Active vs index, etc.

[JBTX]

To preface, i totally buy into the philosophy that index fund / passive is better than active. That argument has been settled by data over and over again.

Having said that, I didn't always think that way. Years ago I tended to think the best fund managers could beat it. I don't think that anymore. I still think MAYBE some fund managers may be able to do better ON A RISK ADJUSTED basis. Noticed I have even qualified that. The net result is I have a few actively managed funds and I haven't yet felt compelled to bail on them yet. Some of them I probably should and haven't because of laziness the others my decision not to has been more deliberate. For those active funds I do go to Morningstar and eyeball performance over various periods to make sure they are at least comparable to the applicable index.

All of my funds are in retirement accounts so no issues of tax gain recognition.

Examples:

Vanguard Wellington - low fee and conservative. Fees are low enough to almost be an index fund

FPA Crescent. Been in this 5-7 years. One of two or three funds with relatively high fees. I keep this fund because the manager seems to have a knack for minimizing the downside. One of my largest holdings

Fidelity Contrafund - I've had this for years maybe decades. Early on it beat the market but now pretty much tracks it given it is so large. I've sold some of it but still have a decent chunk. It seems like it's risk level is comparable to the S&P. The reason for keeping it is becoming less and less.

Fidelity Low Price stock. This one decades too. I think we are probably also past the point of outperformance on this one too. Mostly a mid Cap play. I'll probably continue to hold for now but keep it on my watch list

Dodge and cox international - partly because I like value style and partly because I have limited choices on a couple of 401k accounts. Also I tend to think (just a wild assed unsubstantiated hunch ) that there may be more opportunities worldwide for the best active managers to be competitive vs indexes. For years I also had dodge and cox domestic but dumped them because I was kind of miffed that got killed so badly 2007/2008 with their overweighting on financials.

Vanguard dividend growth and vanguard dividend appreciation etf. Picked these up over the years because intended to think there was less downside risks on some of these high quality stable companies. Those companies have had a decent run and not sure if my logic still holds as much.

I do have some other active funds but they are relatively immaterial compared to the total pie and I will eventually roll them over to applicable index substitutes. And I do have quite a bit in index funds too.

I'm certainly not looking for affirmation of this from a bunch of die hard indexing fans, but curious if anybody else here either is or was in comparable situations? Also, does anybody else think that some of the best fund managers maybe able to minimally manage downside risks vs indexing? At 54 I want to stay invested but at the same time am much more risk averse than I was at 30.

[Avo]

Of course the best fund managers add value (alpha). The problem is that they usually don't do it consistently, and you never know when they're going to stop, and it's hard to know who was actually good and who was just lucky.

Wellington, Contrafund, and Low-Priced Stock have well rewarded their long-term shareholders. I used to own the latter two, but became an indexer some time ago. I wish I had held on, but who knew?

I looked at Crescent a few years ago, I don't like it. High fees, 15% cash, and underperforming (including on the downside) Vanguard Balanaced Index over the past 10 years. Also I don't generally like balanced funds unless the manager is adding alpha by switching in and out of stocks. Very hard to do consistently.

My wife still owns Dodge & Cox Stock in her IRA. I soured on them after they screwed up the 2008 crash. Longtime CEO Harry Hagy had retired a couple of years earlier. I think he had been the alpha generator there.

I would sell Crescent, possibly hold Contrafund and Low Priced Stock (but manager Joel Tillinghouse recently had a long sabbatical, not sure how involved he still is, if he's not I would sell).

For myself, I was always nervous about active funds; how do you know when to get out? A couple of years of bad underperformance can wipe out decades of steady overperformance.

[alex_686]

3 thoughts here.

I am a fan of the "semi" flavor of the efficient market hypothesis. Superior skills can generate superior returns. Cultivating, generating, and identifying those skill is very hard.

"Risk Adjusted" covers a huge area. I do think a tailor portfolio has a better chance of meeting a investor goals on a risk adjusted basis. The market portfolio is very efficient but it may not exactly align with what a investor needs. Liability matching falls here. Of course this implies that one should use a custom index when investing, a level of complexity that is out of reach of most people.

