspiracy. The point of their existence is that they hold the market weight in every industry; they have no reason to favour the success of one over any other. If a conspiracy were to occur, it would surely be driven by active mangers buying very large stakes in a particular industry, and hoping to benefit accordingly.

There is an element of ​reductio ad absurdum about the anti-passive arguments. Yes, if the market was 100% owned by index funds, that would be a problem. And if there were no crime, policemen would be out of work. But we are not near that point. Stop worrying and enjoy the low fees.”

Smartt comment: An investment publication noted in early April of this year that Vanguard, “the nation’s largest mutual fund company, has $5.1 trillion in global assets.” Vanguard’s success is partially based on its mutual ownership. We, the shareholders of Vanguard funds in effect own the company. When Vanguard has a good year, and their recent years have been ​very good​, Vanguard doesn’t pay a dividend to some other group of Vanguard company owners, it instead lowers the cost of Vanguard funds and ETFs. When I began investing in Vanguard, in 1989, my money was not part of the first $1 billion to enter Vanguard management, but it was part of the second billion. At that time the Vanguard S&P 500 index fund cost 24/100% per year unless you owned more than $50,000 of the fund. Now we can buy any large or small amount of that fund’s ETF, or the more diversified Total Stock Market Index ETF for 4/100% per year. Stop worrying and enjoy the low fees indeed.

What Are YOUR and MY Asset Allocations?

Each of us has a different ability to live with uncertainty (risk) and so our investments will be different:

As of March 31, 2018 Clients John Smartt
Money Market Funds 2.1 0.6%
Bond Funds 24.3 20.9%
Stock Funds 73.6 78.5%
Totals 100.0% 100.0%

Remember each of us has different goals and needs and our asset allocation should fit us and our family. If you have questions about your asset allocation, or your retirement plan investments, I’d be pleased to assist.

If you have questions, don’t hesitate to contact me.

Vanguard Rates of Return (through Latest Quarter End)

Performance percentages are per Morningstar.  Amounts in parentheses are percentile rankings

(1= best and 100= worst) within category.

Performance percentages are per Morningstar.  Amounts in parentheses are percentile rankings

(1= best and 100= worst) within category.

Periods ended March 31, 2018 Yr.-to-date 5 Years 10 Years
Total Stock Market Index Admiral -0.6% (34) 13.0% (23) 9.7% (14)
Tax-Managed Capital Appreciation Admiral -0.5% (31) 13.5% (9) 9.8% (13)
Tax-Managed Small Capitalization 0.6% (13) 13.5% (3) 11.4% (7)
REIT Index Admiral -8.1% (84) 5.8% (46) 6.5% (30)
FTSE All-World ex-US Index Admiral -0.5% (31) 6.3% (52) 3.0% (34)
Balanced Index Admiral -0.9% (45) 8.5% (12) 7.6% (13)
Total Bond Market Index Admiral -1.5% (60) 1.7% (49) 3.6% (66)
Interim-Term Investment-Grade Bond -1.8% (35) 2.3% (78) 4.7% (69)
High–Yield Corporate Bond -1.5% (85) 4.4% (30) 6.9% (45)
For comparison, here are several stock and bond benchmarks:
Periods ended March 31, 2018 Yr.-to-date 5 Years 10 Years
S & P 500 (large stocks) -0.8% 13.3% 9.5%
Russell 2000 (small stocks)

MSCI World Index







Barclays Aggregate Bond Index -1.5% 1.7% 3.5%
BofAML US High Yield Master II TR

(bond index)

-0.9% 5.0% 8.1%


Vanguard mutual funds and ETFs (exchange-traded funds) continue to perform as expected.  I expect each Vanguard fund or ETF, for each ten-year period to be in the top 1/3 before taxes based on low cost, and they ought to be in the top 1/4 (stock funds) after income taxes.  

The Vanguard High Yield Corporate Bond fund takes significantly less risk that the average “high yield” (also known as “junk bond”) fund.  The Vanguard fund, which takes less risk, continues to rank reasonably highly in the rankings over the last ten year period. When the more risky portions of the “junk bond” investment sector are under stress, the Vanguard fund shines.  Over the last ten years the Vanguard fund has captured just over 70% of the excess of junk bond returns over good quality bond returns—meeting my expectation. I continue to believe that, for tax deferred accounts, this fund is a reasonable, additional diversification and comprises more than 50% of my personal bond holdings.

If you have questions about your investment asset allocation, please contact me.

The Forever Letter, A New Twist on the Ethical Will:

This is part of a book review appearing in the March, 2018 issue of the ​NAPFA Advisor (the magazine of the largest fee-only financial planner organization.) I am a member.

“Many…are familiar with the concept of ethical wills and how they can be a heartfelt and treasured tool for passing down values, hopes, and explanations to the next generation. And several excellent books are available, such as the widely read ​Ethical Wills by Dr. Barry Baines or Susan Turnbull’s workbook on ​The Wealth of your Life.

The Forever Letter by Elana Zaiman takes a different approach to ethical wills.

While the basic premise of an ethical will is a letter given to heirs ​after death, Zaiman argues that you should not wait until you die to write these letters and give them to your loved ones. So, while loosely based on the idea of ethical wills, this book actually focuses more generally on communication through letters. Letters written and read during life mean that readers can hear in their minds and hold in their hands the writer’s words at different stages of their lives—for example, upon the birth of a child, then again as a young parent, and again after children have grown, and perhaps one more time for good measure.

Zaiman includes plenty of examples of famous ethical wills of old, and anecdotes about more modern letters and stories, but the real message here is that letter writing, in this age of instant messaging and easy-come easy-go communication, is an art worth preserving…

Given how much we use email and text messaging today, mastering tone can be a tricky thing indeed, and something most of us can benefit from. She qualifies one of her ‘do’s’ (Impart Values) with a ‘don’t’ (Rule from the Grave). The biggest don’t of all: Don’t share big secrets in your forever letter, especially letters you leave to be read after you die. And if you feel the need to write to your heirs about their shortcomings, do it in the context of your own shortcomings. As a rabbi and a chaplain, it is clear the author has seen firsthand how these types of letters enhance lives. Providing her own story, using a letter from her father, and other case studies peppered throughout this book, the author gives real-world examples which really drive home the impact of these letters.”

Smartt comment: On a bit of a different topic, my parents, at my urging, wrote a letter to each of my siblings in the early 1990s after they had re-done their basic estate planning. The purpose of the letter was to tell each of the members of my generation what would be their probable bequest. This allowed each of us to thank our parents while they lived and, just as important, to do a better job of planning our retirement and financial lives.