For those interested in the extensive research behind passive and index investing, this is the place to be. Here we offer a brief primer about the most important research of the past 60 years and the practical application of that research for investors.
How Markets Work
Worldwide financial markets historically reward investors for the capital they supply. According to financial theory, in a free market economy, capital markets accurately set securities prices so investors receive reasonable rewards for taking long-term risks.
While markets have grown more complex and sophisticated, they still offer a simple and powerful way for people to exchange value and improve their well-being. Entrepreneurs and investors meet in the capital markets. People supply capital with an expectation of receiving a reasonable return for its use. Their investment capital fuels economic activity. Businesses compete for this capital by offering higher returns, and investors compete with each other to find the most attractive returns. This competition quickly drives prices to fair value, ensuring that companies must offer returns in line with their perceived risk.
When markets work properly, no investor can expect greater returns without bearing greater risk. These rewards do not come from choosing the right stocks or selecting the best time to enter and exit the market. Rather, investors are rewarded over the long-term for taking risks that bear compensation.
Passive Investment Strategy
For passive and index mutual fund and ETF portfolio managers like Cardiff Park Advisors, the burden of creating returns is removed from the research process and returned to the responsibility of the market, which sets prices to compensate investors for the risks they bear. Passive portfolio management is a smarter strategy because it acknowledges that returns come from risk, and at least some risk is essential for long-term gain, but that not all risks carry a reliable reward.
Passive and index portfolio managers counsel clients to diversify broadly through index funds and selected ETFs, taking only risks that bear compensation and avoiding risks that don't generate expected return. These risks may include holding too few securities, betting on particular countries or industries, following market predictions, or speculating based on rating services.
For passive and index mutual fund and ETF portfolio managers, the idea is to hold as many stocks in as many industries and as many countries as reasonably possible. Index funds broaden market coverage and promise optimal exposure to reliable dimensions of expected return at minimal cost to the portfolio. Transaction expenses, taxes and tracking error, the byproducts of portfolio management, are the unavoidable costs of asset allocation. Passive and index mutual fund and ETF portfolio managers, like Cardiff Park Advisors, offer a superior way to invest by reducing these and other costs that penalize long-term expected returns.
Index mutual fund and ETF managers design strategies to closely approximate the performance of well-recognized market benchmarks. They buy and hold stocks in the same proportions as they exist in the market or particular market sub-category; for instance, the S&P 500 index (large U.S. companies), the Russell 2000 Index (small U.S. companies) or the Morgan Stanley “EAFE” index (large international companies). Other well-known indexes measure small company stocks, high-book-to-market company (value) stocks, emerging market stocks, foreign stocks, real estate securities, precious metals, gold, commodities and an array of taxable and tax-exempt fixed income strategies.
Passive and index mutual fund and ETF investment advisors build portfolios based on proven principles of asset allocation, using low-cost index funds. Index funds offer the advantages of low operating and trading expenses, excellent diversification within asset categories, and broad access to all segments of the market. The result is a portfolio with hundreds or even thousands of securities.
The tremendous growth in the use of index funds serves as tangible evidence that money management today is being transformed away from attempts at market timing and stock selection to the wider and more important context of asset allocation and diversification. Rather than trying to out-research other market participants, passively managed index fund investors look to asset class diversification to manage uncertainty and to position for long-term growth in the capital markets. For passively managed index mutual fund and ETF portfolio managers like Cardiff Park Advisors, the objective is to devise appropriate long-term strategies that will move investors towards their financial goals with the least amount of risk. These strategies do not fight the capital markets with the goal of trying to beat them so much as they intelligently ride with them.
For more information about Cardiff Park Advisors please review our brochure at https://adviserinfo.sec.gov/firm/summary/126752 or visit www.cardiffpark.com