S3E10: Do Global Index Funds Have A Problem?
Are Global Index Funds too exposed to the US tech sector? Would it be better to just be invested in those companies and get much higher returns? What happens if everyone was a global index investor? Recently Damo did a video on his channel in response to an increase in articles raising concerns about Global Index Funds. He talks T through those concerns and answers your biggest questions.
What you should remember from this episode
• One of the criticisms of global index funds is they don’t give you true diversification because they slant to the biggest companies in America. This means you’re over-exposed to a few companies.
• Right now those companies are the magnificent 7 - Microsoft, Apple, Alphabet, Nvidia, Meta, Tesla and Amazon.
• This raises the question, are we too reliant on tech? Damo thinks we’ve been reliant on tech for millennia. Every company uses technology to some degree.
• Why not just go all in on just the big 7 tech businesses? Well that would be a brave bet. You’re basically betting that what’s true today will be true in the future - and the reality is no one knows in advance which businesses will prosper before they have. Imagine going back to 2000. You’d have been incredibly lucky to have picked the magnificent 7 today, not least because a few of them weren’t even around then! The point is that companies rise and fall, which means at some point your thesis of who the winners are runs dry. You have to keep picking winners over time, which is ridiculously hard.
• Roughly 65% of a global index fund is in American stocks (if market weighted, which means weighted by market cap).
• A market capitalisation ETF is where the size/value (market cap) of each business dictates its proportion of the index, e.g. roughly 5% going to Apple because it’s such a big company, whereas a small company on a global index might get 0.01%.
• Equal weighted means each company takes up the same proportion of the index as each other - i.e. Apple and the smallest company on the index will both take up 1% if there are 100 companies on the index. This means everything you invest is split equally between the companies rather than being concentrated in a handful of companies.
• The S&P produced a report which tracked two versions of the S&P 500 over 20 years to see how they performed. One was equal weighted and the other was based on market capitalisation. The equal weighted came out at 11.48% whilst market cap came out at 10.29% - on average over the period:
• Rebalancing is adjusting or rebalancing your portfolio to make sure your investments reflect your criteria/investing philosophy, e.g. having a 60:40 split between stocks and bonds. You need to keep making decisions and moving money around to maintain that ratio over time because the value of your investments will change.
• What happens if we all become global index fund investors? If everyone becomes a passive investor, we wouldn’t have something called price discovery, which is when active investors assess/invest based on what they think companies are worth. If this didn’t happen, it would be a problem because the indexes would stay locked forever - e.g. with Apple keeping 5% or whatever it is of everything invested in a global index regardless of how Apple performs. We need some active investors but it’s unlikely passive will die completely, not least because there’s (potential) money to be made from active.
• In 2019, passive funds overtook active funds in America. These are funds only - not stock pickers.