Lastly, this brings me to the tyranny of indexing. A recent thread has been talking about PIMCO Income Fund (Ticker PONDX). I find that it is a fascinating fund, one that can justify a high expense ratio. However, in this context, it does not fit well into any index. I can extend this to the small cap and emerging market indexes. It is my opinion that most of the value in these spaces are from small companies. These companies may lack the liquidity to be add to the index.

[JBTX]

Of course the best fund managers add value (alpha). The problem is that they usually don't do it consistently, and you never know when they're going to stop, and it's hard to know who was actually good and who was just lucky.

Wellington, Contrafund, and Low-Priced Stock have well rewarded their long-term shareholders. I used to own the latter two, but became an indexer some time ago. I wish I had held on, but who knew?

I looked at Crescent a few years ago, I don't like it. High fees, 15% cash, and underperforming (including on the downside) Vanguard Balanaced Index over the past 10 years. Also I don't generally like balanced funds unless the manager is adding alpha by switching in and out of stocks. Very hard to do consistently.

My wife still owns Dodge & Cox Stock in her IRA. I soured on them after they screwed up the 2008 crash. Longtime CEO Harry Hagy had retired a couple of years earlier. I think he had been the alpha generator there.

I would sell Crescent, possibly hold Contrafund and Low Priced Stock (but manager Joel Tillinghouse recently had a long sabbatical, not sure how involved he still is, if he's not I would sell).

For myself, I was always nervous about active funds; how do you know when to get out? A couple of years of bad underperformance can wipe out decades of steady overperformance.

Great comments and thanks for the feedback. This ten year view shows Cresent favorable to moderate allocation benchmarks and slightly better than vanguard balanced but close nonetheless.

http://www.morningstar.com/funds/XNAS/FPACX/quote.html

http://www.morningstar.com/funds/XNAS/VBIAX/quote.html

Obviously these comparisons change year to year.

[JBTX]

3 thoughts here.

I am a fan of the "semi" flavor of the efficient market hypothesis. Superior skills can generate superior returns. Cultivating, generating, and identifying those skill is very hard.

"Risk Adjusted" covers a huge area. I do think a tailor portfolio has a better chance of meeting a investor goals on a risk adjusted basis. The market portfolio is very efficient but it may not exactly align with what a investor needs. Liability matching falls here. Of course this implies that one should use a custom index when investing, a level of complexity that is out of reach of most people.

Lastly, this brings me to the tyranny of indexing. A recent thread has been talking about PIMCO Income Fund (Ticker PONDX). I find that it is a fascinating fund, one that can justify a high expense ratio. However, in this context, it does not fit well into any index. I can extend this to the small cap and emerging market indexes. It is my opinion that most of the value in these spaces are from small companies. These companies may lack the liquidity to be add to the index.

What you are saying makes a lot of sense.

[Avo]

This ten year view shows Cresent favorable to moderate allocation benchmarks and slightly better than vanguard balanced but close nonetheless.

http://www.morningstar.com/funds/XNAS/FPACX/quote.html

http://www.morningstar.com/funds/XNAS/VBIAX/quote.html

Obviously these comparisons change year to year.

I wrote 10 years, but I think I was looking at several time periods. The last 3 or 4 year charts make VBIAX look better. I wouldn't keep Crescent, because I would bet on the high fees winning over time. The manager (forgot his name) has to do really well to overcome fees with 55% stock and 15% cash.

Again, personally, I'm done with active funds in traditional spaces, but I'm still open to odder ducks like PONDX and some of the AQR stuff.

But this is probably a behavioral error and I should stick to pure indexing ...

[dbltrbl]

I have had few active funds most by accident or luck. Had Contra, New Millennium and Low Priced stock at Fido. First two are now gone in index funds. Last one low priced I am holding on it but can go. At vanguard we have Prime Cap and Health care in addition to Total Index and International Index. hard to get rid of those especially healthcare in a taxable account. It will create huge capital gains. Granted I am not complaining.

[JBTX]

This ten year view shows Cresent favorable to moderate allocation benchmarks and slightly better than vanguard balanced but close nonetheless.

http://www.morningstar.com/funds/XNAS/FPACX/quote.html

http://www.morningstar.com/funds/XNAS/VBIAX/quote.html

Obviously these comparisons change year to year.

I wrote 10 years, but I think I was looking at several time periods. The last 3 or 4 year charts make VBIAX look better. I wouldn't keep Crescent, because I would bet on the high fees winning over time. The manager (forgot his name) has to do really well to overcome fees with 55% stock and 15% cash.

