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.
One issue that I purposely avoided in my earlier post because of length considerations was that of active mutual fund management performance persistency.
It is significant because it simply does not exist beyond perhaps a momentum-driven one year period. In the investment world “hot hands” cool very rapidly and future underperformance is the rule rather than the exception. The pervasive market force is a regression to the mean.
This is not me talking; it is pretty much all of academia talking. The classic paper most frequently referenced on this topic was written by Mark Carhart in 1997. Not much has changed since that paper quantified the statistical shortfalls of active fund management contrasted against their passive equivalents. Yes there are exceptions, but they are rare indeed.
Carhart’s distressing conclusion is that “the results do not support the existence of skilled or informed mutual fund portfolio managers”.
Here is the Link to his seminal paper “On Persistence in Mutual Fund Performance”:
Most of these fund managers are talented enough to slightly out-toss monkeys at the famed WSJ dart throwing stock picking contest. But they do not score sufficiently higher to recover the additional burdening costs of fund management, research, and frequent trading. Because of these drags, the more active funds that are included in a portfolio, the higher is the likelihood of Index underperformance.
Again, from another perspective, this is not me talking; it is the Monte Carlo simulation studies conducted separately by Allen Roth and Rick Ferri talking.
Both passive Index fund proponents have reported Monte Carlo based results that demonstrate the consistent active management erosion of relative performance as holding period and number of actively managed funds increase.
Here is a Link to a short paper published by Roth in 2005:
After thousands of real world simulations, Roth concluded that the probability of active management just replicating Index performance degrades from 42 % for one fund held one year to an unthinkable and astonishing 1 % for 10 active funds held for 25 years.
Ferri uses Roth’s findings as a point of departure. He too uses Monte Carlo methods. He updates the Roth procedure by introducing more realistic real world scenarios and by exploring 5 extra perturbations of the baseline calculations. Here is a Link to a more expansive report issued by Ferri in 2013 (it can be downloaded for free):
Ferri’s results are similar to those identified by Roth. However, Ferri unleashes a double-barrel assault on active fund management.
Not only does he demonstrate the same dismal comparative performance of active funds when compared to their passive counterparts as a function of time and active fund portfolio population, but he also concludes that the few active winners only generate excess returns that are one-third the average level of those that generate negative excess returns. In no way do the few winners makeup for the many losers relative to proper passive benchmarks.
Some active fund managers are winners each year, but they are challenged to repeat their stellar performance over time. Often they fall victim to a cruel marketplace, but exceptions do exist. The ability to be prescient enough or lucky enough to identify these rare birds a priori is also a daunting challenge for us potential clients. Try we must.
Very interesting comments: I will simplify. I'm convinced that for me consolidation is in order. Now the hardest issue will be and if and how to consolidate funds with big gains in taxable accounts. If they are passed on upon death to my children they get a stepped basis. That's an important benefit, but it complicates the consolidation/ simplification procedure? I can only imagine the multiplicity of factors that need to be taken into account. The most important for someone my age in my 70s has to be life expectancy. Anyone know or have a model for dealing with taxable holdings?
Reply to @golub1: Could you dollar cost average out of the funds versus a one time withdrawal/exchange? In a similar situation, I was fortunate enough to get out of funds with gains in years I had losses so they cancelled each other. I may be wrong so a tax preparer or an accountant friend might be worth a visit if these gains are substantial.
Reply to @Charles: Don't agree with your four stocks strategy for diversification. Way too risky. What happens in five years when AAPL is no longer the darling? Can't think of any financial company I can buy-and-hold forever, etc.
If there is a single fund to be picked, probably Vanguard Star would be closest, but even that one has flaws. FPACX, after Steve Romick?
Fewer funds are good, but to quote Einstein, "Everything should be made as simple as possible, but not simpler"
The way I see it, there is NO magic number. As several people have pointed out, there are so many variables to consider (ages, company retirement accounts, size of accounts, knowledge, time to spend reviewing, etc) that pontificating on this is not a good use of time. We use a wide number of positions in our client accounts, mostly depending on the size of accounts. One client might have four accounts, one of which is very small, while another could be 10 times as big. And need for diversification also plays a role in number of holdings. Again, just too many variables. We have accounts where clients own individual stocks, so we need to consider how these fit into the mix, too. And some folks are married to one or more funds, whether we like them or not, so we have to work around them, sometimes isolate them as NOT a part of our allocation process. Maybe we can just agree to disagree on this.
