Hi Guys,
It is clear that financial and investing decisions are so personal and so tied to both risk aversion and special circumstances that no universal rule will apply to everyone. Each case must be evaluated on its own merits.
That is the primary reason why investment strategies excite so much controversy. That controversy approaches white hot temperatures when debating the pros and cons of passive and active mutual fund tradeoffs. What’s best for you is unique to your special circumstances. It depends.
Given some of my earlier postings, the title of this submittal might have stunned you. I am not a protagonist for a pure Index portfolio. Although I often recommend consideration of passive Index products, I have never exclusively endorsed them for an informed investor’s portfolio.
Personally, I have always maintained a broadly diversified portfolio composed of both passively and actively managed holdings. My mix has changed over a shortening time horizon.
To some degree we are all gamblers. The most successful gamblers know the rules and understand the odds. These two attributes are necessary, but not sufficient conditions to assure a successful investor. The lacunae are a strict money discipline and luck. The successful investor always practices risk control.
A critical distinction exists between the portfolio that a neophyte investor should pursue, and one that a seasoned investor could assemble. That distinction sets the battle-lines between an active and a passive investment discipline. Experience helps to develop the requisite skill kit. An informed investor understands and has access to tools that potentially allow him to make better mutual fund decisions.
Rookie investors are likely best served by opting for the passive fund management style. Seasoned investors might profitably seek active fund management. But what fund categories offer the highest likelihood of outsized rewards? S&P provides research that addresses this issue to tilt the odds just a little.
Standard and Poor’s publishes two research reports that measure the performance of active mutual fund managers relative to Index benchmarks both annually and integrated over three and five year time spans. These reports are the S&P Index Versus Active (SPIVA) semi-annual studies and the S&P Persistence Scorecard studies. These studies benefit both neophyte and mature investors.
The most recent SPIVA release (March, 2012 which documents the comparison through 2011) does not fail to reinforce long standing trendlines. Here is the Link to the update:
http://www.standardandpoors.com/indices/spiva/en/usJust hit the Hyperlink buttons to access both the current and the historical issues of this ongoing study.
Here are a few summary quotes from the 2011 year-end edition of the SPIVA report. Some of the statistical findings defy conventional investing wisdom.
“The only consistent data point we have observed over a five-year horizon is that a majority of active equity and bond managers in most categories lag comparable benchmark indices.”
“Over the last decade, SPIVA has consistently shown that indexing works as well for U.S. small-caps as it does for U.S. large-caps. “
“In the two true bear markets the SPIVA Scorecard has tracked over the last decade, most active equity managers failed to beat their benchmarks.”
In general, the SPIVA documents are myth busters. But exceptions do exist for the enterprising and less risk adverse mutual fund investor.
The SPIVA tables give an investor some feeling for the odds that he faces when electing to travel the active manager route. These odds are not attractive and so a diligent search for managers who persistently overcome these odds is mandatory before selecting an actively managed mutual fund.
Here are a few of my personal observations from the current SPIVA release.
Over the last 5-year measurement period, the actively managed Large-Cap Value category shows that the active managers, on average, have outdistanced their passive counterparts by a substantial percentage. These managers have generated excess returns over their Index benchmarks of 1 % to 2 %, timeframe dependent. The percentage of actively managed funds in this category that outperformed their Index benchmarks in the 2008 market meltdown is particularly impressive.
International Small-Cap Equity also appears to be a category where active management has prospered over passive products. In this arena, active management statistically has delivered a 3 % to 4 % excess return beyond their passive brethren.
In the fixed income marketplace, actively managed intermediate and short term investment-grade bond funds show a small returns advantage over their government proxies. Cost control is a paramount issue in the bond categories given their current challenge to generate annual returns that exceed inflation rates.
I’m certain that the SPIVA report offers individual investors other tidbits of actionable insights that are peculiar to each investors own circumstances. My quick review is surely incomplete.
Please access the Link I provided. I often download it, compare it to previous releases, and examine it carefully for potential portfolio revisions. Take time to absorb some of the lessons embedded in these statistical summary reports. As Edmund Burke said: “Reading without reflection is like eating without digesting." Please digest the report.
Know-how rules over guesswork every time.
Whatever your investment policy, be it passive, active or a mixed fund management proclivity, the key to success is persistence and consistency. To paraphrase the opening lines from Thomas Paine’s “Common Sense”, don’t be a summer soldier or a sunshine patriot. Stay bold, stay firm, stay calm, stay disciplined.
I hope this submittal helps you to better organize your portfolio with regard to active-passive fund management decision tradeoffs.
Your thoughtful comments are always encouraged and appreciated.
Best Regards.
Comments
Hi Maurice,
Thanks for reading my post. I hope you visit and absorb the SPIVA report.
I have a nuanced (only slightly so) reply to your question. I have a two-tier structure to my position on the passive-active debate.
For neophytes to the investment world, I typically recommend a conservative, incremental approach that initially uses a diversified lineup of Index products. As the Newbie acquires knowledge, experience, and confidence, I would advise him to reevaluate and expand his options to include actively managed funds in a limited number of fund categories. The S&P SPIVA scorecards would serve as one input source to guide that option expansion exercise.
Personally, my portfolio has always contained actively managed mutual funds. I purchased my first two mutual funds (Fidelity Magellan and Dodge and Cox Balanced) in the mid-1980s although I had been investing in individual stocks since the mid-1950s. I’m a slow learner. I still own Dodge and Cox. I have always believed that a mix of active and passive products had the potential for excess returns above Index holdings, but it requires experience and constant study to choose wisely. By the time I invested in mutual funds I had acquired those attributes; I was a seasoned, battle-tested veteran.
I believe I have remained consistent to my earlier recommendations and postings.
Thank you once again for your interest.
Best Wishes.