Hi Guys,
The active-passive fund management controversy has been logically and eloquently debated on MFO recently.
Both hard and flexible positions have been defended. Primary data sources for many of these arguments are the SPIVA scorecards and its companion Persistency reports that are issued twice annually by Standard and Poors. These documents celebrated their tenth anniversary about a year ago. In its first decade, its editor was Srikant Dash.
Based on his decade commitment to the project, Mr. Dash assembled a SPIVA lessons learned article that was published last year. He is best positioned to extract a concise lessons learned list given his deep involvement in the work. Here is the Link to that summary article:
http://www.indexuniverse.com/publications/journalofindexes/joi-articles/11140-lessons-learned-from-spiva.htmlFor the most part, Dash finds that passive investing generates more predictable and consistent performance returns over their actively managed equivalents. But there are noteworthy exceptions. He specifically identifies a pair of categories that deliver the goods. Also, by carefully scanning the Tables included in his article, several other active opportunities present themselves.
To encourage your meticulous review of the article, I will not mention them here.
If you have been reading my most recent postings, you are fully aware that I have been more and more strongly gravitating towards a passively managed core portfolio. I like the core and satellite portfolio concept, and still favor actively managed funds to fill the satellite segment of the integrated portfolio.
Given my current posting record, I’m sure some of you guys feel that I’m piling-on with respect to passive Index advocacy. That’s a fair and accurate charge so I’ll just add a little more evidence to it. I can be a very persistent pain-in-the-asp.
I just discovered a great way to illustrate the gamble associated with active fund manager selection. The illustrative game was invented by Bill Schultheis of Coffeehouse Investor fame. The game is called “Outfox the Box”.
Basically, it features 10 boxes with 10 different payouts, one in each box. The payouts start at $1000 dollars and are incremented by $1000 up to a maximum of $10,000. Of course, if all the payouts are revealed, the wise investor picks the maximum payday.
But now the payouts are randomized, and only the $8000 dollar payout is displayed. The choice that is offered is to accept the $8000 or to gamble on another box with an unknown dollar value. The decision is yours, just like it is when you get to choose an active mutual fund manager. Interestingly, the odds are about right, although the payoffs are a little distorted on the negative side.
If you are inclined, you can play this instructive game iteratively on the Coffeehouse website. The Link to Outfox the Box is:
http://www.coffeehouseinvestor.com/coffeehouse-cafe/outfox-the-box/Try it a few times to test how lucky or unlucky you are in choosing a winning box. The odds are two in nine that you will outperform the given return which is representative of an Index-like strategy. Not only are the odds unfavorable, but the integrated underperformance losses far exceed the expected excess rewards. It’s a loser’s game from both perspectives.
Have fun.
Best Regards.
Comments
Regards,
Ted
I've been sitting on this a couple of days, digesting the SPIVA data on performance and persistence. I'm happy to see this, then. I don't at all think this is an overdone subject if people can discuss in good faith.
When I started investing I figured I'd better learn as much as I could, so I started reading voraciously. The first things I read were Bill Bernstein and Burton Malkiel, though there were a couple technical asset allocation guides thrown in. Indexing seemed self-evident based on what they were presenting as evidence. For instance, Bernstein claims in the Intelligent Asset Allocator that due to expense ratios, commissions, bid-ask spreads and AUM impact costs, the average actively managed large cap fund's total expenses are 2.2%, active small cap and developed market funds average 4.1%, and active emerging market funds average an incredible total expense of 9%. Of course all of those costs are mitigated by indexing. But in an efficient market, no manager could ever come close to those numbers, let alone overcome them. So how come some do?
When I started reading the classic value investing literature, it rang far more true. MFO's articles and Charles' research on risk/return also helped me clarify the role of volatility in my equity holdings. The article I linked to before by John Rekenthaller discussing the paper showing most foreign funds narrowly outpace their index sort of cemented the deal for me. Given certain conditions I believe active management can still provide better returns, particularly in less efficient markets, and especially when adjusted for risk.
I don't pretend to have anything but anecdote, and my grasp of statistics isn't great at all. But looking at the SPIVA data, a couple of things stand out to me:
First, the piece on persistence demonstrates something most thoughtful investors already know: there is no such thing as a perfect investment vehicle. Year over year persistence is the wrong measure when you have a 20+ year horizon. As BobC pointed out, rolling returns are far more informative. I do not expect my funds to always have yearly top decile returns. I expect them to behave in particular ways given certain market environments over a market cycle. I expect DODWX to be highly volatile and I expect PRBLX to sort of chug along in up markets while protecting in bears. It doesn't matter to me if they are ahead of the S&P right now, but 5, 10, 20, 30 years from now. Which leads to...
