Canadian article: Why isn’t everyone beating the market?

[Stryker]

Though now retired, I personally have two legs of an investment portfolio going. The Canadian dividend growth portfolio, and a passive index portfolio using a combination of funds and ETF's. Both are keepers. However, lately I've been thinking about starting a third leg, in a Canadian tax free portfolio that's now 100% invested in a high yield savings account making only 1.40% in interest. Already have another emergency cash stash elsewhere.

I've been kicking around other thoughts for the above, such as using some of Ben Graham's ideas in selecting stocks, to giving the Piotroski idea of value investing a try.

That was until this timely article came along a few days ago. I have the feeling I just may stick with with broad based indexing for this new portfolio, which was my original idea for it.

Why isn’t everyone beating the market?

Sometimes I wonder why everyone isn’t getting better returns than a simple Couch Potato portfolio. Spend a little time and you’ll discover all kinds of strategies that beat the market.

[Malachi]

That was a good and thought provoking article.

[bottlecap]

Yeah, a good article.

JT

[GregLee]

I thought it was a good article up to where the author concludes that active investors cannot succeed because they chase performance. But the problem with being an active investor who chases performance is the chasing performance part, not the active investing part.

[Taylor Larimore]

Stryker:

Thank you for a very informative and thought-provoking article.

Happy Memorial Day!
Taylor

[Malachi]

I thought it was a good article up to where the author concludes that active investors cannot succeed because they chase performance. But the problem with being an active investor who chases performance is the chasing performance part, not the active investing part.

I'm not getting the distinction you're trying to make. By my reading, your second sentence precisely restates your first sentence.

[petrico]

I thought it was a good article up to where the author concludes that active investors cannot succeed because they chase performance. But the problem with being an active investor who chases performance is the chasing performance part, not the active investing part.

Active investing provides the possibility of succeeding in beating the market, but simultaneously decreases the probability of doing so. And that's been shown to be true theoretically and empirically.

To me, that's a problem.

--Pete

[yobria]

Thanks for the link. Can't say I agree with that article, which implies you can beat the market if you "just stick with it". That would be nice, but it's wrong.

[bottlecap]

I thought it was a good article up to where the author concludes that active investors cannot succeed because they chase performance. But the problem with being an active investor who chases performance is the chasing performance part, not the active investing part.

I think you missed the author's meaning.

JT

[Imperabo]

Thanks for the link. Can't say I agree with that article, which implies you can beat the market if you "just stick with it". That would be nice, but it's wrong.

When you know that almost all experts disagree with you on a subject perhaps you should have the humility to say that you THINK it's wrong.

[yobria]

Thanks for the link. Can't say I agree with that article, which implies you can beat the market if you "just stick with it". That would be nice, but it's wrong.

When you know that almost all experts disagree with you on a subject perhaps you should have the humility to say that you THINK it's wrong.

If you know of an academic expert who believes strategies like "market timing with technical analysis" or “sell in May and go away" must work going forward if you just "stick with them", please let me know his name.

[Jerry_lee]

The meassage of the article is a good one, but incomplete. Yes, almost no one can stay with their portfolio for any given length of time. But this isn't limited to investors that hold non-cap weighted portfolios (and therefore deviate from the market with the expectation of different-than-market results). Given that TSM portfolios are heavily weighted by the biggest, most successful stocks in the market, any meaningful stretch where LG does poorly (65-81, 00-11) will see TSMers become complacent and start to drift. I've seen this take the form of adding additional sector exposure (reits, nat resources), excessive bond risk (long term and junk), or just good ole fashion market timing (reducing equity exposure and upping fixed income or cash after a downturn).

Discipline is tough regardless of what your portfolio looks like. Personally, I don't think I could stay with a portfolio that has such a heavy bet on just one of the three factors (beta) that drives returns, as TSM does, nor would I want to take a lot of risk in the part of the portfolio that is supposed to dampen risk and provide liquidity (bonds).

Of course we've seen investors struggle with just the opposite: bailing on excessively concentrated SV ETFs after the '08 meltdown. At the end of the day, you have to go with what works for you, so long as you fully understand the risks you are taking and what you maybe sacrifing by avoiding other allocations.

[Imperabo]

Thanks for the link. Can't say I agree with that article, which implies you can beat the market if you "just stick with it". That would be nice, but it's wrong.

