The End of Indexing: Six structural mega-trends that threaten passive investing

by Niels Jensen

I expect nothing extraordinary from US equity markets – at least for the next 10 years or so, when US demographics begin to improve again (much sooner than European demographics will). My main concern as far as US equities are concerned is valuation. US equities are just so expensive. Having said that, as I have already pointed out, overvaluation can prevail for a long time, and it would be outright foolish of me to try and project when I think it will correct itself.

The gamma risks I would prefer to be exposed to over the next 10 years are (from least to most favoured): Size risk Style risk Income risk Illiquidity risk

When bond yields decline, growth stocks outperform value stocks, and vice versa. With declining bond yields for most of the last 35 years, it is easy to understand why many investors are infatuated with growth stocks. An entire generation of investors have never seen value stocks outperform growth stocks for any extended period of time, and those who have hardly remember anymore, because it is more than 35 years ago. Now, assuming we stand in front of a multi-year rise in interest rates, even if it is of modest proportions (as I think it will be), all that could be about to change. Moreover, if you are not comfortable assuming any beta risk at all, it would be quite easy to go long a value ETF and short a growth ETF on a risk-adjusted basis and thereby eliminate the beta risk.

In an unconstrained portfolio, I would allocate next to nothing to beta risk (with the possible exception of Africa), no more than 25% to alpha risk, and around 75% to credit and gamma risk.