FYI: P assive investing is eating the mutual-fund industry, as money floods out of actively managed funds and into index funds and exchange-traded funds. “Passive” typically means two things -- diversification and minimal trading. Active funds are supposed to make money by concentrating their investments and taking advantage of good opportunities. The case for passive investing is that active investing is a losing game.
Regards,
Ted
https://www.bloomberg.com/view/articles/2016-11-16/stock-picking-pros-beat-the-indexers
Comments
Nothing could be more misleading than the title of this referenced article. The article does acknowledge that there are smart active fund managers among many who are not so smart, but time and fees work against the small cohort of successful active fund managers.
Here is a Link that summarizes just how small that cohort of smart active fund managers is:
https://www.justetf.com/uk/news/passive-investing/the-proof-that-active-managers-cannot-beat-the-market.html
The odds are not attractive. This article clearly demonstrates the high percentage of actively managed funds that fail to beat appropriate benchmarks. I was surprised by the dismal records registered by funds outside the US marketplace. I wrongly believed that foreign operated actively managed mutual funds were superior in their limited market sphere. The data seems to demonstrate otherwise.
Although forecasting which funds will be winners in the future is a hazardous challenge, some actively managed funds have terrific past performance records. So history can serve as an imperfect guide on the basis that positive momentum might persist. Recently I have added a mix of Index products to my portfolio, but I still own a few actively managed funds that have delivered acceptable performance.
Market beating funds are out there. They are few in number so they may be difficult to find. The long term performance records do identify some of these attractive products. Here is a Link to a short list published by Barron's:
http://www.barrons.com/articles/4-managers-who-consistently-beat-the-market-1452318197
Although the list is very short, it is supplemented with some near misses that are also identified. Hope is eternal. Enjoy and profit.
Best Wishes.
http://mobile.usablenet.com/mt/www.barrons.com/articles/4-managers-who-consistently-beat-the-market-1452318197
I thought Ahlsten was responsible for Dodson's latterday success, but am out of that family.
A manager may be very adapt at identifying great long-term prospects following a nasty correction. However, if large amounts of money are flooding out of his fund at this point, seems to me his hands are largely tied. He's not able to buy at the lower prices. Inversely, I fear managers are often compelled (err...inclined) to invest money when it is flooding in after a period of rising equity prices.
Personally, I stick to active management because it's what I best understand based on many years of investing. Some of these active managers incorporate passive investments into their funds resulting is cost savings. I'm skeptical of narrowly focused newer smaller funds - precisely the type most vulnerable to hot money influences. But I'm keenly aware that all my funds are subject to this danger.
As an aside, I'll toss out for reflection the idea that part of the success of PRWCX and similar funds is that they are less likely to be hampered by hot money flows in and out. Almost by definition, funds like this attract and retain longer term money. Also - Can anyone make a good argument that passive (indexed based) open-end funds would be inherently less vulnerable to the detrimental effects of hot money?
(Added) Yes - I understand these passive funds invest in indexes. But are not indexes (representing the broader market) also heavily swayed by money moving in and out? In fact, since actively managed funds often hold ballast in the form of cash or bonds, one could infer they might be less influenced by hot money chasing market returns.
But regarding this, I take a long-term view (5-10 years) on everything. A one or two-year record doesn't mean much.
Thank you for participating. I am a long term investor so I hesitate to address issues associated with the influence of "hot money". I just don't play in that arena and have not thought much about it.
From my narrow and uninformed perspective, the problem with hot money is its unpredictability. That unpredictability adds to the uncertainties of investing which just compounds risk. So hot money is mostly a market disruption in the wrong direction. Those responsible for organizing a marketplace seek ways to control and limit hot money flows. Hot money hurts more often than it helps.
Surely when hot money enters the marketplace, it drives prices upward on a short time scale. Since productivity and earnings are more stable on a longer and different time scale, a mismatch happens and things become more expensive for no other reason than the hot money entry. That distortion impacts all market participants.
However, that distortion likely does not impact all participants equally since basic investment strategies differ. A momentum philosophy would encourage that type of player to join the trend whereas a value oriented player would tend to reject that opportunity for specific equities experiencing the hot money influx. Since an Index investor theoretically buys the whole market, he is a partial participant in the hot money influence.
That Indexer might be intimidated by sudden, irrational price swings and elect to abandon his market positions entirely. I suspect that there are no easy one size fits all answers to your challenging question. It depends on the individual investors decision process which itself is likely to change rapidly and in an unpredictable manner. That's why some investors are defaulting to automatic machine programs to make buy/sell decisions thus eliminating faulty emotionally driven investor decisions.
Well it appears that I have come full circle without providing you with an actionable response. Sorry about that, but I did try. My time scale is similar to that reported by MFOer Low Tech.
Best Wishes.
Thanks for your response. It's helpful but may not (as you suggest) answer my fundamental question of how much long-term investors like you are injured by other less disciplined investors who flood funds (including those using passive index based strategies) with money when valuations are high and than stampede out after large market declines. Whether in actively managed or passively managed funds, this herd instinct would appear to work against all of us because the fund is forced to some extent to buy high and sell low. Perhaps I have this wrong. Wonder if there's been any studies attempting to quantify this negative influence, especially regarding actively managed funds.
Here's a different but related issue with funds: Like you, I am largely buy and hold. But I've been known to speculate on beaten-up (highly focused) funds over very short time frames (measured in months rather than years) and than sell after a nice bounce (may not always work). The fund industry calls this "skimming" and works hard to prevent it. However - if I make a fast 25%-35% profit on a short term speculative venture, I assume that money had to come from somewhere. I further assume it's the "stay-put" long-term investors who picked up the tab. ??
Not being too familiar with the hot money issue doesn't dissuade me from making a guesstimate of its likely impact on investor's returns. My arrogance is such that I'll invent a method to estimate its impact at least in a possible magnitude sense.
Expected long-term compound geometric annual rate of return is calculated by taking the expected average annual return and subtracting its volatility drag. Volititity drag is the square of standard deviation. As you know, many folks interpret standard deviation as a measure of risk.
In my model, hot money must increase standard deviation without substantially changing basic expected returns. If that is true, we can use the relationship of Expected Annual Return equals Average Annual Return minus one-half Variance to examine the potential impact of hot money on Expected Annual Returns.
Here is an example (be free to use your own set of test numbers). If you anticipate your portfolio will deliver a 7% average annual return with a standard deviation of 15%, the normal expected annual return is 5.88%. Using the proposed hot money model, the average annual return remains at the 7% level, but standard deviation might increase by say 30% to a 19.5% level. In that case, expected annual return is reduced to 5.10%.
So the proposed hot money impact on market volatility significantly attenuates expected returns. Toss in your own numbers and do a few cases to explore the sensitivities of the relationship.
Note that as average annual returns decrease, the impact of hot money has a larger influence. If average annual return is likely to be in the 4% range with still a 15% standard deviation, the nominal expected return is 2.88% and the hot money expected return is 2.10%. Hot money does proportionately more damage as market rewards decrease.
I'm sure this simplistic analysis misses some pertinent considerations, but it might get an investor into the ballpark in terms of weighing the influence of hot money on potential returns.
Hank, I think I'll stop at this juncture; otherwise I fear some folks will start talking.
Best Wishes.