When you know that almost all experts disagree with you on a subject perhaps you should have the humility to say that you THINK it's wrong.

If you know of an academic expert who believes strategies like "market timing with technical analysis" or “sell in May and go away" must work going forward if you just "stick with them", please let me know his name.

I assumed you were talking about SCV, because that's the only strategy the article gave any credence to.

[GregLee]

I thought it was a good article up to where the author concludes that active investors cannot succeed because they chase performance. But the problem with being an active investor who chases performance is the chasing performance part, not the active investing part.

I'm not getting the distinction you're trying to make. By my reading, your second sentence precisely restates your first sentence.

As I understand the terms, active investing is investing without using a passive index fund. Chasing performance is buying the currently best performing securities and selling the currently worst performing ones. If you, for instance, invest in actively managed mutual funds (making you an active investor), and buy the currently worst performing funds (not the best performing ones), then you are an active investor who does not chase performance. Whether active investors can expect to profit in the long run is arguable, but attacking active investing because it chases performance does not make sense. There is nothing about active investing that requires you to chase performance. Some active investors do chase performance; others don't.

I hope I'm being clearer.

[yobria]

Thanks for the link. Can't say I agree with that article, which implies you can beat the market if you "just stick with it". That would be nice, but it's wrong.

When you know that almost all experts disagree with you on a subject perhaps you should have the humility to say that you THINK it's wrong.

If you know of an academic expert who believes strategies like "market timing with technical analysis" or “sell in May and go away" must work going forward if you just "stick with them", please let me know his name.

I assumed you were talking about SCV, because that's the only strategy the article gave any credence to.

He seemed to be giving credence to all of them by stating: "If there are at least a dozen simple ways to beat the market, how come so few investors are actually getting these returns?". He does allude to "backtesting", which makes me think he understands the actual flaw in these schemes. But the explicit message in the article is that investor behavior, not the strategy, is the problem.

[ResNullius]

Excellent article.

[pkcrafter]

This is rather interesting. On one had we have Greg Lee saying:

I thought it was a good article up to where the author concludes that active investors cannot succeed because they chase performance.

It's certainly true that active investors cannot succeed IF they chase performance, and it's also true that there is no guarantee they will succeed if they don't. There are many other reasons why active investors may fail, and some are beyond the control of the investor.

Then we have Yobia saying:

Can't say I agree with that article, which implies you can beat the market if you "just stick with it".

I don't know what information in the article caused the above conclusions, maybe it was here:

Some active investors have been rewarded for sticking to their strategy during rough stretches, but they are exceedingly rare.

There really is only two reasons to use active funds; one is you have no other choice, and two, to attempt to outperform the market. Some active investors will say they use active stock funds only because they want to minimize downside losses. In either case, it's still an attempt to outperform. Chasing performance, as mentioned by Greg Lee, is a behavioral fault that will certainly hurt performance, but indexers are not immune to this behavioral mistake.

The article does not claim that by sticking with a strategy one can outperform. It merely says one might have a better chance. That's true with any strategy--except indexing where you know you will be better than average, unless you make errors and can't follow the strategy. No matter, the answer to whether an active individual investor or a fund manager will outperform is only known after the fact. There is just no way to select an active strategy with a known outcome.


Paul

[GregLee]

The article does not claim that by sticking with a strategy one can outperform. It merely says one might have a better chance.

I can't find this in the article.

[pkcrafter]

The article does not claim that by sticking with a strategy one can outperform. It merely says one might have a better chance.

I can't find this in the article.

Greg, I made the post because I could not find a reference to what you or Yobria claim and I was trying to guess as to were you might have gotten your impression. I though it might be in the quote below, but I cannot find anything that says investors can't succeed because they chase performance.

By definition, active investors expect to beat the market. Most acknowledge they can never do this over every period, but their behaviour suggests they don’t have a lot of patience with underperformance of even two or three years. And there’s the rub: even if you accept there are legitimate market-beating strategies, all of them will see multi-year periods when they will lag. Even small-cap and value stocks—which probably will deliver higher-risk adjusted returns over periods of many decades—have endured prolonged stretches of dramatic underperformance. Some active investors have been rewarded for sticking to their strategy during rough stretches, but they are exceedingly rare.

Paul

[Rick_J-]

lately I've been thinking about starting a third leg, in a Canadian tax free portfolio that's now 100% invested in a high yield savings account making only 1.40% in interest.