Again, personally, I'm done with active funds in traditional spaces, but I'm still open to odder ducks like PONDX and some of the AQR stuff.

But this is probably a behavioral error and I should stick to pure indexing ...

Over the last 5 years returns are near identical. Over the last 3 you are right vanguard balanced has edged out FPA. Currently FPA only has a 55% equity position. That has likely hurt his returns and he is taking a defensive position. But given my fears the markets may be too rich his defensive position makes some sense. I am not holding the fund to beat or match the market but to give some downside protection. But is worth watching. If over the long term he can't provide more value than a simple low fee balanced fund the the 1.0% fee isn't buying you anything.

[whodidntante]

I think DFA and AQR have funds that add value after expenses so I hold those. I own T. Rowe Price New Income and TRP Stable Value for fixed income due to limited choice in my 401k.

I used to own a few Fidelity active funds including contrafund, but I currently do not.

[Leidsekade]

I'm new to investing and still undecided whether I want to go down the passive route, especially as history says we're closer to the end of the bull cycle than the start.

However, while I initially believed that the best active managers would provide significant downside protection during a bear market, this article I read yesterday makes me think otherwise (I'm UK-based):

https://www.tddirectinvesting.co.uk/bes ... d-managers#

Most of the top performers fell in line with their benchmarks from 2007 to 2009 and then took off once markets recovered. Also, only the top 19 fund managers in the entire country outperformed their benchmark by more than 1.5% annually over the past 10 years!

As I said, I'm a novice, so I would be interested to know if I've interpreted this correctly.

For what it's worth, I don't personally believe that the bull market will end in the next couple of years, so I'm still inclined to further research the best, infrequently traded active funds with OCFs under 1% to get above-market gains. However, I need to do further research on how paying someone to lose my money during a possible bear cycle within a few years will impact me until the next bull market (and then consider whether that fund manager will still be around!).

[alex_686]

I'm new to investing and still undecided whether I want to go down the passive route, especially as history says we're closer to the end of the bull cycle than the start.

Actually, history can't tell us if we are closer to the end of a bull cycle or not. The length of a bull market has no predictive power. Bull markets have lasted for a year and for 20 years.

In the same vein, past performance of a mutual fund does not indicate future performance. Here too there is no predictive power. This is not quite true - there is some information to be gleaned from past performance but it is not what you are thinking.

As to the link that you pointed to, it is of limited use. At a very simply level fund performance can be broken down into Beta and Alpha. Beta indicates how much of the return is from the market. Many high preforming funds are just high Beta funds - they invest in the most volatile stocks. When the market goes up their funds go way up, when the market goes down their funds go way down. Return generated by Alpha is from skill - from superior insights and execution. So, from the link you posted, I can't tell if the return was from luck (Beta) or from skill (Alpha)

As somebody who has done this for a living one can identify superior fund managers, in the same way a coach can identify star football players. Better than the average Joe, but still with a lot of duds. I personally think it is easier to identify superior individual stocks than funds.

I am not 100% against active funds, but one needs a solid reason. However you need to articulate why you think it will do better on a risk adjusted return basis than a passive fund. That is a pretty high bar to clear.

[North Texas Cajun]

If you read any books about randomness written over the past two decades, you would probably start to realize that a few of the thousands of active funds are going to beat indexes for long periods of time. That some have done so is almost certainly by chance, and has nothing to do with the ability of those funds' managers.

[North Texas Cajun]

I'm new to investing and still undecided whether I want to go down the passive route, especially as history says we're closer to the end of the bull cycle than the start.

.
.
.

However, I need to do further research on how paying someone to lose my money during a possible bear cycle within a few years will impact me until the next bull market (and then consider whether that fund manager will still be around!).

The only way passive index investors can lose money during a bear market is by selling. Bear markets only last a few years. Those who try to "prove" otherwise generally combine multiple bear and bull markets and cherry pick data (such as calling 1929 to 1946 - or 1968 to 1982 - a long bear market and ignoring the fluctuations and buying/selling opportunities of the interim years). Almost everyone who holds broad market equities and continues to invest over 20 or more years is going to do better than someone who tries to time markets or pick a few winners.

