I talk a lot about index funds in this
video series I have told you that
low-cost index funds are the most
sensible way to invest and that you
should do everything that you can to
avoid the typical high fee mutual funds
that most Canadians invest in great well
that's easy then buy index funds where
do I sign up
unfortunately the financial industry
does not like making things easy for
investors with the increasing popularity
of index funds index creation has become
big business there are sector index
funds smart baby
index funds equal weighted index funds
and many other things making it much
more challenging for investors to make
sensible investment decisions I'm Ben
Felix associate portfolio manager at PWL
capital in this episode of common sense
investing I'm going to tell you why not
all index funds are good investments
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let's start with the basics an index is
a grouping of stocks or bonds that has
been designed to represent some part of
the stock or bond market most of the
indexes that you hear about day-to-day
are market capitalization weighted the
S&P 500 an index representing the US
market is a cap weighted index this just
means that the weights of the stocks
included in the index reflect their
relative size a larger company like
Apple holds more weight in the sp500
than a smaller company like Under Armor
you can buy a fund that just buys the
stocks in the index when the index
changes the holdings in the fund change
this all sounds great so far low-cost
index investing is what it's all about
one problem for investors is that big
name indexes like the S&P 500 only track
large cap stocks historically large cap
stocks have had lower returns than small
cap and mid-cap stocks so excluding
those types of stocks from your
portfolio could be detrimental the
Center for Research and security prices
or crisp is another index provider the
crisp 1/10 index is a market cap
weighted index covering the total US
market while the S&P 500 offers exposure
to 500 stocks covering about 80% of the
value of the US market the crisp 1/10
offers exposure to over 3,500 stocks
covering the vast majority of the value
of the US market including the smaller
stocks missed by the S&P 500 an index
fund tracking the crisp 1/10 is what you
would call a cap weighted total market
index fund this is the building block
for an excellent portfolio there are
total market indexes and index funds
attract them available for Canadian US
international and emerging market stocks
the MSCI all country world index is what
it sounds like a total market index
covering the whole world an ETF tracking
this index can be found in the Canadian
couch-potato ETF model portfolios total
market index funds are well diversified
and extremely low-cost to own that is
exactly what you want as an investor the
Canadian couch potato ETF model
portfolios which are globally
diversified total market index fund
portfolios have a weighted average
Emme are of around 0.15 percent that is
exactly why fund companies have had to
come up with other index products
try and sell you they need a reason to
make you pay higher fees one way that
fun companies have been able to increase
the fees on their index funds is by
focusing on indexes that track specific
sectors the horizons marijuana life
sciences index ETF captures a sector
that many people are interested in right
now it has an any R of 0.75 percent
there is no rational reason to buy this
ETF other than to speculate on a hot
sector but horizons is cashing in
another buzzword that fun companies have
been using to charge higher fees on
index funds is smart beta smart beta
funds attempt to find characteristics of
stocks that seem to have explained
higher returns in the past some of these
factors are extremely well researched a
1992 paper by Eugene fama and Kenneth
French the cross-section of expected
stock returns pulled together past
research to present the idea that a
large portion of stock returns could be
explained by company size and relative
price in 1997 mark Carhartt in his study
on persistence and mutual fund
performance added to the thamma french
research to show that momentum further
explains stock returns finally Robert
Nova Marxist June 2012 paper the other
side of value the gross profitability
premium showed the profitability further
explains the stock returns together
those characteristics are responsible
for the majority of stock returns so
owning more stocks with those
characteristics in your portfolio might
be a good idea fund companies have tried
to build products around this research
but the execution has not always been
great in a 2016 blog post my pwl
colleague Justin bender analyzed the
iShares multi-factor ETS ETS tracking
indexes that target some of the well
research factors Justin found that they
did not deliver on their promise of
factor exposure disappointing
considering their relatively high cost
compared to a total market ETF there are
other fun companies like dimensional
Fund Advisors with a long history of
capturing the well research factors
I recommend products from dimensional
Fund Advisors in the portfolios that I
oversee I keep saying well researched
factors because there are companies
building indexes based on factors
they're not as well researched they may
be based on bad research bad data or
data mining in their 2014 paper
long-term capital budgeting
there's urine levy and evil Welch
examines 600 factors from both the
academic and practitioner literature not
all of these factors would be expected
to give you a better investment outcome
but they do give fun companies a reason
to charge you a higher fee for most
investors a portfolio of market cap
weighted total market index funds is all
that you need many of the other index
fund products out there claiming to
track some special index are gimmicks
designed to convince you to pay an extra
fee thanks for watching my name is ben
felix of PWL capital and this is common
sense investing I'll be talking about a
lot more common sense investing topics
in this series so subscribe and click
the bell for updates I'd also love to
read your thoughts and questions about
this video in the comments
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