Stryker, I am a Canadian investor as well, you may want to check out People Trust Tax Free Saving Account yielding 3% which is CDIC insured (same as FDIC). This is a risk free rate that our American neighbors would drool over (and the price that is paid for US treasuries being the preferred investment world wide during flights to safety) given that is 100% liquid and government backed and can be held tax free in a Tax Free Savings Account.

Rick

[bottlecap]

The article does not claim that by sticking with a strategy one can outperform. It merely says one might have a better chance.

I can't find this in the article.

Greg, I made the post because I could not find a reference to what you or Yobria claim and I was trying to guess as to were you might have gotten your impression. I though it might be in the quote below, but I cannot find anything that says investors can't succeed because they chase performance.

By definition, active investors expect to beat the market. Most acknowledge they can never do this over every period, but their behaviour suggests they don’t have a lot of patience with underperformance of even two or three years. And there’s the rub: even if you accept there are legitimate market-beating strategies, all of them will see multi-year periods when they will lag. Even small-cap and value stocks—which probably will deliver higher-risk adjusted returns over periods of many decades—have endured prolonged stretches of dramatic underperformance. Some active investors have been rewarded for sticking to their strategy during rough stretches, but they are exceedingly rare.

I agree, I think that is where GregLee misinterprets the author.

If you think about it, all selections of active investments are based on past performance. If not, why would someone invest in someone or something that has stunk it up in the past? As an investor who picks active managers, the only thing you can base your pick on is past performance - you'd be stupid not to. Once your manager begins to underperform, you're forced to reassess your pick (if you had independent knowledge you wouldn't have to rely on a manager). You have to reassess your picks by looking at updated past performance and go with whomever continues to outperform. Of course, by doing so, your are doing nothing but chasing perfromance and will undoubtedly have to reassess every few years. There are some lucky folks that picked a WB-like manager in his salad years, but those are few and far between. The vast majority of active investors are simply performance chasing. They have to be to be active.

Now you can argue that performance chasing is better than indexing if you want, but you can't say that active investors aren't performance chasing.

JT

[yobria]

Then we have Yobia saying:

Can't say I agree with that article, which implies you can beat the market if you "just stick with it".

I don't know what information in the article caused the above conclusions, maybe it was here:

Some active investors have been rewarded for sticking to their strategy during rough stretches, but they are exceedingly rare.

The whole point of the article, in my reading, was that while there are many simple market beating strategies, active investors don't realize that outperformance because they don't stick with them.

[GregLee]

The vast majority of active investors are simply performance chasing.

Maybe that's true -- I don't know. But I'm saying that not all active investors are performance chasers. The author distinguishes between investments and investors and says that while an investment strategy may be sound, investors may not do well following that strategy because they become impatient when some of their stocks are not doing well, and they sell. He is making the same point that Larry Swedroe has made in a couple of recent columns, mentioning research which compares the returns of various investments with the much lower returns found for investors who made those investments. Regardless of the merits or defects of an investment strategy, investors can find a way to screw it up.

[bottlecap]

But I'm saying that not all active investors are performance chasers. The author distinguishes between investments and investors and says that while an investment strategy may be sound, investors may not do well following that strategy because they become impatient when some of their stocks are not doing well, and they sell.

I see what you're saying about the author now. He allows for the assumption that things like charting work, but just most investors can't implement it.

I guess his assumptions are questionable, but the conclusion is correct.

JT

[pkcrafter]

yobria wrote:

The whole point of the article, in my reading, was that while there are many simple market beating strategies, active investors don't realize that outperformance because they don't stick with them.

I didn't get this from reading the article, but in reading it again I can see how you came to that conclusion. I think the comments on lots of strategies that can beat the market were a bit of sarcasm. If he did mean that investors fail because they don't stick with their strategy, that is also true. An active investor does not have the option of sitting on a strategy that appears not to be working because lagging performance, even if temporary--and who knows how long that will be--virtually guarantees underperformance in the long term. There just isn't enough of an edge to make it tolerable. So, while an investor may still not change the strategy, he may change managers, which always brings along the risk of more underperformance in the near future if he's not lucky.

The problem is the same old problem: an active investor cannot know with certainty that his chosen strategy will outperform, but he also knows if he sits on periods of underperformance, he's certain to underperform in the long term.