[WoodSpinner]

OP,

I also have kept a few active funds in the portfolio for some of the same reasons.

PONPX - PIMCO Income Fund Class P
I think there is a good case to be made for an active approach for Bonds. Risk is increased over Treasuries but it seemed a good trade off. ER is about .55 and they are delivering 3.95% while consistently outperforming the benchmark indexes. Morningstar 5-star Silver rated.

Vanguard PRIMECAP Fund Admiral Shares (VPMAX)
Long time holding that has done very well for me and consistently delivered returns above the S&P, ER .33%. Morningstar 5-star Gold rated.

I just finished a major portfolio restructuring and simplification, but haven't convinced myself to part with these Active finds

I am still a newbie at all of this and would appreciate comments on this holding and the value of the Morningstar Rating System

TIA

[Nowizard]

As they say, all generalizations are inaccurate, including this one. "This one" meaning that index funds outperform active funds. True with total portfolios, not true with individual funds if you can pick the ones that perform best. To answer your question, yes some do have a mix of active and index funds. We own Wellington and Dodge and Cox Stock funds, for example. Vanguard Total Stock Market (Admiral) is up 8.99% YTD and 14.54% annually over past five years. Dodge and Cox is up 6.81% YTD and annually 16.36% over the past five years. Will it continue to outperform? Who knows, but sometimes past history, combined with the emotional aspects of things such as an active fund scratching an itch to "see" if you can beat an index fund trumps using only index funds with a portion of one's portfolio.

Tim

[North Texas Cajun]

As they say, all generalizations are inaccurate, including this one. "This one" meaning that index funds outperform active funds. True with total portfolios, not true with individual funds if you can pick the ones that perform best.

What I believe to be true is that the active mutual funds which have performed the best - over any period you choose - did so as a result of pure randomness. There are over 100,000 mutual funds worldwide - over 9,000 in the U.S. But that only counts the ones still in business. There have likely been at least that many that failed over the past 30 years. It is extremely likely that 1% or 2% of those 200,00 existing plus failed global funds - or 18,000 existing plus failed U.S. funds - would have outperformed their relevant indexes for almost all the years of their existence. Such outstanding performance would have nothing to do with the ability of the fund managers to pick stocks and time markets. Rather, using an expression I read in a Nassim Taleb book, these long term winners are the "lucky monkeys on typewriters'".

[ruralavalon]

To preface, i totally buy into the philosophy that index fund / passive is better than active. That argument has been settled by data over and over again.
. . . . .

All of my funds are in retirement accounts so no issues of tax gain recognition.

Examples:
. . . . .
Dodge and cox international - partly because I like value style and partly because I have limited choices on a couple of 401k accounts. Also I tend to think (just a wild assed unsubstantiated hunch ) that there may be more opportunities worldwide for the best active managers to be competitive vs indexes. . . .
. . . . .

I don't reflexively reject all actively managed funds. My preference is a good index fund over a good actively managed fund. But in 401ks there is often no good international index fund offered.

I agree that Dodge & Cox International Stock (DODFX) ER 0.64% is a good international stock fund. Although actively managed, it has a modest expense ratio, low turnover (17%), and is well diversified covering larger companies in both emerging markets and developed markets including Canada. I would not hesitate to use it in a 401k.

I do have some other active funds but they are relatively immaterial compared to the total pie and I will eventually roll them over to applicable index substitutes. And I do have quite a bit in index funds too.

I'm certainly not looking for affirmation of this from a bunch of die hard indexing fans, but curious if anybody else here either is or was in comparable situations? Also, does anybody else think that some of the best fund managers maybe able to minimally manage downside risks vs indexing? At 54 I want to stay invested but at the same time am much more risk averse than I was at 30.

Why the hesitation to get out of your small immaterial positions in other active funds? Just for simplification, if nothing else, why not just go ahead and now switch those small holdings to a broadly diversified, low ER index fund of some type?

For what it's worth, all of our accounts are at Vanguard, all our funds are Vanguard funds, my 401k is rolled over to a Vanguard IRA, and we have one actively managed fund. That one actively managed fund is Vanguard Intermediate-term Investment Grade Admiral Shares (VFIDX) ER 0.10%, used because I wanted to add more exposure to corporate bonds.

