Here's a statement of the obvious: The opinions expressed here are those of the participants, not those of the Mutual Fund Observer. We cannot vouch for the accuracy or appropriateness of any of it, though we do encourage civility and good humor.
Financial writer Chuck Jaffe offers a partial answer here.
I say only partially right because his article merely addresses the tip of the iceberg in terms of what an active investor copes with when challenged by the serious headwinds he encounters when seeking positive Alpha, excess returns.
Jaffe dutifully reports the chronic shortfalls that the typical mutual fund investor experiences when exercising entry and exit point decisions in the investment process. The Morningstar database that Jaffe references simply reinforces the findings that Dalbar has consistently documented for decades. Mutual fund purchasers do not receive the rewards earned by the funds that they choose.
Their timing is terrible. That’s true for individual investors as well as for those who employ advisors. Although the numbers change a little, that’s equally true for both active investors and for investors who use passive Index and ETF products as their trading media.
But the Jaffe piece just captures one part of a multi-dimensional drain on positive equity outcomes when deploying an active fund management strategy.
If you are a male investor who trades a diversified portfolio of actively managed funds, a debilitating multiplier factor effect infects outcomes to your disadvantage.
The bedrock observation is that active managers are the marketplace, and, on average, can only deliver average equity returns minus their expense ratios and trading costs. So, active fund management erodes 1 to 2 % of projected market returns from the get-go.
The Standard and Poors’ SPIVA and Persistency scorecard studies year after year document the shortfalls of active fund management. Their results show a very asymmetric rewards distribution with the losers far outstripping the winner group in total number and excess return sizes. And from that small winner cohort, persistent outperformance is a mirage. Some limited miracles do happen, but good luck at forecasting these rare winners.
Jaffe’s article discussed the poor timing tendencies of most investors which additionally erode investor returns. Morningstar and Dalbar studies support this assertion.
Monte Carlo analyses demonstrate that the more active funds you hold in your portfolio, and the longer period that you hold these funds, the likelihood of outdistancing the marketplace approaches a zero probability. Although as a general rule diversification is a positive thing, active portfolio diversification over passive portfolio diversification is a loser’s game.
Academic studies conclude that frequent trading is hazardous to your end wealth. These studies show that after a trade is executed, the traded holding outperforms the newly acquired product. The primary reasons for the trade is poor recent performance of the traded holding, and superior recent performance of the acquired holding. I suppose a reversion-to-the-mean seems to be in constant play here.
Further, more nuanced versions of these studies uncover that women are better investors than men. That finding is mostly attributed to trading frequency.
I suppose all these findings suggest that a passive mutual fund portfolio that is held for long (but not indeterminate) periods and is equally controlled by a male/female mix should optimize end wealth accumulation.
Truth be told, I only partially subscribe to this strategy. My wife and I decide together and own a mix of active and passive mutual fund and ETF products.
So I practice a policy that Linkster Ted referenced earlier today: “Active vs. Passive: The Answer is Sometimes Both”. This WSJ article reflects the spirit of my current feelings towards the active-passive mutual fund debate.
We just completed a near-perfect ocean cruise, but I’m happy to rejoin the MFO discussions once again. I’ll need a little time to reclaim pre-cruise form.
Comments
Financial writer Chuck Jaffe offers a partial answer here.
I say only partially right because his article merely addresses the tip of the iceberg in terms of what an active investor copes with when challenged by the serious headwinds he encounters when seeking positive Alpha, excess returns.
Jaffe dutifully reports the chronic shortfalls that the typical mutual fund investor experiences when exercising entry and exit point decisions in the investment process. The Morningstar database that Jaffe references simply reinforces the findings that Dalbar has consistently documented for decades. Mutual fund purchasers do not receive the rewards earned by the funds that they choose.
Their timing is terrible. That’s true for individual investors as well as for those who employ advisors. Although the numbers change a little, that’s equally true for both active investors and for investors who use passive Index and ETF products as their trading media.
But the Jaffe piece just captures one part of a multi-dimensional drain on positive equity outcomes when deploying an active fund management strategy.
If you are a male investor who trades a diversified portfolio of actively managed funds, a debilitating multiplier factor effect infects outcomes to your disadvantage.
The bedrock observation is that active managers are the marketplace, and, on average, can only deliver average equity returns minus their expense ratios and trading costs. So, active fund management erodes 1 to 2 % of projected market returns from the get-go.
The Standard and Poors’ SPIVA and Persistency scorecard studies year after year document the shortfalls of active fund management. Their results show a very asymmetric rewards distribution with the losers far outstripping the winner group in total number and excess return sizes. And from that small winner cohort, persistent outperformance is a mirage. Some limited miracles do happen, but good luck at forecasting these rare winners.
Jaffe’s article discussed the poor timing tendencies of most investors which additionally erode investor returns. Morningstar and Dalbar studies support this assertion.
Monte Carlo analyses demonstrate that the more active funds you hold in your portfolio, and the longer period that you hold these funds, the likelihood of outdistancing the marketplace approaches a zero probability. Although as a general rule diversification is a positive thing, active portfolio diversification over passive portfolio diversification is a loser’s game.
Academic studies conclude that frequent trading is hazardous to your end wealth. These studies show that after a trade is executed, the traded holding outperforms the newly acquired product. The primary reasons for the trade is poor recent performance of the traded holding, and superior recent performance of the acquired holding. I suppose a reversion-to-the-mean seems to be in constant play here.
Further, more nuanced versions of these studies uncover that women are better investors than men. That finding is mostly attributed to trading frequency.
I suppose all these findings suggest that a passive mutual fund portfolio that is held for long (but not indeterminate) periods and is equally controlled by a male/female mix should optimize end wealth accumulation.
Truth be told, I only partially subscribe to this strategy. My wife and I decide together and own a mix of active and passive mutual fund and ETF products.
So I practice a policy that Linkster Ted referenced earlier today: “Active vs. Passive: The Answer is Sometimes Both”. This WSJ article reflects the spirit of my current feelings towards the active-passive mutual fund debate.
We just completed a near-perfect ocean cruise, but I’m happy to rejoin the MFO discussions once again. I’ll need a little time to reclaim pre-cruise form.
Best Regards.