Paul

[GregLee]

The problem is the same old problem: an active investor cannot know with certainty that his chosen strategy will outperform, but he also knows if he sits on periods of underperformance, he's certain to underperform in the long term.

I don't understand this at all. There is just no logical connection between active investing and holding securities through periods of underperformance, or doubling down on your losers. Look, I am an active investor -- I don't have a penny in index funds. I'm currently invested in 13 mutual funds, all actively managed. Yet I have never chased performance, in 40 years of investing. I think it's dumb. Just because I don't happen to agree with the prevailing opinion in this forum that passive investing works better, that doesn't mean I must have taken a stupid pill.

[bottlecap]

The problem is the same old problem: an active investor cannot know with certainty that his chosen strategy will outperform, but he also knows if he sits on periods of underperformance, he's certain to underperform in the long term.

I don't understand this at all. There is just no logical connection between active investing and holding securities through periods of underperformance, or doubling down on your losers. Look, I am an active investor -- I don't have a penny in index funds. I'm currently invested in 13 mutual funds, all actively managed. Yet I have never chased performance, in 40 years of investing. I think it's dumb. Just because I don't happen to agree with the prevailing opinion in this forum that passive investing works better, that doesn't mean I must have taken a stupid pill.

My thought is that a particular strategy might not be performance chasing or even market timing, although it would be hard to avoid those two as an active investor in mutual funds. Value investing might be an example, for instance. Someone who believes in the outperformance of value investing might not be performance chasing if they were to buy into a logical rationale for the supposed outperformance. Not to say that they would necessarily be right, but they are probably no more performance chasing than someone who believes in MPT based on the experience of the last 100 years and a sound theory.

Out of curiosity, what is your strategy or theory?

JT

[GregLee]

Out of curiosity, what is your strategy or theory?

My strategy is to buy good mutual funds when they've had a recent decline in price, over at least half a year. The theory is RTM (reversion to the mean): when a security is far from its average price, it has an higher chance of returning closer to its average in the future than it has of becoming even more distant from its long term average.

[3CT_Paddler]

Out of curiosity, what is your strategy or theory?

My strategy is to buy good mutual funds when they've had a recent decline in price, over at least half a year. The theory is RTM (reversion to the mean): when a security is far from its average price, it has an higher chance of returning closer to its average in the future than it has of becoming even more distant from its long term average.

So you invested in Bill Miller's Legg Mason fund? It sounds like you are also a believer in persistent manager skill.

[GregLee]

So you invested in Bill Miller's Legg Mason fund? It sounds like you are also a believer in persistent manager skill.

No, neither of those things. What do they have to do with what I said?

[petrico]

Out of curiosity, what is your strategy or theory?

My strategy is to buy good mutual funds when they've had a recent decline in price, over at least half a year. The theory is RTM (reversion to the mean): when a security is far from its average price, it has an higher chance of returning closer to its average in the future than it has of becoming even more distant from its long term average.

I'd also be curious to know how that strategy has performed relative to a comparable (same asset allocation) index fund portfolio that was bought, held, and rebalanced. One complication in attempting a comparison might be that the asset allocation of the active fund portfolio has been in constant flux, due to both an ever-changing rotation of funds and a shifting of allocations within each fund. Another potential complication is that, often, the holder of an active fund portfolio only has a vague idea what the actual asset allocation is at any point in time.

--Pete

[GregLee]

I'd also be curious to know how that strategy has performed relative to a comparable (same asset allocation) index fund portfolio that was bought, held, and rebalanced.

I don't know, and I haven't been doing it for long, only since last August, and only for a part of my portfolio (8 mutual funds, 83%/17%). But I can give you an idea. From August 5 to now, the DJIA has gone up 9.9%, and my investment is up 8.5% for that period, above the total of cash buys (which have been scattered out over the 10 month period).

[3CT_Paddler]

So you invested in Bill Miller's Legg Mason fund? It sounds like you are also a believer in persistent manager skill.

No, neither of those things. What do they have to do with what I said?

Maybe I am misinterpreting, but I would think looking for 'good' mutual funds is based on looking at past performance, which is also based on the idea of mutual fund management skill. One example of a 'good' mutual fund would be Bill Miller's fund, which had a long track record of outperforming the market, only to miss the mark over the last couple of years.

[GregLee]

One example of a 'good' mutual fund would be Bill Miller's fund, which had a long track record of outperforming the market, only to miss the mark over the last couple of years.

