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If index funds always beat the market, why bother with individual stocks?

- Katharine C. 

Answer: Investing in an index tracker is like putting a chip on every number on the roulette table — you won’t win, nor will you lose. But it’s impossible to conclude that the index always beats a portfolio of individual shares. Which portfolios? There must be a huge number of individual portfolios that one cannot measure.

The beauty of active management is to seek out a portfolio of businesses that will power the index in five to 10 years’ time. That’s the challenge of being a portfolio manager. Ten years ago, if you had invested $100 in semiconductor company Nvidia, you would have underperformed the S&P 500 index for four years — 2012-2016. But over 10 years, your $100 in Nvidia would be valued at  $5,561; in the S&P 500 your $100 would have done very well. It would be worth $304.

If the incentive to search for the next Nvidia or ASML or LVMH — or, in the SA  context, Thungela or Transaction Capital — disappears, stock markets around the world will come to a grinding halt. Think of what the stock market would look like if you could invest only in index funds. We’re already witnessing the consequences on the JSE, where the popularity of playing it safe and hugging the index has taken the adventure out of investing in individual shares, and with it the ability of small and medium businesses to raise equity capital on the stock exchange.

Eventually the market shrinks, together with the firms and analysts who cover the listed companies. Another element is that index tracking removes activism — managers of trackers have scant interest in attending annual general meetings or monitoring the behaviour of individual companies.

Sadly, investing in the stock market has been overwhelmed by large institutions pushing their index-linked products on investors through armies of neutered financial intermediaries. They’ve taken the fun out of watching markets. They’re making it mind-numbingly boring. No wonder one can’t raise advertising revenue any more. Soon there will be no financial media. At the end of the day there will be a column on the sports page that tells you where your index traded.

— David Shapiro is a portfolio manager at Sasfin Securities

Send us your questions! yourmoney@fm.co.za


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