Welcome (Back) to The Index Investor

“Broadly Diversify…and Anticipate Downside Risks”

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From 1997 to 2011, we provided independent analysis and insight each month on asset class valuation, portfolio construction, decision making in the face of uncertainty, and downside risk management to a global audience of investment managers, financial advisors, family offices, and sophisticated individual investors.

In 2011, we suspended publication when our key writers moved on, either to other publications, or, in the case of contributing editor Tom Coyne, to spend four years on the Good Judgment Project team, which won the Intelligence Advanced Research Projects Activity’s forecasting tournament, with forecast accuracy that was more than 50% better than the tournament's control groups. The team's experience is described in Professor Philip Tetlock's book, “Superforecasting.”

Tom later co-founded
Britten Coyne Partners, a firm that provides education courses and consulting services on strategic risk management and governance. It helps clients to better anticipate, more accurately assess, and adapt in time to emerging strategic threats to their survival.

We left the Index Investor website up five years, and
all our back issues are still freely available so that investors can continue to benefit from our content. It is a rich source of material for people who want to know what it was like to try to make sense of the tumultuous first decade of the 21st century in real time.

Our new
Research Library is also free. Investors can browse our curated content on a wide range of issues affecting medium and long-term asset class valuations, including technological, economic, environmental, national security, social, demographic, and political trends and uncertainties, as well as potential "grey swan" wildcards like environmental, infectious disease, cyber, and large-scale electromagnetic events.

Now we’re back publishing again. Why?

As former Bank of England Governor Mervyn King has so aptly described it, we now live in a world of radical uncertainty, that has become a much more dangerous place for investors. Former US Treasury Secretary and Goldman Sachs Co-Chairman Henry Paulson shares this view, noting that "we are living in an age of unprecedented risks."

In recent years information overload, anxiety, and fear have all grown exponentially worse, and the integrated meaning of everything that is happening around us has become harder than ever to discern.

Perhaps more importantly, the exponential increase in connectivity the world has seen over the past 20 years has made global economic, political, and financial systems far more complex, and therefore uncertain. Research has demonstrated that in such circumstances, evolution has primed human beings to become more prone to conformity and to place more emphasis on imitating what others are doing (so-called "social learning").

Paradoxically then, as uncertainty increases, people — including many sophisticated investors — are more likely to become attached to a smaller (not larger) number of dominant narratives and expectations about the future.

This makes the highly interconnected systems highly vulnerable to small changes in information, feelings (fear is transmitted between human beings far more quickly than greed), and behavior that are all rapidly transmitted to many people, amplified by algorithms of various kinds, and whose impact is therefore increasingly both rapid in speed and exponential in size.

In the world we live in today, it is therefore critical to consciously consider explanations and forecasts from a wide range of independent sources, and seek an inevitably imperfect understanding of the complex dynamics driving the system towards a range of possible (and irreducibly uncertain) outcomes.

Pilots and air traffic controllers use a term — "having the bubble" — to describe having this sense of how a complex dynamic situation is evolving in real time, and a feeling of control within, if not over it.

This is no less important for investors and their advisors — but in today's world it has become much more difficult. We're publishing again to help our subscribers "have the bubble" — a better sense of understanding and control — in our rapidly changing, uncertain, and non-linear world, where threats to investment goals and strategies abound.

Our mission is to help our subscribers develop an edge in anticipating downside risks, accurately assessing them, and adapting to them in time to avoid large losses.

Why else are we relaunching The Index Investor?

Because index investing is more popular than ever, even though too many index funds aren't passive at all, but rather just a cheaper version of traditional active investment products.

Because too many investors' economic situations are more precarious than ever before, and getting their investment strategy right has never been more important.

Because there still seem to be more people and publications telling investors how to earn higher returns, but hardly any that focus on helping them avoid the large losses that are mathematically devastating to long-term portfolio returns.

And because the Good Judgment Project has finished, and we think our analytical and predictive methodologies are better than ever (though as our early warnings ahead of the
2008 and 2000 crises showed, our forecasting was pretty good back then too).

Here's what subscribers get in each monthly issue of the new Index Investor:

(1) Estimated asset class over/under valuations, and updated market stress indicators, using the same methodologies we've used in the past.

(2) Narrative forecasts and quantitative probability estimates for negative asset class valuation changes of 20% or more over the next 12 months. These periods of high uncertainty tend to be relative short, and transition to longer-lasting states/regimes. Given this, we also provide probability forecasts that contingent on the initial 20% loss/shift to the high uncertainty regime. Specifically, we provide narrative and probability forecasts for three subsequent outcomes: a return to the normal regime, a persistent deflation regime, and a high inflation regime. Our goal is to help subscribers have a good sense of what could happen not just one, but two or more steps ahead.

(3) A comprehensive, chronological "Evidence File", that contains high value information that we have used to update our monthly forecasts. This information is categorized by month, and divided into separate sections covering developments in technology, the economy, national security, society, politics, financial markets, and out three "wildcards": energy and the environment, infectious disease, and cyber and electromagnetic events. The Evidence File helps subscribers to better understand the trajectory and dynamics of developments in each of these critical areas.

