There’s never a lack of news in the financial press:  new studies, new reporting, new crises, new opportunities … it never ends.

Some of it is worth heeding; most of it is just noise. One of our roles at Hill Investment Group is to help you find the hidden gems in all that “new news.” Here are two worthy reminders that trying to pick individual stocks or forecast the market’s many moods remains as ill-advised as ever.

On the Dangers of Stock-Picking …

In his recently published piece, “Hot Stocks Can Make You Rich. But They Probably Won’t,” Jeff Sommer of The New York Times reflects on how investors may be tempted to chase surging stocks in hot markets. “But,” he cautions (emphasis ours), “before you jump headlong into stock picking, you may want to consider the odds … [O]ver the long run, while the total stock market has prospered, most individual stocks have not.”

This may seem counterintuitive, but for supporting evidence, Sommer cites a new study by Hendrik Bessembinder of Arizona State University’s business school (my own alma mater). Sommer points out two remarkable findings from the study, often overlooked in all the excitement:

• “58 percent of individual stocks since 1926 have failed to outperform one-month Treasury bills over their lifetimes.”
• “[A] mere 4 percent of the stocks in the entire market … accounted for all of the net market returns from 1926 through 2015.”

Professor Bessembinder’s study concludes that individual stock picks are like lottery tickets. A stock picker may beat the odds and win big, but if you’d rather focus on winning sustainably while managing the risks, you’re better off accepting wider market returns.

On the Dangers of Market-Timing …

On the same day Sommer’s article appeared, The Wall Street Journal’s Jason Zweig published a nicely paired piece, “Sorry, Stock Pickers: History Shows You Underperform in Bad Markets, Too.”

You may need a subscription to read the entire article, but the title says a lot. Based on data points going back to the 1960s, Zweig notes: “The odds of finding a stock picker who can do better in down markets have long been less than 50/50.” Not only are the odds against those who try to beat the market, the costs tend to be high in every market, up or down. So, while stock pickers often tout their ability to shine the brightest when the markets are at their darkest, the evidence again suggests otherwise.

So, What’s New?

Bottom line, a traditional active investor faces hurdles that are simply too tall to be enticing, especially when there is a more logical, evidence-based strategy to lead the way. This may not be breaking news to anyone who’s been following our work for a while, but I’d say it’s still as fresh and relevant as ever.

When we talk about evidence-based investing, we often mention the importance of going global.

Global diversification ensures that you aren’t placing all of your financial faith in the fate of any one country’s concentrated risks. It also helps you combat your natural tendency to bulk up on investments closer to home, where you imagine you’ll be safer or better off over the long haul.

That’s known in behavioral finance as “familiarity” or “home-town” bias, and it’s premised on false assumptions. We’re as patriotic as the next Americans. But the evidence still informs us that human commerce knows few borders, so neither should our investments.

That’s the long view on global diversification. But have you ever wondered about some of the details?

Say, for example, you were to invest half of your portfolio in a U.S. equity index fund, and the other half in an international index fund, “ex-U.S.” In terms of number of stocks as well as market cap (the total dollar value of a public company’s outstanding shares), how diversified are you, really? Are you still at a 50/50 split?

Dimensional Fund Advisors recently published “Going Global: A Look at Public Company Listings,” to explore some of these underlying questions. Some of its findings:

• Worldwide, there are more publicly traded stocks than their used to be, increasing from about 23,000 to 33,000 between 1995 and year-end 2016.
• In the U.S., there are fewer publicly traded stocks than their used to be. Using the Wilshire 5000 Total Market Index as a benchmark, U.S. stocks declined from about 5,000 to 3,600 companies between 2005 and year-end 2016. (That’s right, the “Wilshire 5000” actually only tracks about 3,600 stocks these days.)
• As measured by market cap, the U.S. still dominates global markets – by far, at 54% of the world’s market cap. That’s also an increase from 40% in 1995. The next biggest contender? Japan at 8%. (See our accompanying “Illustration of the Month.”) 
• Many index funds only expose their shareholders to a fraction of these total available stocks. From Dimensional’s report: “For example, one well-known global benchmark, the MSCI All Country World Index Investable Market Index (MSCI ACWI IMI) contains between 8,000 and 9,000 stocks. … For comparison, the Dimensional investable universe, at around 13,000 stocks, is broader.”

What can you draw from these insights besides trivia to share at your next social gathering? Zooming back to our favorite vantage point – the Long View – there are still plenty of opportunities in plenty of places to maintain your efficient, effective, globally diversified investment strategy.

Part of our job here at Hill Investment Group is to keep a relatively close eye on financial industry news, so our clients don’t have to (unless they find it interesting). One technical tidbit caught our eye recently when Vanguard’s advisor news channel reported on how its index funds will be impacted by a change to the way the Center for Research in Security Prices (CRSP) will be reconstituting its indexes.

Wow, that’s a lot of jargon. Let’s translate.

Most investors are familiar with the broad strokes of index investing. An index fund identifies a slice of the market to invest in – such as U.S. small-company value stocks. The fund manager then picks an index that tracks that same swath, and buys up essentially everything that index is holding. For the past several years, Vanguard has been using CRSP indexes to fulfill that role.

Mostly, that’s a relatively sensible way to go about investing. CRSP indexes are at least as robust as any others for tracking particular markets. And index funds are certainly better than active managers, who spend their time and your money trying to dodge in and out of markets, without adding expected extra worth.

If there weren’t an even better – let’s say best – way to go about it, we’d probably be all in on index funds ourselves (and there are times we use them, when we feel they are the ideal tool for the job at hand). But, instead of investing in funds that follow indexes that follow a swath of the market … we typically prefer funds that skip the index “middle man,” and buy into the vast majority of a market swath directly. Dimensional Fund Advisors is one such fund manager, and the longest-tenured among them, having been around since 1981.

Vanguard’s recent announcement speaks to one reason we prefer the more direct approach. One bugaboo index funds face is what to do whenever its underlying index “reconstitutes,” or changes the securities it’s tracking. Every index does this from time to time. For example, say a small company becomes a big company. A small-cap index must then stop tracking its stock and, usually, pick a different one to track instead.

That means any index fund tracking that index must actually sell and buy those same swapped-out securities – and relatively quickly if it wants to keep accurately reflecting its target index. You may already be a step ahead of me if you recognize that this creates some pricing challenges. If several index fund managers are all trying to sell and buy the same securities at around the same time, the trades can end up costing more than if there weren’t an essentially artificial supply-and-demand issue at play.

To help alleviate (although probably not eliminate) that challenge, CRSP has announced it will spread its reconstitution activities across five days instead of just one.

Again, that’s a sensible idea, and it may help some. But remember, fund managers like Dimensional allow us to avoid the reconstitution challenge entirely by more directly tracking the small-cap value market (and many others). This is a topic for another post, but direct tracking also offers other advantages over being tied to an index. Suffice it to say here that not all small-cap value funds are equally as effective at capturing the expected premiums available from this relatively narrow market.

So, with respect to Vanguard’s recent announcement, “better” is nice. But when the choice is, “better or best?” … we still prefer best.