Charlie Munger: 95% of People Have No Chance of Beating The S&P 500 Index | DJ 2017 【C:C.M Ep.255】
[Transcript]
AUDIENCE MEMBER: With regard to the proliferation of index funds, do you think that there may be issues with liquidity any time we go through another large crisis? And then, do you think that that will create large discrepancies between the price of the index fund and the values of the securities underneath?
CHARLIE MUNGER: Well, the index funds of the S&P, it’s like 75 percent of the market, so I don’t think the exact problem you’re talking about is going to be a big problem because you’re talking about the S&P index.
But is there a point where index funds theoretically can’t work? Of course. If everybody bought nothing but index funds, the whole world wouldn’t work as people expect.
There’s also the problem…one of the reasons you buy a big index like the S&P is because if you buy a small index and it gets popular, you have a self-defeating situation. When the Nifty 50 were the rage, JP Morgan talked everybody into buying just 50 stocks and they didn’t care what the price was, they just bought those 50 stocks. Of course in due time, their own buying forced those 50 stocks up to 60 times earnings whereupon it broke and everything went down by like two-thirds quite fast.
In other words, if you get too much faddishness in one sector or in one narrow index, of course you can get catastrophic changes like they had with the Nifty 50 in that former era. I don’t see that happening when the index is three-quarters of the whole market. The problem is the whole thing can’t work perfectly forever, but it will work for a long time.
The indexes have caused just absolute agony among the intelligent investment professionals because basically 95 percent of the people have almost no chance of beating it over time, and yet all the people expect, if they have some money, they can hire somebody who will let them beat the indexes, and of course the honest, sensible people know we’re selling something they can’t quite deliver and that has to be agony. Most people handle that with denial.
They think that it will be better next year, or they just don’t want to think about that and I understand that. I mean, I don’t want to think of my own death either, but it’s a terrible problem, beating those indexes, and it’s a problem that investment professionals didn’t have in the past.
And what’s happening of course is that the prices for managing really big sums of money are going down, down, down, 20 basis points and so on. The people who rose in investment management didn’t do it by getting paid 20 basis points, but that’s where we’re going I think in terms of people who manage big portfolios of the American Equities in the equivalent of the S&P. It’s a huge, huge, problem. It makes your generation of money managers have way more difficulties and it causes a lot of worry and fretfulness, and I think the people who are worried and fretful are absolutely right.
I would hate to manage a trillion dollars in the big stocks and try and beat the indexes. I don’t think I could do it. In fact if you look at Berkshire, take out a hundred decisions, which is like two a year, the success of Berkshire came from two decisions a year over 50 years. We may have beaten the indexes, but we didn’t do it by having big portfolios of securities and having subdivisions managing the drugs and subdivisions, and so the indexes are a hell of a problem for you people, but you know, why shouldn’t life be hard? It’s what had to happen, what’s happened now.
If you take these people doing some of those early trading by computer algorithms that worked, then somebody else would come in and do the same thing with the same algorithm and play the same game, and of course the returns went down. Well, that’s what’s happening in the whole field is the returns you’re really going to get are being pushed down by the progress of the sums.
(Source: https://youtu.be/BLctqhNClqY)
[YAPSS Takeaway]
The return will fall if everyone do the same thing.