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Thanks for the SPIVA reminder. It's a terrific service that deserves more investor attention.
These guys have been doing this mind numbing, numbers crunching job for a good many years now, I agree with your observation that the output is monotonous and easily predictable. A major fraction of Active fund managers have consistently and persistently failed to match their benchmark standards.
There are a few random exceptions for brief periods, but the record is substantial and overall it is very discouraging. It is depressing!
What is even more depressing is the fact that many investors still seek and fail to find the magic criteria that allow a forecast of who these few exceptions might be ahead of time. There's a good reason for that failure too. Those elusive magic criteria simply do not exist. What works now will likely change and fail in the future. The investment world is in constant change.
It took me a long time to learn that lesson. I recommend that MFO regulars consider just how challenging the Active fund management selection task really is. There are multiple thousands of candidate funds and only a handful will succeed for a short period. Given those dire odds, Index choices seem like an attractive alternate portfolio construction approach.
It's not that Active managers are not smart guys. They are very smart, totally committed, with large research staffs. That's just not enough to win. Their costs and competition against one another limits their potential outsized performance, and turns their considerable efforts into a Loser's game.
That's too, too bad, but that's the current ballgame. There will be a few brief exceptions. Good luck on identifying and capturing these exceptions in a timely and a profitable manner.
I am reminded of Adam Smith's invisible hand when reviewing data such as this. The investment world is complex and constantly changing. There are many intelligent and highly competitive players. This report again suggests that outmaneuvering the markets' invisible hand is very challenging in the long run -- particularly when it come to large cap US stocks. But, in an attempt to smooth the ride somewhat and somewhat just for the sport of it, my portfolio remains committed to actively managed funds...albeit with limited remaining general exposure large cap US stocks (SPHD). I suppose DSENX could be included in that category too. But its black box investments make it hard to pigeon hole that fund.
I take its CAPE portion to be simply rules-based, so not active the way my other actively managed funds are. I also wouldn't call CAPE black-box. The bond sauce, maybe.
Over the last 15 years, how many *passively* managed domestic large cap funds beat their index? If they are truly tracking their index, don't they all fail each year by at least the amount of their expense ratio?
A likely explanation for the unimpressive performance of actively managed domestic large cap funds is that a high percentage of their holdings tend to duplicate the Index that matches their style. They are far too passive at deviating with original investment ideas. Therefore their performance is often slightly below their Index results because of cost drag.
Over many measurement time periods, the active management shortfalls are often slightly less than their cost drag because they do have some selection talent that helps to reduce their cost penalty. A few manage to fully overcome that operational cost penalty.
Over time the percentage that manage this feat changes, but it typically is a percentage that is less than 25% , and that's a generous estimate most timeframes. That percentage decreases as the timeframe expands. Active fund management typically doesn't deliver the goods.
A well managed index fund can do a little better than the index minus expenses.
It can make some money by lending its securities. (Some funds let the fund management keep some or all of this; in Vanguard funds all of this revenue goes into the fund.)
Depending on the flexibility allowed to the fund, it can trade a little earlier or later than when the index changes, allowing it to take advantage of price movements. DFA advertises this "patient trading" as a specific advantage of its funds.
Virtually all funds even index funds keep some cash around to manage cash flows. Most years (when the market is rising) this "cash drag" pulls the performance of the fund down (toward the performance of the cash, which is now around 0%). But in years when the index drops, this "drag" tends to pull the fund performance up toward zero.
Thank you for answering my second question, msf. I think that we would consider VFINX an example of a well managed S&P 500 Index fund, but its 1-, 3-, 5-, 10-, and 15-year trailing total returns fall short of those of the S&P 500 Index, according to Morningstar: http://performance.morningstar.com/fund/performance-return.action?t=VFINX®ion=usa&culture=en-US Thus, it fails to meet the same criterion that SPIVA sets for active funds.
Thank you for sharing your in-depth knowledge of how mutual funds conduct their operations. Your explanations are clear, concise, and even fun reading. Good stuff!
I get the sense that Index funds will have a difficult time in the next bear market.
Index funds tend to fuel markets higher as the are forced to buy "the index" regardless of its valuation. Most investors are willing to ride the rising tide, but will they remain holders of these index efts or mutual funds as the index tumbles?
Just as Index funds are force to be buy 100% in the market when dollars flow into these funds, they will also be force to sell 100% of the index as investors pull dollars out.
In a world of highly correlated assets hedging index fund risk seems like a worthy management expense, but do these types of investments exist?
Anyone aware of Asset Allocation / Balanced / Hybrid funds that consist of one or more Indices (for all the reasons Index investments work) and uncorrelated market assets (for all the reason that index investments don't work)?
@bee, I am not sure these exactly fit, but they are interesting to follow (perhaps you already know them), and sometimes to own, although never particularly exciting: AOA, AOR, AOM, AOK. But not actively managed, just according to how component sectors do.
