Passive Investing: The Movie

There are countless books laying out the case for index investing, but as far as I know there has never been a film—until now. A UK investment firm has just released a 54-minute documentary called Passive Investing: The Evidence, which includes cameos from some of the leading proponents of strategy.

The film was financed by Barnett Ravenscroft Wealth Management, which manages portfolios using products from Dimensional Fund Advisors and Vanguard, so they clearly have a vested interest in promoting the strategy, but it would be unfair to dismiss the film as an hour-long infomercial. BRWM works only with individuals and institutions who have over £1 million in investable assets, yet the company seems eager to get its message out to the UK public, even though the vast majority of the film’s audience will never become clients.

They’ve certainly made a significant investment in the film: the production quality is very high and the interviews include luminaries such as John Bogle, Charles Ellis, Rick Ferri, Kenneth French, William Bernstein, Burton Malkiel and William Sharpe. Not since Toy Story have so many potatoes appeared in one film.

A shaky foundation

The documentary is divided into eight chapters. The first two do a good job of covering ground familiar to Couch Potatoes: the failure of most active funds to outperform and the erosion caused by high costs. Part 3 lays some theoretical groundwork, including the Capital Asset Pricing Model (CAPM) and the Efficient Markets Hypothesis. I appreciate the challenges of bringing these complex ideas to the public, but I found this chapter problematic. CAPM—which predicts the expected return of a security based on its beta—is still widely taught, but it doesn’t do a particularly good job of explaining returns in the real world. (The Fama-French three-factor model is a dramatic improvement.) So I’m surprised the film’s website describes CAPM as “the mathematical foundation of passive investing.”

It’s also going too far to suggest that in an efficient market “shares are always priced correctly because they already reflect everything that is publicly known about the company.” I’m not sure anyone believes stocks are “always priced correctly.” The more subtle argument is that inefficiencies in the market certainly exist, but they are short-lived and extremely difficult to exploit in any systematic way.

Why isn’t passive more popular?

French1Part 6 is an interesting look at why active strategies remain so popular, despite the evidence that most of them fail. Here the film hits all the right notes, explaining that it’s a combination of powerful marketing by investment firms, distractions in the financial media, and behavioral biases such as overconfidence. The best quote comes from Ken French when discussing the constant need for newspapers and magazines to celebrate hot fund managers: “Put me on the cover and you’re not selling anything.”

In Part 7, the film argues that passive strategies are gaining a foothold in the UK, where they currently make up only 7% of retail investor assets, compared with about 30% of institutional assets. (I’d estimate the popularity of indexing is similar in Canada, though it’s about twice as high in the US.) The discussion touches on the arrival of Vanguard in the UK in 2009: “Vanguard believes that passive investing has far greater potential in the UK because the cost of active fund management is higher over here than it is in the US.” Of course, those costs are even higher in Canada, so Vanguard must have seen enormous potential when it landed here in 2011. Unfortunately, a lot of that potential remains untapped.

If you’ve got a friend or relative who’s interested in the Couch Potato strategy but not inclined to read a whole book about it, send them a link to this short film, which is also available via YouTube. It might be the best 54-minute investment they’ll make this year.

55 Responses to Passive Investing: The Movie

  1. Canadian Couch Potato February 14, 2013 at 8:12 am #

    @Oldie: Those numbers are board lots, which are typically 100 shares. So 300 actually means 30,000 shares.

  2. Oldie February 14, 2013 at 11:34 am #

    @CCP: Again, sorry for my loose terminology — I had done the conversion in my head to number of shares to help my figuring — at the time in question, the bid and ask lot sizes on NYSE were actually 3 and 1. Now, I don’t know what this implies for rapidity of liquidation of shares, but it would seem to me to impede the sale of large amounts of shares.

  3. Canadian Couch Potato February 14, 2013 at 1:33 pm #

    @Oldie: I’m not comfortable offering advice on a proposed trade of $1.4 million. My suggestion is to contact your brokerage and make sure you have answers to all your questions before you proceed. You may also want to ask their rate for converting the currency with Norbert’s gambit, since it’s not uncommon for them to offer a genuinely competitive rate on large amounts.