[pkcrafter]

Here's my take on indexing. Total market index funds get get total market returns. What is wrong with getting that return? Most investors don't get that return because of behavioral mistakes. Those investors include both indexers and active investors, but those who are attempting to beat the market will not have the patience and tolerance to stay with a plan when they are losing to index performance so they go even deeper in the hole as they blindly search for better funds.

Investors who use active funds must choose them on past returns. Investors use active funds because they believe their chosen funds will beat index returns, and yet 80% of active investors don't beat the total market index over longer periods of time. The second part of that problem is the top two quintiles of winners roll over, the bottom three tend to stay there. This means that even if you pick a top quintile fund it may not stay there. The third part of the problem is if your chosen funds do not outperform over time you won't get the outperformance and you won't get the market return either.

Question: We can identify some active funds with good long term performance--Vanguard, Dodge and Cox, TRPrce and even American funds and some others as well. So my question is, How many reliable active funds with good long term records are there?

I really would like to hear your answers to that question. You don't need to name them, just provide your guess as to how many active funds have consistently outperformed.



Paul

[ruralavalon]

OP,

I also have kept a few active funds in the portfolio for some of the same reasons.

PONPX - PIMCO Income Fund Class P
I think there is a good case to be made for an active approach for Bonds. Risk is increased over Treasuries but it seemed a good trade off. ER is about .55 and they are delivering 3.95% while consistently outperforming the benchmark indexes. Morningstar 5-star Silver rated.

Vanguard PRIMECAP Fund Admiral Shares (VPMAX)
Long time holding that has done very well for me and consistently delivered returns above the S&P, ER .33%. Morningstar 5-star Gold rated.

I just finished a major portfolio restructuring and simplification, but haven't convinced myself to part with these Active finds

I am still a newbie at all of this and would appreciate comments on this holding and the value of the Morningstar Rating System

TIA

I don't reflexively reject actively manged funds. My preference is a good index fund over a good actively managed fund. Often a 401k will lack a good index fund for bonds, and sometimes not even have a low expense ratio domestic stock index fund.

Both Vanguard PRIMECAP Fund Admiral Shares (VPMAX) ER 0.33% turnover rate 06% and PIMCO Income Fund Class P (PONPX) ER 0.55% are good actively managed funds.

They each have modest expense ratios. Lower expense ratios are critical to long-term investing performance. Vanguard blog post, "Stopping the silent killer of returns". Please see the table at the end of the post, "Cumulative impact of fees on ending wealth at various time horizons." Also, here is a calculator you could use to estimate the impact of investing expenses. Bankrate.com, "Mutual fund fees calculator".

The Morningstar star ratings are based on past performance, are not an attempt to predict future performance, and I generally pay almost no attention to them (the exception: very low performance tends to persist, so I pay attention to single star ratings). According to Morningstar, low expense ratios are the best predictor of future performance. Morningstar, "How Expense Ratios and Star Ratings Predict Success". “If there's anything in the whole world of mutual funds that you can take to the bank, it's that expense ratios help you make a better decision. In every single time period and data point tested, low-cost funds beat high-cost funds.” “Investors should make expense ratios a primary test in fund selection. They are still the most dependable predictor of performance.”

The Morningstar gold/silver/bronze medal ratings do attempt to predict future performance, but are new and we don't know if that attempt is successful. I tend to doubt it.

For what it's worth, all of our accounts are at Vanguard, all our funds are Vanguard funds, my 401k is rolled over to a Vanguard IRA, and we have one actively managed fund. That one actively managed fund is Vanguard Intermediate-term Investment Grade Admiral Shares (VFIDX) ER 0.10%, used because I wanted to add more exposure to corporate bonds. We I initially bought the fund I just assumed that it was an index fund because of the low expense ratio.

[Leidsekade]

@alex_686 @North Texas Cajun -- thanks.

[Kenkat]

As they say, all generalizations are inaccurate, including this one. "This one" meaning that index funds outperform active funds. True with total portfolios, not true with individual funds if you can pick the ones that perform best.