If you mean a fund that allocates among different sectors or asset classes using etfs rather than stocks or bonds there are a few ETFs like that. I am thinking of Cambria ( an ETF they run is GAA) and CMGwealth.com.
The latter has a very informative newsletter weekly and a weekly asset allocation model using ETFs. It is worth reading but has a very bearish tilt so far.
Steve Blumenthal posts their performance figures online, but they cater mostly to advisors in separately managed accounts
They have several mutual funds PEGAX for example that have the same name as the strategy but I am not clear that they are actually run the same. Morningstar lists rather odd portfolio holdings for them sometimes.
It all depends on how smart (or lucky?) the black box is behind the allocations
Comments
Thanks for the SPIVA reminder. It's a terrific service that deserves more investor attention.
These guys have been doing this mind numbing, numbers crunching job for a good many years now, I agree with your observation that the output is monotonous and easily predictable. A major fraction of Active fund managers have consistently and persistently failed to match their benchmark standards.
There are a few random exceptions for brief periods, but the record is substantial and overall it is very discouraging. It is depressing!
What is even more depressing is the fact that many investors still seek and fail to find the magic criteria that allow a forecast of who these few exceptions might be ahead of time. There's a good reason for that failure too. Those elusive magic criteria simply do not exist. What works now will likely change and fail in the future. The investment world is in constant change.
It took me a long time to learn that lesson. I recommend that MFO regulars consider just how challenging the Active fund management selection task really is. There are multiple thousands of candidate funds and only a handful will succeed for a short period. Given those dire odds, Index choices seem like an attractive alternate portfolio construction approach.
It's not that Active managers are not smart guys. They are very smart, totally committed, with large research staffs. That's just not enough to win. Their costs and competition against one another limits their potential outsized performance, and turns their considerable efforts into a Loser's game.
That's too, too bad, but that's the current ballgame. There will be a few brief exceptions. Good luck on identifying and capturing these exceptions in a timely and a profitable manner.
Best Wishes
Thanks for your participation and question.
A likely explanation for the unimpressive performance of actively managed domestic large cap funds is that a high percentage of their holdings tend to duplicate the Index that matches their style. They are far too passive at deviating with original investment ideas. Therefore their performance is often slightly below their Index results because of cost drag.
Over many measurement time periods, the active management shortfalls are often slightly less than their cost drag because they do have some selection talent that helps to reduce their cost penalty. A few manage to fully overcome that operational cost penalty.
Over time the percentage that manage this feat changes, but it typically is a percentage that is less than 25% , and that's a generous estimate most timeframes. That percentage decreases as the timeframe expands. Active fund management typically doesn't deliver the goods.
Best Wishes
It can make some money by lending its securities. (Some funds let the fund management keep some or all of this; in Vanguard funds all of this revenue goes into the fund.)
Depending on the flexibility allowed to the fund, it can trade a little earlier or later than when the index changes, allowing it to take advantage of price movements. DFA advertises this "patient trading" as a specific advantage of its funds.
Virtually all funds even index funds keep some cash around to manage cash flows. Most years (when the market is rising) this "cash drag" pulls the performance of the fund down (toward the performance of the cash, which is now around 0%). But in years when the index drops, this "drag" tends to pull the fund performance up toward zero.
Thus, it fails to meet the same criterion that SPIVA sets for active funds.
Thank you for sharing your in-depth knowledge of how mutual funds conduct their operations. Your explanations are clear, concise, and even fun reading. Good stuff!
Best Wishes
Index funds tend to fuel markets higher as the are forced to buy "the index" regardless of its valuation. Most investors are willing to ride the rising tide, but will they remain holders of these index efts or mutual funds as the index tumbles?
Just as Index funds are force to be buy 100% in the market when dollars flow into these funds, they will also be force to sell 100% of the index as investors pull dollars out.
In a world of highly correlated assets hedging index fund risk seems like a worthy management expense, but do these types of investments exist?
Anyone aware of Asset Allocation / Balanced / Hybrid funds that consist of one or more Indices (for all the reasons Index investments work) and uncorrelated market assets (for all the reason that index investments don't work)?
AOA, AOR, AOM, AOK. But not actively managed, just according to how component sectors do.
The latter has a very informative newsletter weekly and a weekly asset allocation model using ETFs. It is worth reading but has a very bearish tilt so far.
Steve Blumenthal posts their performance figures online, but they cater mostly to advisors in separately managed accounts
https://www.cmgwealth.com/ri/cmg-q1-2017-quarterly-performance-update/
They have several mutual funds PEGAX for example that have the same name as the strategy but I am not clear that they are actually run the same. Morningstar lists rather odd portfolio holdings for them sometimes.
It all depends on how smart (or lucky?) the black box is behind the allocations