Reply to @golub1: You've given a good argument for legacy funds - if they are decent funds, and you have substantial gains that you expect to get wiped out (eventually) upon your demise, let it ride.
But there are still things you can do. You can (somewhat) reduce the holdings by selling specific shares - shares that were purchased at a higher (or at least not much lower) price than the current market price. Be careful if you've already used average cost basis though - the cost of those specific shares may not be what you think.
Another thing you can do is stop reinvesting dividends. Take those dividends and invest them in the funds you really want to grow. This usually doesn't stop the growth of the legacy fund, but it does slow it down, sometimes substantially.
If you're donating to charities during your lifetime (as opposed to through your will), donate the most appreciated shares (or complete positions). You'll be able to write off the current value while never recognizing the gain.
"... active mutual fund management performance persistency ... is significant because it simply does not exist beyond perhaps a momentum-driven one year period."
Hmm ... I'd agree to a point. And, I'd conjecture that a similar lack of consistency might well exist in various market indexes. One including gold and commodities, for example, would display markedly differing performance characteristics over different 20-year periods. (Yes ... over 75-year spans this probably all averages out nicely:-)
What the persistency argument does not fully account for is the size, resources, stability, and investment culture of the sponsoring institution - in this case T. Rowe Price. Though they assign specific portfolio managers to various funds, I've always considered PRWCX - and many of Price's others - to incorporate a "team" approach. Numerous manager changes over the fund's 27-year history have done little to shake the boat. So, what gives? Without their strong competent research capabilities, a culture which recruits, nurtures and promotes managers from within, and the considerable financial resources to carry out these practices, such "persistency" would likely not exist.
There are of course many other reasons to account for the fund's success. Many of these are much more apparent in hindsight and may not be repeated going forward. They include: (1) effective use of bonds during a long, persistent falling rate environment, (2) effective use of alternative investments (convertibles and high-yield securities) to help ride-out periods of extreme equity over-valuation, (3) augmenting large cap investments with mid-caps, (4) strategic allocation changes (shifts among cash, bonds, equities) as markets changed, (5) a conservative strategy that is generally unattractive to market-timers, who can detract from fund returns and increase expenses.
Might you or I have replicated or exceeded the fund's 11.46% annualized return while maintaining a similar low-risk profile since 1986 with our own blend of index funds, cash and bonds? Yes. But, I'd suspect we'd need a MBA or equivalent to pull that off. And, without Price's strong in-house research capabilities, I'm still not certain it would have worked. Thanks for your perspectives. Regards
Thank you for your thoughtful and fair reply. It is well crafted with many fine observations embedded throughout. I enjoyed reading it. I understood and agreed with all the major points that you highlighted. Congratulations on an excellent post.
Your reply emphasizes the critical nature of investment organizational persistency; my submittals centered on the performance persistency aspects of fund investment decisions. In no way do I casually dismiss the significance of a firm’s commitment to stability in the hazardous jungles of investment decision-making. I simply focused on a single aspect of this multi-dimensional problem. I rank performance and organizational reliability equally.
I too seek and do business with firms that exhibit a constancy of philosophy and practice execution dependability. T. Rowe Price is certainly one such firm. In my opinion, Dodge and Cox is also one such organization. I do business with both these superior outfits. It is not surprising that both these firms are often disproportionately represented on favored fund lists such as the Kiplinger 25. From my perspective, these guys are rock solid.
Although I often stress passive investment concepts in my MFO postings, please understand that I am not 100 % committed to that approach. I own a generous mix of both passive and active funds in my portfolio. That’s why I sort of ended my last post with a “try we must” optimistic admonition. There are some winning, not easily a priori identifiable, strategies somewhere out in the mutual fund wilderness.
You know that I am a strong proponent of Monte Carlo analysis. To play any game well, you must be fully aware of the odds.