I agree that by the criteria I gave, Bill Miller's fund would be a candidate for purchase now, in light of its poor recent performance. I don't see that it follows I must have actually bought it, and I didn't.

[Stryker]

yobria wrote:

The whole point of the article, in my reading, was that while there are many simple market beating strategies, active investors don't realize that outperformance because they don't stick with them.

I didn't get this from reading the article, but in reading it again I can see how you came to that conclusion. I think the comments on lots of strategies that can beat the market were a bit of sarcasm. If he did mean that investors fail because they don't stick with their strategy, that is also true. An active investor does not have the option of sitting on a strategy that appears not to be working because lagging performance, even if temporary--and who knows how long that will be--virtually guarantees underperformance in the long term. There just isn't enough of an edge to make it tolerable. So, while an investor may still not change the strategy, he may change managers, which always brings along the risk of more underperformance in the near future if he's not lucky.

The problem is the same old problem: an active investor cannot know with certainty that his chosen strategy will outperform, but he also knows if he sits on periods of underperformance, he's certain to underperform in the long term.

Paul

What Paul said above, really relates to this. I was doing a computer search for something else this morning, and this old 2011 article popped up regarding Cliff Asness. I don't follow him but I certainly have heard the name before. This hedge fund manager has a great past record with endorsements from leading academics. If you read the article right through you come to realize that it's almost like playing the odds. He may beat the index in future, certainly his past data show that, but he also may not. Their strategy of combining value and momentum just hasn't been working for the last few years. How long does an investor wait for the formula to prove itself again? Asness is very clever, there's no doubting that, but after reading it, I don't think I'd be interested in throwing the dice with the strategy. A strategy may look great on paper, and you can have the data to prove it, but it's only back testing. When you get whipsawed by unexpected occurrences in the market, it may turn negative in your own portfolio, versus just doing it the easy way, by buying the market.

[pkcrafter]

The problem is the same old problem: an active investor cannot know with certainty that his chosen strategy will outperform, but he also knows if he sits on periods of underperformance, he's certain to underperform in the long term.

I don't understand this at all. There is just no logical connection between active investing and holding securities through periods of underperformance, or doubling down on your losers. Look, I am an active investor -- I don't have a penny in index funds. I'm currently invested in 13 mutual funds, all actively managed. Yet I have never chased performance, in 40 years of investing. I think it's dumb. Just because I don't happen to agree with the prevailing opinion in this forum that passive investing works better, that doesn't mean I must have taken a stupid pill.

Greg, one has to wonder why you are a member of this forum if you don't believe in indexing. Doesn't matter really, just curious. If you have been investing 40 years or been on the forum for awhile, then the following is probably already known to you, but I'll say it again for the benefit of other investors. I'd also like to know if you agree with it.

It sounds like you are a value investor, and that is certainly a reasonable strategy, but looking past that you hold 13 funds. There can be only one reason why you are using active funds, and that is an attempt to beat the benchmarks. Furthermore, you must have chosen your funds based on past performance and some confidence in the fund managers to continue to do the job. OK, but you must realize that if even one of your funds underperforms, the possibility of underperforming on a portfolio basis is almost guaranteed.

I can tell you without a doubt that one or two of your funds will underperform sooner rather than later. Example: On average, top twenty fund lists change at least two funds/year. Have you held the same funds for 40 years? When that happens you face the decision of having to sell the fund or wait out the lag time. And that is the problem. You will not know if the fund will recover or will be the next Bill Miller. My observation is that most active investors don't have much tolerance for poor performance--that isn't what they bought their funds for. And they certainly do not want to pay higher fees for underperfomance. They will wait 2 years, maybe three, then they realize if they continue to hold, their total portfolio return will suffer and active fund investing will have failed. You do realize it does fail vs index funds more than 80% of the time over 20 years. So, an active investor does not have to set out to chase performance, but he also cannot tolerate extended periods of underperformance or he will find himself in the 80% who underperformed. How do you get into the 20% who do outperform? By pure luck. Over that 20 years you will experience many situations where you must make a decision to hold or sell, and you will not really have any concrete basis to make the decision.