  4. Oldie February 14, 2013 at 4:52 pm #

    @CCP,@Noel, re: Norbert’s Gambit — I have just returned from my financial advisor’s office and am still shaking with excitement at what transpired there. My advisor had done a lot of homework at my request, with many phone calls and 30 e-mails to the head office and had finally determined that what I was asking for technically could not be done, but there was a workaround involving a lot of work and a real-time 3 way conference call to the brokerage office. He and the company were willing to do just that for “a valued client” with the understanding that this was likely to be a “one-off” occurrence, and that I don’t spread the word that this company would do this. True, I had told him, from what I understood, all I needed to do was to open an account at RBC Direct Investing and I could do it myself, no phone calls needed. But, as he had put in so much effort, I felt it was only reasonable to take him up on his offer. To make things less confusing, I actually went to his office so I could watch everything unfold on his screen and to eliminate misunderstanding due to 3-way telephone conversations.

    I was really glad I did; the education was profound. After some preliminary getting up to speed with the trader (on speakerphone), and exposure to some real-time transaction data of TD on the NYSE, I decided on dividing up the US$1.4M into 4 tranches of about 4100 shares each; at that moment TD was trading at US$82.88 -$82.89. The actual trading was almost anticlimactic. The purchase transaction was fully completed within 30 – 60 seconds of being requested at market price in NY. So whatever fears I may have had about small bid and ask lots never amounted to any glitch. The trader had tried to get access to a look at the depth of the market, i.e. the 2nd and 3rd tier asks lined up behind the ask lot listed on the screen that I could see, but he reported that for some reason he could not get that data from the NYSE at the time. But the mere fact that there were multiple layers of bids and asks beyond that which was listed had never occurred to me, and could explain why the small numbers in the quoted bid/ask lots may not tell the whole picture.

    Once the purchase was almost completed I gave approval for a sell at market price on the TSE, and again, this was completed within 30-60 seconds. We repeated the whole process 3 more times over the next 10-20 minutes, and during this time period the TD share price on the NYSE ranged from $82.88-$82.89, down to $82.84-$82.86 then all the way up to $82.96-$82.97. But most of the price drifting took place between the buy-sell sequences of the 4 separate gambits, not during.

    When the dust had settled, my advisor calculated how much I would have received in CAD if I had used the brokerage best deal (which he said was a really good rate) for my US$1.4M, and it was $8,400 less than what I actually received doing the 4 Norbert’s Gambits. So it was well worth the effort. I should also mention that in addition to saving this amount (due to my own research and legwork), there was a huge “incidental” benefit ($>30k!!) of getting C$1.00+ compared to last month, where I would have only got 97.5 Canadian cents per USD; I did have some control over this — the rates had shifted, in fact I had missed the sweet spot by a few days, and I wanted to rush to get this deal done today before the Loonie strengthened again. But then again, you never know, the Loonie might keep on dropping.

    So, the lesson seems to be, if you have a good relationship with your broker, and if the company technically can’t do what you’re asking, keep asking for imaginative solutions, and he/she might come through for you; and then ,of course, one should reciprocate correspondingly with loyalty. And secondly, get all your ducks in a row; every bit of certainty helps, especially with a large amount, then execute smoothly and rapidly, preferably in the middle of the day.

    So thanks to all in the CCP community for the advice from all sides, and sorry if I have been a PITA for a long time; the uncertainty at the time was really unsettling, and I’m glad it’s done.

  5. Noel February 14, 2013 at 8:12 pm #

    @Oldie – I tried to reply yesterday (while on vacation laying on a beach in South Australia) using my iPhone but it wouldn’t work so had to wait until I got to my laptop.

    Bid/ask lot is irrelevant. You just needed to enter a limit price, press the key to buy and then to sell. Simple. The only difference between using RBC and TD is a phone call for the latter to journal the entry over. No mess, no spill, no involvement from any other human being.

    There are many bid/ask lots lined up behind the one you see. If not then it would be impossible for hundreds of thousands to millions of shares of TD to trade a day. I usually have done $300-$400K worth of shares at a time and have entered both the ask price and 1 cent above and have always gotten my entire order filled right away.

    Too bad I couldn’t reply to your initial post. After reading your posts I am quite shocked your ‘financial advisor’ (perhaps more of a mutual fund salesperson?) turned this into some huge wild goose chase with emails flying back and forth, conference calls and the like. This is not something that ‘technically’ can’t be done. And, no legwork is required. It’s a simple procedure and I do it all the time without the rigmarole this guy put you through. He obviously has no clue how the market works. Furthermore, I am surprised he claims he is doing you a favour as a valued client and that this is a one-off occurence and not to spread the word. He did you no favours, it was nothing special, he didn’t need to be involved and whatever he did was totally unnecessary. Sheesh!

    Also, I always check the spot rate on large money conversions right before I do the gambit and the savings are often a bit higher than what your advisor has claimed

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