Bogleheads endorse active management

[kenschmidt]

@Rick Ferri: Yes Rick, this reason (inability to find corresponding index fund) is clear and understood. My question is about funds like the Health Care one in the book or the Wellington on from Vanguard. (That's why I have the "P.S." part of the OP )

Actually, Wellington had lower turnover than Balanced Index last year and the ER of the Admiral Shares is only higher by 0.09%. So, if you believe that costs are all that really matters in determining performance - i.e., the same managers who can't add value also can't subtract it net of costs, you could make the case that the active fund is perhaps the better choice.

[bertilak]

Actually, Wellington had lower turnover than Balanced Index last year and the ER of the Admiral Shares is only higher by 0.09%. So, if you believe that costs are all that really matters in determining performance - i.e., the same managers who can't add value also can't subtract it net of costs, you could make the case that the active fund is perhaps the better choice.

And note that Wellington was not forced to hold APPL! And doesn't.

[retiredjg]

learning_head, it seems that you expected all bogleheads to be identical and to rigidly follow some set of rules that define "boglehead". That would be like all Republicans thinking the same thing. Or all Democrats. Or all Catholics. Or all NRA members. Or all....anything!

It just doesn't work that way. Life is messy. Very few things are black and white and this type of investing philosophy is no exception. But that doesn't mean there isn't some sort of cohesive group thinking going on that is at the core of bogleheadom.

I guess I must be missing the point to this thread. Your original question has been answered pretty thoroughly. And you've gotten direct answers from two of the original book's authors. What else are you looking for?

You seem to have some kind of agenda in this thread. Maybe I'm off the mark, but it doesn't feel very warm and fuzzy to me.

What is your point, exactly?

[learning_head]

Actually, Wellington had lower turnover than Balanced Index last year and the ER of the Admiral Shares is only higher by 0.09%.

So, is turnover difference high enough to overcome the 0.09% difference?

So, if you believe that costs are all that really matters in determining performance - i.e., the same managers who can't add value also can't subtract it net of costs, you could make the case that the active fund is perhaps the better choice.

From what I read, managers are more likely to subtract value then add it over longer time horizons.

And note that Wellington was not forced to hold APPL! And doesn't.

And this is the standard argument of all active-management funds when they indicate why they are better than passive ones

@retiredjg: I heard from Taylor and thanks to your post just realized I missed a few posts including Mel's. I understand their reason for owning the funds (which is mostly historical and large cap gains) and I am happy they responded where they both indicated they would not have invested in these had indexing options been available.

Regarding your other point, I don't expect all bogleheards to be identical but want to see how one of the messages I see on these forums matches up with what folks do in practice. I got some good responses and appreciate them. In others, I found that folks do NOT put much emphasis on whether a fund is managed or not but only on fund expenses. This is surprising to me personally and maybe I am the only one surprised about it, and not something I expected from bogleheads, so I am definitely interested in hearing what others think as well. I do see from Taylor, Mel, and Rick that they all effectively said on this thread they would use indexes if they were available, and if they did not have to sell for a large gain that will disappear upon bequest. It sounds like many others here (from those that responded) care about expenses way more than whether funds are indexed or actively managed.

@Mel, sorry I missed your response. As I mentioned in my reply to Taylor, I understand the reasons you mentioned. They make sense to me (although it was not nearly as clear to me when reading the section in the book). Thanks for clearing it up for me.

[Levett]

sscritic wrote:

A) If you are a boglehead, you don't own managed funds
B) Some bogleheads own Wellesley and Wellington.

Here is how you reconcile these two statements:

There is no such thing as a boglehead.

Problem solved.

Here's my take:

A. Bogleheads prefer index funds.
B. Bogleheads make exceptions.

Reconciliation: Bogleheads are obviously exceptional!

Lev

[kenschmidt]

So, is turnover difference high enough to overcome the 0.09% difference?

I don't know. At some point, turnover will cost you. I do know that Vanguard changed the underlying index that many of their index funds tracked mid-2000's as the old indexes had excessive turnover which was impacting returns.

From what I read, managers are more likely to subtract value then add it over longer time horizons.