One last comment on active funds--there are at least two studies on active fund performance that conclude those funds that outperform have certain characteristics in common. One being high active share (the amount of stocks deviating from the benchmark, and another being that the successful funds hold a very limited number of stocks. The studies conclude that investing in any other types of active funds results in underperformance. There aren't many funds that meet the requirements, and those that do are going to be the most susceptible to getting knocked off the crest of the wave because they are fragile. I suppose it doesn't matter because most active investors have ignored the studies, which ought to be the subject of another study.


Paul

[3CT_Paddler]

One example of a 'good' mutual fund would be Bill Miller's fund, which had a long track record of outperforming the market, only to miss the mark over the last couple of years.

I agree that by the criteria I gave, Bill Miller's fund would be a candidate for purchase now, in light of its poor recent performance. I don't see that it follows I must have actually bought it, and I didn't.

Whether or not you bought it, you seem to be agreeing that your methodology is based on the premise of investor skill (by looking for a 'good' mutual fund). If you had gone into Miller's fund after it had a bad year or two, things would have ended badly for you in this case (the returns only got worse after an initial underperformance). Maybe you have been fortunate with your methodology, but historical data of mutual funds points to pure chance/luck, not skill being the primary driver of active fund management returns.

[bottlecap]

Out of curiosity, what is your strategy or theory?

My strategy is to buy good mutual funds when they've had a recent decline in price, over at least half a year. The theory is RTM (reversion to the mean): when a security is far from its average price, it has an higher chance of returning closer to its average in the future than it has of becoming even more distant from its long term average.

Although I would agree with some of the other posters concerning this strategy (particularly the idea that a fund is good, what an "average" price is, etc...), I really hate to critique too much, as I really asked to find out about the theory and not to try to beat you up over the strategy.

That said, I do wonder about the "theory" behind the strategy. Reversion to the mean would seem to be a reasonable presumption when talking about an entire market, but I don't think it's directly applicable to individual mutual funds. While individual funds might be affected by market sentiment or general market movements that lend themselves to RTM, they also may have declined for a host of other more fundamental reasons or risks. For these same reasons, it would also seem that this theory would best be utilized with broader index funds to capture the true benefit of RTM. But at this point, while this wouldn't exactly be "performance" chasing, we're basically talking about market timing based on some metric.

Interesting.

JT

[GregLee]

Greg, one has to wonder why you are a member of this forum if you don't believe in indexing. Doesn't matter really, just curious.

I'm interested in indexing. I don't have to believe in it to be interested. I'm skeptical, but then I'm also skeptical about my own investment strategies.

OK, but you must realize that if even one of your funds underperforms, the possibility of outperfroming on a portfolio basis is almost guaranteed.

What? I guess you mean "underperforming on a portfolio basis", but even so, it doesn't follow. If one fund goes down, another may go up even more.

I can tell you without a doubt that one or two of your funds will underperform sooner rather than later.

Well, sure. That's the point of holding a diverse set of funds -- to give me good buying opportunities when funds underperform. My current worst performer is the TRP Latin America fund, which has been sinking lower and lower ever since I bought shares of it last Fall. I bought more of it in February, April, and May. As long as it stays down, it's my plan to buy more. That's the way a contrarian, non-performance-chasing strategy works. That's what I'm telling you about.

Example: On average, top twenty fund lists change at least two funds/year. Have you held the same funds for 40 years?

No, the longest I've held a fund is 30 years, for my wife's TRP New Horizon fund, bought in 1982.

When that happens you face the decision of having to sell the fund or wait out the lag time. And that is the problem.

No problem for me. I always wait it out. I'm a patient, long-term investor. But this has nothing to do with me being an active investor. There's no connection.

[pkcrafter]

Paul:

OK, but you must realize that if even one of your funds underperforms, the possibility of outperfroming on a portfolio basis is almost guaranteed.


Greg: What? I guess you mean "underperforming on a portfolio basis", but even so, it doesn't follow. If one fund goes down, another may go up even more.

Yes, thank you for catching that. Corrected above.

Paul

[pkcrafter]

See comments in blue...

Greg, one has to wonder why you are a member of this forum if you don't believe in indexing. Doesn't matter really, just curious.

I'm interested in indexing. I don't have to believe in it to be interested. I'm skeptical, but then I'm also skeptical about my own investment strategies.

That's as good as reason as any.

OK, but you must realize that if even one of your funds underperforms, the possibility of underperforming on a portfolio basis is almost guaranteed.

What? I guess you mean "underperforming on a portfolio basis", but even so, it doesn't follow. If one fund goes down, another may go up even more.