Along those lines, I recently sent an e-mail to Rick Ferri asking him to do yet another Monte Carlo fund scenario. I suggested that he consider completing his random fund selections using the Kiplinger 25 as the active fund management pool. Such an analysis might well uncover a high probability of active fund management successes for an integrated portfolio. Hope springs eternal.
I have not yet received a response from Mr. Ferri. Again, hope is eternal.
Once again, thanks for your contribution and kind reply. It’s good to have honest conversations to balance a few persistently hostile exchanges.
Comments
One issue that I purposely avoided in my earlier post because of length considerations was that of active mutual fund management performance persistency.
It is significant because it simply does not exist beyond perhaps a momentum-driven one year period. In the investment world “hot hands” cool very rapidly and future underperformance is the rule rather than the exception. The pervasive market force is a regression to the mean.
This is not me talking; it is pretty much all of academia talking. The classic paper most frequently referenced on this topic was written by Mark Carhart in 1997. Not much has changed since that paper quantified the statistical shortfalls of active fund management contrasted against their passive equivalents. Yes there are exceptions, but they are rare indeed.
Carhart’s distressing conclusion is that “the results do not support the existence of skilled or informed mutual fund portfolio managers”.
Here is the Link to his seminal paper “On Persistence in Mutual Fund Performance”:
http://faculty.chicagobooth.edu/john.cochrane/teaching/35150_advanced_investments/Carhart_funds_jf.pdf
Most of these fund managers are talented enough to slightly out-toss monkeys at the famed WSJ dart throwing stock picking contest. But they do not score sufficiently higher to recover the additional burdening costs of fund management, research, and frequent trading. Because of these drags, the more active funds that are included in a portfolio, the higher is the likelihood of Index underperformance.
Again, from another perspective, this is not me talking; it is the Monte Carlo simulation studies conducted separately by Allen Roth and Rick Ferri talking.
Both passive Index fund proponents have reported Monte Carlo based results that demonstrate the consistent active management erosion of relative performance as holding period and number of actively managed funds increase.
Here is a Link to a short paper published by Roth in 2005:
http://daretobedull.com/download/Odds of Investing.pdf
After thousands of real world simulations, Roth concluded that the probability of active management just replicating Index performance degrades from 42 % for one fund held one year to an unthinkable and astonishing 1 % for 10 active funds held for 25 years.
Ferri uses Roth’s findings as a point of departure. He too uses Monte Carlo methods. He updates the Roth procedure by introducing more realistic real world scenarios and by exploring 5 extra perturbations of the baseline calculations. Here is a Link to a more expansive report issued by Ferri in 2013 (it can be downloaded for free):
http://www.rickferri.com/books-by-rick-ferri/Portfolio-whitepaper
Ferri’s results are similar to those identified by Roth. However, Ferri unleashes a double-barrel assault on active fund management.
Not only does he demonstrate the same dismal comparative performance of active funds when compared to their passive counterparts as a function of time and active fund portfolio population, but he also concludes that the few active winners only generate excess returns that are one-third the average level of those that generate negative excess returns. In no way do the few winners makeup for the many losers relative to proper passive benchmarks.
Some active fund managers are winners each year, but they are challenged to repeat their stellar performance over time. Often they fall victim to a cruel marketplace, but exceptions do exist. The ability to be prescient enough or lucky enough to identify these rare birds a priori is also a daunting challenge for us potential clients. Try we must.
Your comments are always welcomed.
Best Wishes.
If there is a single fund to be picked, probably Vanguard Star would be closest, but even that one has flaws. FPACX, after Steve Romick?
Fewer funds are good, but to quote Einstein, "Everything should be made as simple
as possible, but not simpler"
But there are still things you can do. You can (somewhat) reduce the holdings by selling specific shares - shares that were purchased at a higher (or at least not much lower) price than the current market price. Be careful if you've already used average cost basis though - the cost of those specific shares may not be what you think.
Another thing you can do is stop reinvesting dividends. Take those dividends and invest them in the funds you really want to grow. This usually doesn't stop the growth of the legacy fund, but it does slow it down, sometimes substantially.
