Source : http://www.investorsadv.com
While I believe that index investing has its merits, I do not believe that it is the only means of getting your investment compass to point true north. Advisors who buy into MPT fail to acknowledge the many issues with indexing – so allow me to provide some counterpoints to their argument.
There are a lot of bright analysts and economists who make convincing arguments that our equity markets are currently embedded in a long-term secular bear market. Ed Easterling of Crestmont research is one of these such analysts. He says in his paper titled “Markowitz Misunderstood: Modern Portfolio Theory Should Come With a Warning Label”:
Almost unanimously throughout the past century, when the P/E is above average (average is 14.5), subsequent returns are below average. As well, below average P/E’s drive above average returns…So since the current P/E is well above average, shouldn’t the assumption for Markowitz’s model be below average returns?
If you have a 100 year time-frame, index investing is great way to go, but if you have a 20-30 year timeframe, index investing is as much subject to secular trends as any other equity focused strategy.
Not a single index investor that I know of recommended real estate in the late 90’s, but now they all include real estate in their portfolios. The biggest proponent of index investing in my hometown of Dallas, TX is a fellow by the name of Scott Burn’s. In the late 90’s, Burns, the creator of the infamous “Couch Potato Portfolio”, couldn’t even spell Real Estate but a few years ago he created the The Four & Five-Fold Portfolios which conveniently include a 20% allocation to REITs. (I’m actually a big fan of Mr. Burns. His work to uncover the insidious evils of variable annuities and all things insurance is priceless.)
Few, if any, MPTer’s currently suggest building a commodity allocation in your portfolio - the only asset class that truly provides negative correlation to equities and bonds. But they will all include a commodity allocation in the next 5 years after the biggest gains of the current commodity secular bull market have already been missed. (A few started recommending commodities prior to the pullback in the space last summer. The pullback was just strong enough to scare these advisors away causing their clients to lose out on the second stage of the secular commodity bull market.)
There is a very basic, fundamental flaw with index investing which is that they use backwards tested data in making forward looking projections. They calculate what would have worked best and assume that that strategy will continue to work best. Unfortunately, the markets work in the exact opposite manner resulting in MPTer’s “buying high” and “selling low”. Furthermore, it results in them adding sectors or asset classes long after the “easy” money has been made. (Ironically, Markowitz’s paper ever-so-briefly addresses this issue but it is largely ignored by MPTer’s who see their strategy as flawless.)
MPTer’s don’t include Commodities because the sector was such a lousy performer over the last two full decades. If they included a commodity allocation, their “projected returns” based on the extrapolation of historical returns would be far less appealing. However, in 2000, the best thing you could have done was move your portfolio to commodities. (Did you know, that the Dow Jones Index is actually down when priced in Gold since it started its rally in Oct of ’02.)
I could go on and on about how inaccurate your post is on index investing, however, all I really need to say is that Warren Buffet has underperformed the S and P 500 over the past 10 years.