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By Christine Benz | 09-03-2013 12:00 PM

Malkiel Encouraged by Indexed Products

The author and Princeton professor favors plain-vanilla, index-based investments and says specialized, high-cost products are bad for the ETF industry.

Christine Benz: You're a big proponent of efficient-markets hypothesis. Are you encouraged by the strong uptake we have seen of index-based products? Even though we have not seen great flows into equity funds, we have seen a lot of uptake of exchange-traded funds in particular over the past several years.

Burton Malkiel: I am. I think, in general, the more plain-vanilla of these have been absolutely wonderful for investors, and I am extremely encouraged. You know, a number of people will say to me, "Burt, aren't you discouraged that maybe for individuals, maybe 25% to 30% of their money is in indexed-type products, and you've been on this indexing bandwagon for 40 years. Are you discouraged?"

I'm not a bit discouraged. I mean, I'm a glass-half-full guy rather than a glass-half-empty. I think that ideas that really started in the academy have had a lot of uptake in the real world. I think, it's been good, I think it's going to continue, and I think we're going to see more and more of it. I am very encouraged about the growth of what I would call the more plain-vanilla, very broad-based, very low-cost indexed products.

Benz: How do you feel about the different higher-cost products that we have seen launch over the past several years. We have certainly seen a lot of very specialized ETFs which seem like maybe not the types of products that people will use well?

Malkiel: I think that is very bad. Unfortunately, a lot of people when they think of ETFs, they think of some of these products, and it gives the whole ETF world a bad name. I think that it's crazy to buy something that will give you 3 times the S&P 500 on the upside or the downside. These products really have nothing to do with investing, and in fact, they don't even do what they purport to do. They will do it for one day. You can't be a long-term holder of these and get what they tell you they are going to give you. Those more specialized ones and more speculative ones are, in my view, very, very troubling. As far as I'm concerned, they are very gimmickry, and they are typically, as your question suggested, high-cost.

But does this undermine the case for indexing? No. It says, these aren't really true indexed products. What I am talking about when I talk about an indexed product is a very broad-based product that if it's for the United States, it would be a total stock market indexed fund and would include all the stocks in the U.S. And if it were a European product, it would include all the ones for Europe and would be low-turnover and low-cost. And that's what I mean by indexing and good ETFs. I certainly wouldn't include some of the products that are high-cost and gimmickry.

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