If you're donating to charities during your lifetime (as opposed to through your will), donate the most appreciated shares (or complete positions). You'll be able to write off the current value while never recognizing the gain.
"... active mutual fund management performance persistency ... is significant because it simply does not exist beyond perhaps a momentum-driven one year period."
Hmm ... I'd agree to a point. And, I'd conjecture that a similar lack of consistency might well exist in various market indexes. One including gold and commodities, for example, would display markedly differing performance characteristics over different 20-year periods. (Yes ... over 75-year spans this probably all averages out nicely:-)
What the persistency argument does not fully account for is the size, resources, stability, and investment culture of the sponsoring institution - in this case T. Rowe Price. Though they assign specific portfolio managers to various funds, I've always considered PRWCX - and many of Price's others - to incorporate a "team" approach. Numerous manager changes over the fund's 27-year history have done little to shake the boat. So, what gives? Without their strong competent research capabilities, a culture which recruits, nurtures and promotes managers from within, and the considerable financial resources to carry out these practices, such "persistency" would likely not exist.
They're not perfect. Some of their funds have clearly not excelled, and most tend not to be category leaders in any given year. However, PRWCX, has persistently achieved stellar returns with relatively low risk since its 1986 inception. http://investing.schwab.com/public/schwab_oldpublicsite/research_strategies/mutual_funds/summary/non_schwab/performance.html?&ticker_sym_nm=PRWCX&schwabplan1=&type=#ChartView
There are of course many other reasons to account for the fund's success. Many of these are much more apparent in hindsight and may not be repeated going forward. They include: (1) effective use of bonds during a long, persistent falling rate environment, (2) effective use of alternative investments (convertibles and high-yield securities) to help ride-out periods of extreme equity over-valuation, (3) augmenting large cap investments with mid-caps, (4) strategic allocation changes (shifts among cash, bonds, equities) as markets changed, (5) a conservative strategy that is generally unattractive to market-timers, who can detract from fund returns and increase expenses.
Might you or I have replicated or exceeded the fund's 11.46% annualized return while maintaining a similar low-risk profile since 1986 with our own blend of index funds, cash and bonds? Yes. But, I'd suspect we'd need a MBA or equivalent to pull that off. And, without Price's strong in-house research capabilities, I'm still not certain it would have worked. Thanks for your perspectives. Regards
Hi Hank,
Thank you for your thoughtful and fair reply. It is well crafted with many fine observations embedded throughout. I enjoyed reading it. I understood and agreed with all the major points that you highlighted. Congratulations on an excellent post.
Your reply emphasizes the critical nature of investment organizational persistency; my submittals centered on the performance persistency aspects of fund investment decisions. In no way do I casually dismiss the significance of a firm’s commitment to stability in the hazardous jungles of investment decision-making. I simply focused on a single aspect of this multi-dimensional problem. I rank performance and organizational reliability equally.
I too seek and do business with firms that exhibit a constancy of philosophy and practice execution dependability. T. Rowe Price is certainly one such firm. In my opinion, Dodge and Cox is also one such organization. I do business with both these superior outfits. It is not surprising that both these firms are often disproportionately represented on favored fund lists such as the Kiplinger 25. From my perspective, these guys are rock solid.
Although I often stress passive investment concepts in my MFO postings, please understand that I am not 100 % committed to that approach. I own a generous mix of both passive and active funds in my portfolio. That’s why I sort of ended my last post with a “try we must” optimistic admonition. There are some winning, not easily a priori identifiable, strategies somewhere out in the mutual fund wilderness.
You know that I am a strong proponent of Monte Carlo analysis. To play any game well, you must be fully aware of the odds.
Along those lines, I recently sent an e-mail to Rick Ferri asking him to do yet another Monte Carlo fund scenario. I suggested that he consider completing his random fund selections using the Kiplinger 25 as the active fund management pool. Such an analysis might well uncover a high probability of active fund management successes for an integrated portfolio. Hope springs eternal.
I have not yet received a response from Mr. Ferri. Again, hope is eternal.
Once again, thanks for your contribution and kind reply. It’s good to have honest conversations to balance a few persistently hostile exchanges.
Best Wishes.