What I meant is if you have one fund underperforming it's benchmark, it will cause the entire portfolio to underperform. There just isn't any room for problems when you must overcome the fee barrier just to match performance. Whatever edge you might get from active funds after fees is very hard to hold onto. The idea that one fund may be going down and others going up is a benefit of diversification, but indexers get the same benefit and they capture it by rebalancing.

I can tell you without a doubt that one or two of your funds will underperform sooner rather than later./quote]

Well, sure. That's the point of holding a diverse set of funds -- to give me good buying opportunities when funds underperform.

No distinction between active funds and index funds there. What I mean by underperforming is in relation to the benchmark--not just producing lower returns than it used to. With any given asset class and index fund will track the performance of that asset class whereas an actively managed fund may not. When an index fund goes down you know the asset class performance has gone down, but an actively managed fund can go down when the returns of the asset class did not. That's the underperformance you have to watch for.

My current worst performer is the TRP Latin America fund, which has been sinking lower and lower ever since I bought shares of it last Fall. I bought more of it in February, April, and May. As long as it stays down, it's my plan to buy more. That's the way a contrarian, non-performance-chasing strategy works. That's what I'm telling you about.

Yes, but you have to look at it's performance relative to the benchmark. If it was outperforming the benchmark and now isn't you won't know why nor will you know if it will right itself. This may ultimately force a decision on whether to hold or sell, and their is no way for you to make anything but a guess on which to do.

Example: On average, top twenty fund lists change at least two funds/year. Have you held the same funds for 40 years?

No, the longest I've held a fund is 30 years, for my wife's TRP New Horizon fund, bought in 1982.

When that happens you face the decision of having to sell the fund or wait out the lag time. And that is the problem.

No problem for me. I always wait it out. I'm a patient, long-term investor. But this has nothing to do with me being an active investor. There's no connection.

We have to define active investor. The common definition for an active investor is one who uses actively managed funds, so you are an active investor, but not one that trades frequently or chases performance. On the issue of always waiting it out, there can be situations where waiting it out nets you many years of poor performance. If you had bought Bill Miller's fund near the end of his run, you would be netting entire portfolio returns that did not beat indexing. I used to track active funds in the 90s and I had favorites that disappeared off the radar for an entire decade before emerging again as top picks.

To sum up, active funds must first overcome the added costs to even match an index fund in the same asset class. This turns out to be a formidable task over long periods of time. The cost drag is cumulative and compounds. The other main problems with active funds is they will cheat on you and their performance can wane and you won't know why, nor will you know if they will ever regain their glory. There are several reasons why a fund might start to underperform, some related to management, and some beyond his control.

The cheating aspect is due to an active fund switching it's asset class or strategy. Many do not remain investing in the same thing that you wanted to invest in. You may not care if the fund is performing well, but it still plays havoc on your carefully chosen asset allocation.

Drops in performance will force a decision to hold on and hope for better days or just dump the fund for a new, shinny one. The point is much of what happens hinges on luck. If you simply hold an underperformer you defeat the purpose of paying higher fees for better performance, and you guarantee that you will not outperform a portfolio of simple, low cost index funds.


Paul

[tadamsmar]

Thanks for the link. Can't say I agree with that article, which implies you can beat the market if you "just stick with it". That would be nice, but it's wrong.

When you know that almost all experts disagree with you on a subject perhaps you should have the humility to say that you THINK it's wrong.

If you know of an academic expert who believes strategies like "market timing with technical analysis" or “sell in May and go away" must work going forward if you just "stick with them", please let me know his name.

I assumed you were talking about SCV, because that's the only strategy the article gave any credence to.

He seemed to be giving credence to all of them by stating: "If there are at least a dozen simple ways to beat the market, how come so few investors are actually getting these returns?". He does allude to "backtesting", which makes me think he understands the actual flaw in these schemes. But the explicit message in the article is that investor behavior, not the strategy, is the problem.

If you think he is giving credence to all of them, then you missed this part:

Obviously the costs and taxes involved in implementing these backtested strategies are a huge part of the problem—in fact, they’re enough to immediately render most of them useless.

He thinks most are useless because costs and taxes were left out of the backtest. But, at this point, he does not specify which are not useless. Later, one can perhaps infer that he thinks SCV "works" or at least passes a a credible backtest. (I assume SCV is some sort of code for the small/value thing)

Larry, an SCV believer (I think), often sums up the whole article with a phrase stating that SCV investors must endure tracking error.

