AP Story: "Study Sheds New Light on Funds' Investing Costs"

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AP Story: "Study Sheds New Light on Funds' Investing Costs"

Postby Mrs.Feeley » Fri Mar 15, 2013 6:03 am

http://www.nytimes.com/aponline/2013/03 ... f=aponline

The study's authors found that the typical fund's trading-related expenses take a bigger bite out of investment returns than the separate fund management costs reflected in the expense ratio. They estimate trading costs shave an average 1.44 percent from returns a year. That's substantially more than the impact from funds' posted expenses, as the average expense ratio of the funds studied was 1.19 percent.
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Re: AP Story: "Study Sheds New Light on Funds' Investing Cos

Postby Call_Me_Op » Fri Mar 15, 2013 6:32 am

They needed another study to show that trading costs detract from returns?
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Re: AP Story: "Study Sheds New Light on Funds' Investing Cos

Postby richard » Fri Mar 15, 2013 6:37 am

Call_Me_Op wrote:They needed another study to show that trading costs detract from returns?

They needed another study to determine the magnitude of the problem

"They estimate trading costs shave an average 1.44 percent from returns a year. That's substantially more than the impact from funds' posted expenses, as the average expense ratio of the funds studied was 1.19 percent."
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Re: AP Story: "Study Sheds New Light on Funds' Investing Cos

Postby Call_Me_Op » Fri Mar 15, 2013 6:42 am

richard wrote:
Call_Me_Op wrote:They needed another study to show that trading costs detract from returns?

They needed another study to determine the magnitude of the problem

"They estimate trading costs shave an average 1.44 percent from returns a year. That's substantially more than the impact from funds' posted expenses, as the average expense ratio of the funds studied was 1.19 percent."


I have seen other studies that looked at the magnitude. This seems like a very basic thing. The rule of thumb I have heard (based upon previous studies) is 1% cost per 100% turnover. In any case, I am glad it's settled now. :happy
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Re: AP Story: "Study Sheds New Light on Funds' Investing Cos

Postby richard » Fri Mar 15, 2013 6:59 am

Nothing is ever settled in this area, but it's nice to have a ballpark average.

Vanguard's broad index funds usually come very close to their target. That's a major advantage over the studied funds, which are losing an average of more than 2.5% per year to costs.
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Re: AP Story: "Study Sheds New Light on Funds' Investing Cos

Postby ThePrune » Fri Mar 15, 2013 10:09 am

Also refer to this detailed study on trading costs from 2009: R.W. Kopcke, F.M. Vitagliano and Z.S. Karamcheva, Fees and Trading Costs of Equity Mutual Funds in 401(k) Plans and Potential Savings from ETFs and Commingled Trusts, Center for Retirement Research Paper WP 2009-27 (2009), 32pp.

They estimated the following relationship between stock turnover and annual trading costs:
7% turnover --> 0.11% cost
36% turnover --> 0.39% cost
45% turnover --> 0.66% cost
50% turnover --> 1.15% cost
79% turnover --> 1.99% cost

You'll find these data in Table 1, top row (located at the end of the article).
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Re: AP Story: "Study Sheds New Light on Funds' Investing Cos

Postby bogleblitz » Fri Mar 15, 2013 12:04 pm

What is the turnover rate for vanguard funds like Total US or Total International?
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Re: AP Story: "Study Sheds New Light on Funds' Investing Cos

Postby dave.d » Fri Mar 15, 2013 12:30 pm

Tiny, around 3% last year, although I recall 5-6% from previous years.

Turnover is noticeably higher for style funds. Last year small cap index was 14%; value and small value index were both 20-25%. However, the expense that would be associated with those levels of turnover is still considerably less than the extra return Fama and French would expect from those styles, long-term.
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Re: AP Story: "Study Sheds New Light on Funds' Investing Cos

Postby dumbmoney » Fri Mar 15, 2013 12:42 pm

Most trades made by actively managed funds are discretionary. If the fund manager is competent, the trades are on average profitable. The "cost" of the trade is irrelevant.

This story makes it sound like funds could increase their return 1-2% if they just completely stopped trading.
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Re: AP Story: "Study Sheds New Light on Funds' Investing Cos

Postby bUU » Fri Mar 15, 2013 1:03 pm

I suppose it is possible to read the article different ways. It seems to me more a matter of being part of the explanation of why index funds beat actively-traded counterparts.
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Re: AP Story: "Study Sheds New Light on Funds' Investing Cos

Postby Taylor Larimore » Fri Mar 15, 2013 1:06 pm

dumbmoney wrote:This story makes it sound like funds could increase their return 1-2% if they just completely stopped trading.

You are probably right. Read this Forbes article by Boglehead author and adviser, Rick Ferri:

SPIVA Spikes Mutual Fund Managers Again

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Re: AP Story: "Study Sheds New Light on Funds' Investing Cos

Postby arcticpineapplecorp. » Fri Mar 15, 2013 10:17 pm

bogleblitz wrote:What is the turnover rate for vanguard funds like Total US or Total International?


From the summary prospectuses (prospecti?)
Total Stock Market Index:
"During the most recent fiscal year, the Fund’s portfolio turnover rate was 5%"

For the Total International Stock Market Index fund:
"During the most recent fiscal year, the Fund’s portfolio turnover rate was 3%."

Hope that helps.

It's all in the prospectus. And they've made the prospectuses (prospecti?) very simple to understand with their recent (few years ago?) attempts to write the prospectus using "plain talk".
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Re: AP Story: "Study Sheds New Light on Funds' Investing Cos

Postby Rick Ferri » Fri Mar 15, 2013 10:30 pm

From the article:

John Rekenthaler, vice president of research with Morningstar, says his company's studies also have found that trading costs can significantly reduce a fund's returns. Although he didn't make any specific criticisms of the methods used by Edelen and his co-authors, Rekenthaler said the estimate of a 1.44 percent average annual impact for a typical stock fund sounds high.


The 1.44% sounds very high to me also. Let's work it backwards from a return perspective. Relative to the markets, on a risk adjusted-basis, mutual funds return the market less expenses (the expense ratio and trading costs). There's a slight negative after adjusting for only the expense ratio. This would be the trading cost, which is no where near 1.44%.

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Last edited by Rick Ferri on Fri Mar 15, 2013 11:12 pm, edited 1 time in total.
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Re: AP Story: "Study Sheds New Light on Funds' Investing Cos

Postby lawman3966 » Fri Mar 15, 2013 11:07 pm

richard wrote:They needed another study to determine the magnitude of the problem


There are two ways to look at the "magnitude of the problem." First, there's the gist of this discussion - namely the amount of the loss to fund investors over and above losses imposed by the Expense Ratio.

The second "magnitude" is the proportion of the investing population that will never know about this, and might not care if you told them the raw numbers. Look who knows about this article: Bogleheads and people who read the NY Times Finance pages - in other words people who likely knew something about this already. I suspect that the other 99% of the population won't be helped by any of these revelations. That magnitude is the real story here.
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