*cremeegg* I decided to dive into your spat with *Sarenco* and I think it is you who are in error. In essence you are saying that the implied investment algorithm of the index is superior to a buy and hold strategy. This runs contrary to the EMH which would rule out any superior investment algorithm. And it has been shown that "sloth" funds do compare favourably with rebalanced indexes.

But I can see the paradox you are referring to. So let us posit a very simple model for the market. Every stock has an even money chance of growing 20% or falling 10% so on average an expected return of 5% p.a. Let's say that this remains true for any well diversified portfolio. It doesn't matter whether you update your portfolio or leave it alone - you will earn 5% p.a. So compare an investor who buys the 500 constituents of the S&P 500 and holds them. She will earn 5% per annum for the next 20 years and indeed the S&P index will grow 5% p.a. for the next 20 years. But our investor's portfolio will bear no resemblance whatsoever to the S&P 500 of 2040. It will contain maybe 250 "dogs" which have long since dropped out of the index.

The paradox is explained by observing that whilst by definition the S&P 500 constituents are the winners over the recent past, the fact is that the index "paid" fair value for rebalancing into them and gained no pricing advantage.

*PS on reading Sarenco's latest. This is a separate point to the one Sarenco is making which is that index tracking funds should, subject to small transaction costs, successfully perform that function. That is because the index is rebalanced at market values.*

Developing this theme for slow learners.

Imagine a contest between the following investment algorithms.

Start with the 500 constituents of the S&P 500

1. Never rebalance (Buy and Hold)

2. Rebalance every time a stock rises 20% above its low by replacing it with another(randomly chosen) stock (Sell High)

3. Subsitiute one of the stocks (randomly chosen) with any stock not already there which is 20% below its peak (Buy Low)

4. Randomly replace 50 of the stocks every quarter (Pot Luck)

5. Rebalance to match the top shares by capitalisation (Follow the Index).

Ignoring transaction costs,

*a priori *none of these strategies (algorithms) has any advantage over the other.

So I hope I have convinced you

*cremeegg *that Follow the Index does not have the intrinsic edge over Buy and Hold which you argued that it had.