That can only be true after costs - i.e., active managers are too expensive. In aggregate, before costs, managers cannot subtract value without some other group taking advantage of that and adding value. Here are two studies that provide more detail:

Carhart 1997 - http://www.ntuzov.com/Nik_Site/Niks_fil ... t_1997.pdf
Fama-French 2008 - http://faculty.chicagobooth.edu/john.co ... rmance.pdf

Quick summary - security mix and costs are the overwhelming determinant of returns; there is actually some past persistence in returns (i.e., there are a few good managers and some bad ones that can be identified), but it is a weak correlation and may not still occur.

[retiredjg]

@retiredjg: I heard from Taylor and thanks to your post just realized I missed a few posts including Mel's.

Well that explains a few things. It sort of appeared that you were just going on and on even though the question had been largely answered. Your missing that post puts a different slant on it.

In others, I found that folks do NOT put much emphasis on whether a fund is managed or not but only on fund expenses. This is surprising to me personally and maybe I am the only one surprised about it, and not something I expected from bogleheads, so I am definitely interested in hearing what others think as well.

My feeling is that index funds are suggested because they are low cost and because they can easily be held in a taxable account (they are tax-efficient). I suppose a 3rd reason is that you never know which manager to pick, but I don't see this as being one of the primary reasons that index funds are preferred over actively managed funds. (That's my opinion, I'm not stating it as fact.)

It seems that you have been looking at it as somehow index funds are better, so a true boglehead shouldn't use actively managed funds. I'm looking at it as index funds are better because of the low cost and the tax-efficiency, but if you can achieve those things using actively managed funds, that's ok too if it serves your purpose.

Not trying to endorse actively managed funds here. I'm a big believer in the basic 3 fund portfolio (or whatever you can cobble together along that line). But I just don't believe that some use of actively managed funds is necessarily anti-bogleheaded.

[learning_head]

That can only be true after costs - i.e., active managers are too expensive. In aggregate, before costs, managers cannot subtract value without some other group taking advantage of that and adding value.

I'll take a look, thanks for the links.. Regarding the quote above, I believe this is true only in short term, where index will indeed be in 50th percentile, but over longer term there are inherent difficulties with same manager beating the indexes (e.g. as success of the manager increases, more funds flow to them, the larger the pot the harder it is to grow with outperformance).

That's why I said "over longer time horizons" in the quote to which you were responding

(And then there is the issue of identifying such managers prior to their success / before they become too big...)

[kenyan]

I select index funds when it makes sense. However, I do own:

VIPSX - Inflation-protected securities - because there is no easy/good index fund (and I basically consider this to be an index fund).
VTRIX - Vanguard International Value - because I wish to tilt to value internationally; this fund is imperfect but low-cost and I have no international value index easily available
VINEX - Vanguard International Explorer - because I wish to tilt to small caps internationally. In this case, there *is* an index fund available, but it is higher cost than the actively managed fund. I also own the cheaper ETF, VSS, but it is not available in my largest account, so this fund makes up the balance.
VWIAX - Wellesley - because it is in a taxable account with significant capital gains, purchased prior to committing to Boglehead principles
VCAIX - California Int-Term Muni Bonds - because I wish to own muni bonds in CA and there is no index fund.

I do plan to eliminate VINEX and VWIAX when possible. The other three funds are in asset classes with no index fund available to me.

[retiredjg]

VINEX - Vanguard International Explorer - because I wish to tilt to small caps internationally. In this case, there *is* an index fund available, but it is higher cost than the actively managed fund.

Who'd a thunk it!

[SSSS]

VINEX - Vanguard International Explorer - because I wish to tilt to small caps internationally. In this case, there *is* an index fund available, but it is higher cost than the actively managed fund.

Who'd a thunk it!

VINEX 0.42%, VSS 0.28% (exactly 2/3rds of VINEX's expense ratio). Contrary to what you may hear, ETFs are not necessarily the devil, especially when there are not admiral shares available.

Also, think a better subject for this thread would be "Bogleheads tolerate active management".

[Taylor Larimore]

Bogleheads:

I can think of 14 reasons to prefer index funds over managed funds:

1. Low cost: Morningstar research has shown that "low-cost" is the best predictor of future returns. Index funds have much lower costs than most managed funds.

