Is Indexing Doomed? Financial Leader Believes So
The End of the Era of Mutual Funds: Index funds -mutual funds that track an "index" of dozens or hundreds of companies- have been a popular investment for decades. With nominal expense ratios and built-in diversification, they offer a strong basis for a retirement portfolio. But Niels Jensen, the UK-based founder of Absolute Return Partners, has written a book predicting that mutual funds will soon lose their luster. By analyzing long-term macroeconomic mega trends, he has come to the conclusion that mutual funds will go belly under. The Debt Super-cycle May Stop Churning: Borrowing -particularly on a margin- has led to unparalleled standards of living. As TV dad Archie Bunker once said, "[c]redit is the only thing that stands between us and Communism." But as the sovereign debt of developed nations is untenable, as some economists predict will happen soon, the entire global financial system will have to be restructured. This means that the dominance of mutual funds will also end, and leads us to Jensen's next salient point... The Rise of the East: With the ascendancy of the BRICS countries (Brazil, Russia, India, China and South Africa), some are doubting the centuries-long dominance of the Anglo-American economies and their allies. Though the BRICS nations still have multiple millions of people living on wages less than $2 a day, which means they also have more room to grow. China, in particular, has been a
development success story. Many index funds are focused on the developed markets of the US, the UK, the EU, Japan and increasingly South Korea. Even international funds are woefully underexposed to developing markets. The Baby Boomer Bust: The West is facing a demographic crisis: the Baby Boom generation is beginning to retire. That leaves to the smaller generations X, Y, and Z to make up for their productivity. Jensen suggests that industrial automation may be able to make up for some of this workforce loss. Also, Baby Boomers are having to make more with less due to inflation and other factors. This segues into another of Mr. Jensen's points... The declining spending power of the middle classes: As the price of consumer staples declines, middle-class people are left with less discretionary income. This leads to a stagnation for cyclical firms as consumer spending decreases. Worse still, this leads to fewer jobs being created. This vicious cycle could do serious harm to index funds that depend on cyclical businesses to heighten gains during booms. The death of fossil fuels: Renewable energy firms have been taking advantage of the jump in demand for their products. The solar and wind sub-sectors, specifically, are challenging conventional fossil fuel utilities for market share. This threatens mutual funds, as some of their best dividends come from companies like BP and ExxonMobil. While yieldcos offer decent dividends, they still fall far short of those provided by conventional energy. Will investors accept lower dividends from more sustainable sources?
Mark Angelo co-founded the Investment Manager in August 2009.