But I think it's OK to say that SCV is wrong. Fama says it a risk story, meaning that it does not increase your risk-adjusted return. Malkiel seems skeptical that it will work going forward.

[tadamsmar]

Heck, back in 2008 and early 2009 there was a good bit of talk here about some sort of mysterious unspecified Plan B by some old hands.

I never figured out what Plan B was, but clearly the B stood for Bailing out of Your AA.

And we indeed had some threads form investors with Boglehead-style AAs who bailed out near the bottom.

So you can't assume all Bogleheads are immune to underperforming "cash under the mattress" for even 6 or 8 months.

And there seems to be a lot of talk about bailing out of bonds these days from Bogleheads, and even from Burton Malkiel.

[GregLee]

The cheating aspect is due to an active fund switching it's asset class or strategy.

I don't care whether my funds switch asset classes or strategy. I'm in it for the money -- whatever works. I don't have preconceived ideas about what asset classes I want to invest in. My largest fund investment is TRP New Horizons, whose managers say they deliberately let the average capitalization of their companies rise from that typical for a Small Growth fund, as the companies grow. They selected the stocks in the first place because they thought the companies would grow, so when they do grow, that's a good thing, not a bad thing. And holding growth stocks that have grown instead of selling them to stay in a style category minimizes transaction costs.

There are a number of places in your comments where, it seems to me, you assume that passive investing is a superior strategy, then argue that since active investing is different, it must therefore be inferior. But, you see, I don't share your assumption that passive investing is superior.

[pkcrafter]

Greg, in regard to active funds cheating on you, you wrote:

I don't care whether my funds switch asset classes or strategy. I'm in it for the money -- whatever works

That is the usual response, and I even said you may not care if a fund stays in it's asset class as long as it's performing well. But then you wrote this:

That's the point of holding a diverse set of funds -- to give me good buying opportunities when funds underperform.

I assumed you were referring to lowering the SD of the portfolio with proper diversification, but now it appears you don't care about diversification. Personally, it is intolerable to me to hold funds that will shift style or size. I want my funds to remain in the asset classes I've selected. Holding funds that move all over the place will weaken the diversification effect, and you run the risk of your managers chasing performance, something you said you didn't do. Is it better when a fund manager does it? I know, you don't care as long as they make money. Another problem you will have is in trying to figure out if your funds are actually beating their benchmark. When they cheat, you can't use a single asset class benchmark to compare performance.

There are a number of places in your comments where, it seems to me, you assume that passive investing is a superior strategy, then argue that since active investing is different, it must therefore be inferior. But, you see, I don't share your assumption that passive investing is superior.

Well, let me put it this way--the record shows that over periods of 20 years a very high percentage of active funds in all asset classes are beaten by index funds. One of the main reasons for this is the higher costs of active investing. A second reason is problems that active funds can and do encounter with enough frequency to force the fund holder to make decisions on whether to hold or sell. You say you will always hold, and that may prove to be a right decision or a wrong decision. The problem is you can never know in advance what the right decision will be. You have about a 20% chance of beating a portfolio of index funds, and maybe you can increase your odds some by avoiding common behavioral mistakes, but in the end your fate will be determined by luck. Not a good enough reason to use active funds in my opinion. Whether an investor uses active funds or index funds is probably based on personality traits rather than facts or reasoning.




Paul

[GregLee]

Holding funds that move all over the place will weaken the diversification effect, ...

I don't follow you here. Why do you think style drift reduces diversification?

Well, let me put it this way--the record shows that over periods of 20 years a very high percentage of active funds in all asset classes are beaten by index funds.

I'm aware of these stats. I've compared the S&P studies that Rick Ferri has written columns about and referred us to, with the performance stats of my own funds. While the average active fund does worse, my funds mostly do better. I posted about that here:
http://www.bogleheads.org/forum/viewtopic.php?f=10&t=92754#p1336592

One of the main reasons for this is the higher costs of active investing.

There you go again. If it were true that my active funds did worse than corresponding index funds, higher costs might well be the reason. But it appears not to be true.

... , but in the end your fate will be determined by luck. Not a good enough reason to use active funds in my opinion.

And so you think the fate of passive investors will not be determined by luck, is that right? You've discovered the secret to avoiding risk in investing. I have some bad news for you ...