Second, the SPIVA scorecard only weighs total return over one, three and five year periods, which seem far too short a time to judge long-term investment performance. That being said, I do not see the slam-dunk case you see here. I do see a lot of reversion over periods of time. For instance, in the LCV realm, only 14.94% of funds outperformed the index last year. But over a five year period, 50.22% of active funds outperformed. Looking at the 'Lessons Learned' article, that number was an astounding 81.3% in August 2011. While growth funds almost always lagged the index over 5 year periods of time, across the capitalization spectrum, value funds, on average, were notably better. This suggests to me that either there is something to value investing that is not mechanical, that value has been a down area of the market (what Bernstein calls Dunn's rule -- that indices do really well when their market section does well, and vice versa) and that managers have mitigated risk, or that market cap indices, because they overweight overbought sections of the market by definition, are really, really susceptible to bubbles like the MSCI EAFE being 65% Japanese stocks in 1989, the 1999 tech boom or financials in 2008. Exactly the sort of crashes behavioral finance holds gets most investors into hot water. I can see some combination of the three at work.
Third, data of the sort SPIVA uses always assume a static, one-time purchase of a fund. But accumulators should be or are DCAing. In order to see how money invested periodically would compound over time, I ran a comparison of some well known core domestic funds against the S&P and LCV indices on M*'s portfolio manager tool. Each fund assumed a yearly investment of $1000 on Jan 1 from 2003 to 2013 ($11,000), with reinvested dividends and cap gains. Most of these are funds I am either interested in, or were "Great Owls." In either case, they aren't random, and this set was certainly data mined. And of course, past returns, future results... But I do think a several of them were low-hanging fruit in 2003 if one was engaged in finding quality active management, and I do think the results demonstrate that if you do find that quality active manager, the time spent looking might pay off. These are the results:
Name / Value 9/17/13 / $ Gain / %Gain / YTD%
FDSAX / 22,864.90 / 11,864.90 / 107.86 / 31.95
YACKX / 22,609.37 / 11,609.39 / 105.54 / 21.39
SEQUX / 20,413.10 / 9,413.07 / 85.57 / 23.08
PRBLX / 20,174.85 / 9,174.84 / 83.41 / 21.93
MPGFX / 20,107.78 / 9,107.83 / 82.8 / 23.36
FMIHX / 19,883.22 / 8,883.18 / 80.76 / 21.4
VDIGX / 19,660.95 / 8,660.91 / 78.74 / 21.77
OAKLX / 19,575.41 / 8,575.42 / 77.96 / 23.7
PRWCX / 19,397.13 / 8,397.14 / 76.34 / 15.82
VEIPX / 19,185.04 / 8,185.00 / 74.41 / 20.98
FPACX / 18,939.87 / 7,939.91 / 72.18 / 15.27
RIMHX / 18,437.03 / 7,437.02 / 67.61 / 14.51
DODGX / 18,297.51 / 7,297.46 / 66.34 / 26.63
FUSEX / 18,025.54 / 7,025.53 / 63.87 / 21.29
VIVAX / 17,722.27 / 6,722.28 / 61.11 / 23.12
AUXFX / 17,625.38 / 6,625.40 / 60.23 / 16.78
Taking Bernstein's total expense of 2.2% for large cap domestic funds, some managers are doing something very, very right. I have another table for global funds, and the results vs. VTWSX are even greater despite what one would assume are greater total expenses.
All of this is really just a long-winded way of saying, IMO, if you are the sort of investor who wants to save money and not think much about it, by all means index. But if you are the sort who wants to actually study what they own, and you pay attention to some basic things like fees, turnover, AUM, manager tenure, manager investment, etc... it might well be possible to find funds which will outperform, particularly in less efficient markets. If that is the case, fund selection isn't quite Whack-A-Mole/"Outfox the Box". That or I'm deluded in my hope.
All best.
Regards,
Ted
Bob Young challenged Bernstein to a 5-year market timing contest based on that post. Bernstein used a constant ratio asset allocation (CRAAL), Young could trade funds using these rules. Young used a momentum strategy that he called the Pony Express.
After 5 years, the results according to Young (click Summary at the bottom of the page):
With an average annual return of 38.5% the Pony Express not only generated over 13 times the return of Bill's CRAAL portfolio but easily beat the return of every mutual fund on the market over the duration of the contest. The Pony Express won nineteen of twenty quarters as CRAAL was soundly and consistently defeated. The Pony Express made a deliberate effort to try to win each and every quarter since Bill was comparing quarterly results. If there really were a random market out there somewhere the odds against the Pony Express winning all twenty quarters would have been over a million to one. The Pony Express did not quite succeed in the attempt to win every quarter but made it very clear that the market surely is not random. Good "luck" selecting your ponies!
Young still maintains a site that posts his current momentum data for most funds. Young traded a lot during the contest, so the real world results might have been less than the contest results.
