What about indexing?

Many commentators and academics recommend that individual investors buy index funds in order to avoid the expenses of actively managed funds. There is a wealth of academic research demonstrating that actively managed funds, on average, do not outperform the broader stock market after fees. Of course, the performance of the index is determined in large part by the collective decisions of all managers; on average, a large enough group of managers should have performance before fees close to that of the index. It is unsurprising that active management taken as a whole does not appear to add much value relative to an index. The problem for investors lies in identifying consistently skillful managers, whose fees are justified by their performance.

Cable Car believes asset prices are not just random variables and that over the long run, asset prices reflect the value of their underlying cash flows. The stock market is not efficient, and securities are frequently mispriced due to misperceptions, investor psychology, and technical factors. When an index fund indiscriminately purchases all securities in an index, for example, that action can contribute to pricing anomalies. Cable Car’s research is a full-time effort to understand businesses and identify potentially mispriced securities. It is competitive, uncertain, and challenging, but far from impossible. Individuals who believe the task of security analysis is futile are well advised to consider index funds.

For investors who desire exposure to individual securities, researching each investment and managing a portfolio demands the services of a competent investment manager. Indexing is an understandable alternative to attempting to manage a portfolio without devoting energy full-time to investment research. However, indexing limits the potential return to that of the market or a sector, while exposing the investor to potentially undesirable holdings on which no due diligence has been conducted and to unpredictable changes in the direction of the stock market as a whole.

Cable Car cannot guarantee the performance of its security selections; however, the risks and potential rewards of each of its investments are carefully considered and researched. Cable Car does not seek to outperform a particular benchmark, but instead strives to compound capital at an attractive rate of return over time.

Posted in: Individual investors