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Put differently, in a complex system that is constantly adapting and evolving, the accuracy of statistical or machine learning based forecasting methods declines exponentially as the time horizon lengthens, as the historical data set on which they were trained bears less and less resemblance to the distribution of outcomes the system is likely to produce in the future. Under these circumstances, accurate forecasts beyond the short term must be based on causal and counterfactual, and not just statistical thinking.

Broadly speaking, our methodology is based on Peter Pirolli and Stuart Card's information foraging and sensemaking model (see their classic article, "
The Sensemaking Process and Leverage Points for Analyst Technology").

More specifically, our forecasts utilize tools learned on the Good Judgment Project and elsewhere.

It is also critical to understand that in order to increase accuracy, our forecasts can (and should) be combined with forecasts subscribers obtain from other sources.


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A key aspect of our methodology is a focus on how endogenous system dynamics can cause regime changes, even in the absence of exogenous shocks. Specifically we focus on key system stocks (e.g., debt levels), and how ongoing system flows (e.g., government deficits) can eventually cause them to exceed critical thresholds and produce non-linear effects. Our methodology analyzes key stocks in five areas, including technology, the economy, national security, society, and politics.

In our free first issue, we discuss in more detail our forecasting concepts and process, including how accuracy can be further increased by extremizing combined average forecasts.

Other benefits to subscribers include:

(4) In between monthly publications, we will publish flash updates — on our
blog, via email, and via our Twitter @indexllc — if and when we obtain high value information that results in a substantial change to a forecast probability.

(5) A feature article providing an in-depth analysis of either a key macro-uncertainty (e.g., how close the system is to one or more critical thresholds)or an aspect of making good investment decisions in the face of complexity and uncertainty. These articles typically synthesize a broad range of academic research and practitioner experience to provide thought provoking insights about critical issues facing investors and their advisors.

Our goal is to provide subscribers with an ongoing understanding of the complex dynamics driving asset class valuations and returns, as well as regularly updated downside risk probabilities for broad asset classes, that are based on an explicit methodology which facilitates their combination with inputs from other sources to improve overall forecast accuracy.

We also provide speaker services on how to increase forecast accuracy, understanding the differences between active, passive, and index investing, and how to overcome the individual, group, and organizational obstacles to making good decisions in the face of uncertainty. Our speaker offerings include seminars for advisors' clients and speeches for larger groups. Click here to learn more.

You can download a free copy of our first issue, which contains a detailed description of our forecasting methodologies, as well as feature article on macro economic, political, and financial changes and challenges between our last issue in 2011 and today.

You can also
send us feedback about how to improve The Index Investor to better meet your needs. Or you can subscribe (our first issue for subscribers will be published in early September).

Investment Philosophy

We believe that in addition to diversification across broad asset classes, avoiding large downside losses is also critical to achieving long term investing goals.

Hence, our focus is on identifying asset classes that are dangerously overvalued today, and, at a longer-term horizon, identifying emerging threats that could cause substantial changes in uncertainty and asset class valuations.

Our research is based on the application of complex adaptive systems theory and advanced forecasting methods to macro factors such as technological, economic, environmental, military, social, demographic, and political trends and uncertainties.

We believe that financial markets are filled with positive feedback loops that produce nonlinear effects through the interaction of competing strategies (for example, value, momentum, and passive approaches) and underlying decisions made by people with imperfect information and limited cognitive capacities who are often pressed for time, affected by emotions, and subject to the influence of other people.



Asset Allocation

While attracted to equilibrium, we believe that financial markets are best described as adaptive systems that never reach it. When they are operating far from equilibrium, substantial over and undervaluations are the usual result.

In contrast, traditional mean-variance optimization is based on an underlying assumption that markets generally operate in or close to equilibrium. This is why this approach often produces disappointing portfolio results.

Our benchmark model portfolio is equally allocated between broad asset classes in order to capture the underlying system and social drivers of financial market returns.

To achieve long-term portfolio goals, avoiding the large losses that follow substantial overvaluations is critical.

This can be achieved through a combination of systematic and episodic portfolio rebalancing that is driven by the extent of asset class over and undervaluation.




Active vs. Passive

Once you've determined the asset allocation that has the highest probability of achieving your long term return goals, you have to implement it via the investments you choose for your portfolio.

At this point, the most important question you have to answer is the the mix of active and passive investments you will use to implement your asset allocation.

In fact,
we wrote a book about the arguments on either side of the active versus passive question.

In a nutshell, the active investor believes that he or she can regularly generate (or choose fund managers who can generate) returns that are above the returns generated by a passive benchmark portfolio, due to a mix of information and/or forecasting skill (i.e., an "edge") that is superior to that possessed by other active investors.

In contrast, the passive investor wants only to match those benchmark returns at the lowest possible cost.




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