All of the above info is from Young's web site. The only other info on the contest is from this site.
Bob Young's Website: http://customer.wcta.net/roberty/index.html
If you want to go with active management, select few fund companies you trust, and/or go with all-in-one funds. That is my opinion formed over the years, while I occasionally admit to disobeying my own dictum.
Currently, I'll add to emerging markets.
So far as the Pony Express is concerned, if he's so smart, where is his multi-billion dollar mutual or hedge fund? Maybe he has trouble selecting the ponies while the betting windows are open?? If he has a fund, I doubt he'd be "giving away" his edge.
So far as I recall, it was a bit harder to see the low hanging fruit in 2003 than now. And I found it very hard to ride Oakmark Select into the WaMu valley, even though I did hang on.
Thank you for contributing to this hot button issue. Your submittals added depth to my original posting. I really do respect your diverse opinions.
The decision to purchase actively managed mutual fund products is a critical portfolio construction factor that demands careful research and a time commitment. Unfortunately, it is often saddled with a vested value attribution bias that resists change.
From Paul Simon: “ A man hears what he wants to hear and disregards the rest”. Active fund investors will energetically and selectively defend their strategic choice; passive fund investors will do the same. Behavioral researchers document this hardwired proclivity time and time again.
Nobody denies that there are excess return successes in the active mutual fund community. However, the historical data suggests these are rare instances that are nearly impossible to identify a priori. The SPIVA data sets and Mr. Dash’s interpretation of that data admit to that finding.
I concur that the odds of finding these super funds improve with diligent, committed research that focuses on cost control, reduced portfolio turnover, manager longevity, and a record of positive Alphas. But these are not new techniques; they have been applied by informed investors for decades. Persistence in these areas is elusive and is the primary issue.
The iron law of regression-to-the-mean has an ugly way of injecting itself into the scenario to ruin the excess returns. Sometimes, a very successful fund manager overrates his skill set and abandons the mutual fund to direct a hedge fund. The payday incentive is strong.
Anecdotally, a long time ago I owned the Magellan fund under Peter Lynch. He generated excess returns for years until he lost the magic and quit at a young age. Today, I own the Fidelity Contrafund under William Danoff’s guidance. He outperformed his benchmark for many years until about five years ago. Since that tipping point, Mr. Danoff is underperforming his benchmark. Indeed, the investment world experiences a strong pull towards the regression iron law. Few managers escape that pull.
If it is your investment preference to use actively managed funds to accomplish your target golden ring, by all means reach out and grasp it. My only reservation is that you be fully aware of the risks of failure and the odds for success. Every gambler knows that the secret for survival is a complete understanding of the odds. Then just go for the dream.
At its core, picking anticipated superstar fund managers is just educated guesstimates. It is equivalent to a gambler rolling dice that he feels he can control. Good luck on that score.
I do wish all MFO investors good fortune. I sincerely hope that your hard work does not go unrewarded. I do believe that you have chosen a twisting, bumpy road, and meticulous industry is mandatory to avoid that road’s many potholes. A touch of good luck is also needed.
I have never divulged my portfolio details; I will not violate this self-imposed rule now. My reasons are simple.
Given my age, the size of my portfolio, and my legacy goals, I expect that within the MFO community, I am in a very thinly populated cohort. With high likelihood, my portfolio is not suitable for anyone else’s purposes. In fact, it might do some harm if improperly interpreted.
Secondly, I consistently choose not to position myself as a racetrack tout. I have a low tolerance for stock and mutual fund pickers. I do not admire Jim Cramer types.
I have forever posted in terms of educational material, statistical base rate know-how, and understandable references. Mutual fund selection for a portfolio is a very personal project; it does not travel well. The numerous best mutual fund lists offered by the media and market gurus are next to useless. That’s my opinion, and I remain loyal to it.
I recognize that it is a mental chore to deal with information that conflicts with investment wisdom that you have adopted. The behavioral wizards would say that the rejection of dissimilar opinions is all about confirmation bias selectivity. But the decision making wizards would say that exposure to alternate options is necessary conflict to reach a better decision. As painful as it might be, I endorse the artful decision maker philosophy.
Group think is to be avoided since it produces flawed and/or non-optimum solutions. The Boglehead website likely (I don’t go there so I’m guessing) suffers that limitation. My post there would do no good; I believe my post here benefits a few MFO members. I plan to continue the march.
With that closing assertion, I will now take my leave.
Once again, thank you all for your generous and gracious participation in this somewhat controversial thread. I appreciate your efforts and your well crafted opinions.
Best Wishes.
At the end of the day I expect that our methods and outlooks are similar. A long-term horizon, patience, persistence, a defined allocation and purchase strategy and the hope for more than a dash of luck.
All the best,