Sometimes fame doesn’t live up to its hype. Legendary value manager Bill Miller always said that his fund only beat the S&P 500 for so many years in a row because of calendar bias: his performance was calculated at the end of every year. Had it been calculated at mid-year, then his numbers might not have looked so favourable.
Despite the Nobel prizes awarded to academic theorists, investing is not a science. Perfection is hard to achieve. There are too many moving parts. Indeed, we have no proven theories of economic growth, or how to muddle our way out of a Great Recession.
As a result, the search for precision can sometimes be otiose. ETFs can deliver risk exposure at lower costs than active funds. They can also deliver psychological comfort. After all, Bill Miller did fall off his market-beating pedestal, and investor reaction is one of the moving parts that prevents investing from being a science.
Satisficing, rather than perfection, is something advisors need to keep in mind when advising clients about ETF portfolios. The lowest MER, the lowest TER, the lowest tracking error, these may not be enough to satisfy the client’s needs. Bonds proportional to age, the 4% sustainable withdrawal rate, again, these may not be sufficient.
The important thing is getting it close to right, given a choice among imperfect alternatives. And so Larry Swedroe, writing on ETF.com, agrees, as many have contended, that the S&P 500 is actively managed. Indeed, stock market guru Jeremy Siegal notes that investors would have been better off keeping the stocks that the S&P index selection committee defenestrated. But that’s a debate for smart-beta circles.
The key point for Swedroe is that the long-term performance of the S&P 500 is barely different than that of better indexes, the Russell 1000 or the CRSP.
So an S&P 500 ETF works well enough. It satisfices. As long as that’s what the client wants.