A client recently asked us what we thought about indexing (as in buying an index fund or ETF as part of a securities portfolio). Our answer gave us the opportunity to highlight why we work with business builders, aka wealth builders. And why we are not wealth managers.
To begin, indexing is fine. It has been blessed by none other than Mr. Buffett himself who says most people should use index funds. We think the methodology matters (there are better factors to use for weighting purposes than market capitalization but that’s a story for another time), but market cap weighted indexing has some nice attributes like low cost, large capacity/scale, and tax efficiency.
So we do not dissuade anyone from indexing (there are many ways to get to heaven in investing). But an index is really just a formulaic way to put together a portfolio of stocks (or businesses if you think of stocks as fractional shares of ownership in an operating company, as we do). Sometimes that collection of stocks/businesses (and stock price can be different from business value – see below) is worth owning; sometimes not. Rearview mirror looks great for the major indices (S&P 500; NASDAQ 100; etc.), but we see signs that the setup today for owning some things that are different to the major indices, or not prominent in the major indices, may be as good as it's ever been.
The method we favor for crafting a portfolio is to carefully select a small number of stocks after diligently researching the businesses represented by those stocks and evaluating the difference between stock price and business value. Over many years we have come to know a small number of investors (managers) who we think have the skill and process to perform this activity consistently well. Not that the results always bear this out (markets can remain irrational longer than you would ever expect, to paraphrase John Maynard Keynes) but this is our preferred approach to manage risk AND build wealth over time.
An example of such a manager is David Samra at Artisan Partners. His latest commentary(1) aligns with how we think about the entire enterprise of building business and investing in business. Refer to pages 2 and 3. You can see that Samra bristles a little at the questions he gets about exposures and underweights/overweights and we feel similarly - it's just not part of how we think about the whole endeavor. If we know and understand a small number of advantaged businesses (or place capital with investors who do so) we can do extremely well (and those who quote Buffett about indexing forget that he once espoused a very different approach: put your eggs in one basket and watch the basket closely).
Business is the path to wealth creation. This is our mindset regardless of whether we are helping an entrepreneur apply capital allocation strategy to their own business or helping them find places away from their business to allocate excess capital.
Business builders are wealth builders. Business and investing are two sides of the same coin. We’ll leave the exposures, the factor weights, and the style box concerns to the wealth managers.