George$ wrote:I think I agree with you on the major issues but I'm wondering if you may not be overstating it. Yes to "statistically significant" but realizing it in finance is difficult and not always a exact science. And too often we get fooled by randomness via data mining in any of its many cloaks.
Both Bernstein and Arnott are sharp and honest (in my view) and I read them both. I welcome one being critical of the other and I try not to assume either uncritically.
I'm not ready to dismiss "fundamental indexing". Why am I interested in this topic? Answer: Arnott's past reputation and the reasoning he gives in his one hour web cast seemed reasonable and compelling. I'm inclined to think his reasoning is sound and has merit. But at the same time I don't give much reality (for going forward) to the 3.76% Canadian outperformance from the past.
Yes the Canadian market is different in many ways from the US but surely there are also common underlying issues that are the same. And if Arnott's logic has merit in the US, then it may also have the same merit here.
I certainly did overstate the case in my last post in response to DenisD: to once again repeat examples of "outperformance" without looking into how
that excess return was earned is meaningless. If I say that my small cap value fund outperformed the S&P 500 over the past 20 years, well, so what?! If we believe Fama-French, that is what we would expect on average. OTOH, Bernstein is not so categorical as to say that fundamental indexing is useless; he only says that its value-added in the US appears "relatively small" and has yet to be statistically proven.
You are absolutely correct, of course, that using statistical evidence, which necessarily is always from the past, to provide guidance for the future is a process that one should undertake with great care. Yet those tools do provide insight, so at least they should be used in a way that allows others to criticize methodology and conclusions. Have you read the Bernstein piece, in particular where he says:
William Bernstein wrote:While noting that three-factor regression of their indexes had "exposure to the value factor and, to a lesser extent, the size factor," as well as an "estimated alpha of –0.1 percent" (presumably per year), [Arnott, Hsu, and Moore] softpedal the possibility that a large part of the excess return of their fundamental indexes came from exposure to the two "supplemental" Fama-French factors, while nodding implicitly to it by observing that other value indexes do even worse, with alphas in the –1.5% range. [emphasis added]
The impression that comes across (although he does not say it, of course) by the use of "softpedal" is that Arnott et al are aware of potential problems with their claims, yet are down-playing those problems. So, we have Bernstein doing the best that we can do in finance, subjecting claims to independent statistical testing, and finding them wanting. The ball is in Arnott's court- has he answered those criticisms directly, has he adduced new evidence, etc.?
A concern of mine is related to something you wrote upthread (very insightful too, if I may say
George$ upthread wrote:I'm wondering how the 0.65% MER gets divided. Any informed thoughts?
It seems to me that IF this RAFI index takes root and becomes "big" - Arnott will become one very wealthy man.
Even just 0.10% of $50 billion is $50 million a year, year after year after year.
I first decided to post in this thread precisely because I felt that there was quite a bit of enthusiasm for fundamental indexing (which I shared at first), without enough critical questioning of the "but how does it work exactly" kind. I suspect, meaning absolutely no disrespect for anyone (posters here or Mr. Arnott and colleagues) that there was a certain sense that this guy is a reigning genius, so if he says it works, it must. But I referred in my first post upthread to "dramatically effective marketing", and that was the feeling one got- fundamental indexing was (and perhaps still is) riding a tidal wave of publicity leading inexorably to product launches. If Mr. Arnott and colleagues do get rich as you wonder, good for them- in our system, they have succeeded.
But is that outcome the same as advancing finance theory? Not necessarily. So it is important to get past the hype and look at the issues critically- and to his credit Arnott has invited such debate by putting his theory out in public in great detail for all to analyze. It is the objective debate, and not the marketing, that will lead to greater understanding of indexing methodologies.
As far as Canada is concerned, you summarized the situation quite well:
George$ wrote:Yes the Canadian market is different in many ways from the US but surely there are also common underlying issues that are the same. And if Arnott's logic has merit in the US, then it may also have the same merit here.
The question which is still up in the air, of course, is whether fundamental indexing even "has merit in the US" in fact, as opposed to theory. More importantly for us, AFAIK there has not been any serious testing of the theory in the Canadian context at all, so we are all equally in the dark here!