Packaged investment products more or less defi ne conventional
wisdom through market cap and valuation categories. Still, these
semantic exercises spring from reasonably credible trends: in general,
small companies have more room to grow than giant companies,
and, in general, large companies are less volatile than small
companies. Of course, in general, actively managed mutual funds
underperform when compared to the Standard & Poor’s (S&P) 500.
That’s why we eschew the general in favor of the specifi c.
We would call adherence to the conventional wisdom a lazy
man’s approach to investing, except that there is no reason even
a lazy man should arbitrarily limit his opportunities to companies
of a certain size or valuation category. A smart lazy man would simply
invest in low-fee market index funds and benefi t from the longterm
performance of the market as a whole. But for anyone seeking
superior results from their investments, conventional wisdom does
not suffi ce.
A Simple Failure of Logic
The lure of “large-cap” and “small-cap” as convenient carrying handles
is understandable but misguided. Why would anyone insist on
buying large-cap stocks if there were better opportunities in small- or
mid-cap stocks, or vice versa? In a marketplace where opportunities
may appear anywhere and at any time, infl exibility is a liability.
Moreover, the conventional wisdom may not be very wise. For
example, the security ascribed to large-caps may be little more than
a self-fulfi lling prophecy: Large fund and pension managers believe
they must own large-cap stocks for security, so they keep buying
them, increasing the demand for shares and keeping the price high,
regardless of the company’s quality or intrinsic value. Seeking security,
they build a house of cards. Expect any large-cap fund to own
General Electric, just as they owned Enron, WorldCom, JDS Uniphase
(JDSU), and so on.
More specialized funds also tend to exert a circular infl uence. If,
for example, the fund requires a specifi c allocation of resources to
technology stocks, a fi nite number of companies fi t that defi nition.
The money must be invested within a narrow selection of companies,
regardless of other factors. This artifi cially infl ates prices and, in
extreme cases, could cause a market bubble. We may be seeing this
today in “emerging markets.”
wisdom through market cap and valuation categories. Still, these
semantic exercises spring from reasonably credible trends: in general,
small companies have more room to grow than giant companies,
and, in general, large companies are less volatile than small
companies. Of course, in general, actively managed mutual funds
underperform when compared to the Standard & Poor’s (S&P) 500.
That’s why we eschew the general in favor of the specifi c.
We would call adherence to the conventional wisdom a lazy
man’s approach to investing, except that there is no reason even
a lazy man should arbitrarily limit his opportunities to companies
of a certain size or valuation category. A smart lazy man would simply
invest in low-fee market index funds and benefi t from the longterm
performance of the market as a whole. But for anyone seeking
superior results from their investments, conventional wisdom does
not suffi ce.
A Simple Failure of Logic
The lure of “large-cap” and “small-cap” as convenient carrying handles
is understandable but misguided. Why would anyone insist on
buying large-cap stocks if there were better opportunities in small- or
mid-cap stocks, or vice versa? In a marketplace where opportunities
may appear anywhere and at any time, infl exibility is a liability.
Moreover, the conventional wisdom may not be very wise. For
example, the security ascribed to large-caps may be little more than
a self-fulfi lling prophecy: Large fund and pension managers believe
they must own large-cap stocks for security, so they keep buying
them, increasing the demand for shares and keeping the price high,
regardless of the company’s quality or intrinsic value. Seeking security,
they build a house of cards. Expect any large-cap fund to own
General Electric, just as they owned Enron, WorldCom, JDS Uniphase
(JDSU), and so on.
More specialized funds also tend to exert a circular infl uence. If,
for example, the fund requires a specifi c allocation of resources to
technology stocks, a fi nite number of companies fi t that defi nition.
The money must be invested within a narrow selection of companies,
regardless of other factors. This artifi cially infl ates prices and, in
extreme cases, could cause a market bubble. We may be seeing this
today in “emerging markets.”
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