2. Higher returns: Index funds (on average) have higher returns than managed funds as this Standard & Poor's Study concluded.

3.Lower risk: The increased diversification of index funds results in lower risk. Baer & Ginsler did a study of Standard Deviation for actively managed funds vs. the total stock market over both 5- and 10-year periods. Their conclusion: "The returns of actively managed funds were 20 to 25% more volatile than the broad market."

4. Consistency: Only once in the past 15-years did Vanguard's Total Stock Market Index Fund fall below its large-blend category average. As a result it is in the top 29% of all large-blend funds before tax, and the top 20% after tax.

5. Continuation: Of 355 actively managed equity mutual funds around in 1974, less than half survive today. Indexers do not have to worry that their fund will disappear.

6. No style drift: We know that asset allocation determines about 90% of portfolio performance. Managed fund allocations often change.

7. No overlap: It is almost inevitable that a portfolio of managed funds will have overlap. This is not a problem with index funds.

8. No manager changes: History tells us that the average manager leaves within five years. Index fund investors do not worry about manager changes.

9. No asset bloat which often causes large successful funds to under-perform (Magellan, Legg Mason Value Trust).

10. Less cash dilution. Index funds hold less cash than active funds.

11. Under-performance: No worry that a manager has "lost his touch."

12. Tax-Efficiency: Index funds are significantly more tax-efficient than most managed funds. It is after-tax return that counts.

13. Low maintenance: Index funds are simple, predictable, and easy to understand, explain, and maintain.

14. Peace of mind: Indexers know the averages are always working for them. The index investor has much less worry and more free time to spend with family and other more enjoyable endeavors.

Best wishes
Taylor

[livesoft]

I would like to see some of the more prominent Bogleheads display their personal portfolios.

They don't need to display the dollar amounts, however it would be interesting to see how their personal asset allocations comport with the theme of this forum.

From Vanguard Portfolio Watch:
The 8.10% of "Actively managed funds" turns out to be:

[retiredjg]

I can think of 14 reasons to prefer index funds over managed funds:

Nicely done, Taylor!

[Johm221122]

I would like to see some of the more prominent Bogleheads display their personal portfolios.

They don't need to display the dollar amounts, however it would be interesting to see how their personal asset allocations comport with the theme of this forum.

Try the search feature,here is one
viewtopic.php?f=10&t=90478
John

[Sunny Sarkar]

If Pat and I could start over, we would own the The Three Fund Portfolio.

Hi Taylor,

Some of us got the opportunity, so we are doing it for you.

Thanks as always for your wisdom.
- Sunny

[Taylor Larimore]

Sunny:

I urge Bogleheads to take advantage of Sunny's link to view his Investment Policy Statement. His IPS is one of the best I have seen.

Best wishes.
Taylor

[baw703916]

I think it's important to make a distinction between true active funds (e.g. International Explorer, Precious Metals and Mining, etc.) and "quasi-index funds" (Inflation Protected Securities, Intermediate Term Tax Exempt, etc.). A lot of the comparisons between active vs. index funds just don't make any sense in the context of Vanguard's "active" bond funds.

--Are they really trying to beat the index? Is there such a thing as a TIPS-picker?

--Because in many cases the asset class has liquidity issues, turning Vanguard's TE bond funds into true index funds would be likely to make them less diversified. An example is the municipal bond ETF MUB, which is restricted to a fairly narrow range of the most liquid munis because it must track an index.

--Tax efficiency in terms of a municipal bond fund? (especially if it's AMT free).

--Manager risk? Style risk?

[kenyan]

VINEX - Vanguard International Explorer - because I wish to tilt to small caps internationally. In this case, there *is* an index fund available, but it is higher cost than the actively managed fund.

Who'd a thunk it!

VINEX 0.42%, VSS 0.28% (exactly 2/3rds of VINEX's expense ratio). Contrary to what you may hear, ETFs are not necessarily the devil, especially when there are not admiral shares available.

Right, which is why I invest in VSS where I can (IRA) and VINEX where I cannot (employer account). Investor Shares of the index fund, which I can invest in, are 0.50% ER, with 0.50% purchase and redemption fees.