What I believe to be true is that the active mutual funds which have performed the best - over any period you choose - did so as a result of pure randomness. There are over 100,000 mutual funds worldwide - over 9,000 in the U.S. But that only counts the ones still in business. There have likely been at least that many that failed over the past 30 years. It is extremely likely that 1% or 2% of those 200,00 existing plus failed global funds - or 18,000 existing plus failed U.S. funds - would have outperformed their relevant indexes for almost all the years of their existence. Such outstanding performance would have nothing to do with the ability of the fund managers to pick stocks and time markets. Rather, using an expression I read in a Nassim Taleb book, these long term winners are the "lucky monkeys on typewriters'".

A major determinant of active fund performance or any fund performance is expense ratio and turnover. Randomness tends to be true over shorter time frames as you say but over longer time frames, high expenses and / or high turnover kills off most outperformers and a pattern emerges where some active funds do seem to stand the test of time.

The mistake I think that gets made in evaluating active funds vs. index fund is this thought process:

1) index funds outperform active funds over long periods due to lower expenses and turnover
2) therefore, index funds are superior to active funds
3) evaluting a fund like Wellington or Primecap, it is actively managed so therefore it is inferior based on #2 above

What is lost is that funds like Wellington or Primecap meet the criteria in #1 above and so #2 doesn't really fully apply.

[JBTX]

To preface, i totally buy into the philosophy that index fund / passive is better than active. That argument has been settled by data over and over again.
. . . . .

All of my funds are in retirement accounts so no issues of tax gain recognition.

Examples:
. . . . .
Dodge and cox international - partly because I like value style and partly because I have limited choices on a couple of 401k accounts. Also I tend to think (just a wild assed unsubstantiated hunch ) that there may be more opportunities worldwide for the best active managers to be competitive vs indexes. . . .
. . . . .

I don't reflexively reject all actively managed funds. My preference is a good index fund over a good actively managed fund. But in 401ks there is often no good international index fund offered.

I agree that Dodge & Cox International Stock (DODFX) ER 0.64% is a good international stock fund. Although actively managed, it has a modest expense ratio, low turnover (17%), and is well diversified covering larger companies in both emerging markets and developed markets including Canada. I would not hesitate to use it in a 401k.

I do have some other active funds but they are relatively immaterial compared to the total pie and I will eventually roll them over to applicable index substitutes. And I do have quite a bit in index funds too.

I'm certainly not looking for affirmation of this from a bunch of die hard indexing fans, but curious if anybody else here either is or was in comparable situations? Also, does anybody else think that some of the best fund managers maybe able to minimally manage downside risks vs indexing? At 54 I want to stay invested but at the same time am much more risk averse than I was at 30.

Why the hesitation to get out of your small immaterial positions in other active funds? Just for simplification, if nothing else, why not just go ahead and now switch those small holdings to a broadly diversified, low ER index fund of some type?

For what it's worth, all of our accounts are at Vanguard, all our funds are Vanguard funds, my 401k is rolled over to a Vanguard IRA, and we have one actively managed fund. That one actively managed fund is Vanguard Intermediate-term Investment Grade Admiral Shares (VFIDX) ER 0.10%, used because I wanted to add more exposure to corporate bonds.

Why hesitation?

1.laziness
2. I have a bunch of different accounts mostly in fidelity and vanguard. Reg and Roth IRAS for me and for my wife. A couple of different 401ks doe me and wife. Also some rollovers. The point is it makes somewhat more difficult to balance everything out like I want them.
3. Psychological - I become attached to certain funds out of longevity.
4. Most of these funds have lower fees than your typical active fund.
5. While I rationally and objectively believe in indexing emotionally I don't always. I just don't like throwing money in a broad based market cap index funds which favor whatever the markets flavor of the month especially when I feel like the markets are overvalued. I feel like I can get more downside protection in some lower fee active funds, although rationally I know rationally I probably can't and most large funds mostly track the market.
6. I tend to compartmentalize too much. I like this fund because it does this and that fund because it does that. But I fully understand you throw them all together they end of tracking the broad market anyway.

I'll eventually get there.

[JBTX]

Here's my take on indexing. Total market index funds get get total market returns. What is wrong with getting that return? Most investors don't get that return because of behavioral mistakes. Those investors include both indexers and active investors, but those who are attempting to beat the market will not have the patience and tolerance to stay with a plan when they are losing to index performance so they go even deeper in the hole as they blindly search for better funds.

Investors who use active funds must choose them on past returns. Investors use active funds because they believe their chosen funds will beat index returns, and yet 80% of active investors don't beat the total market index over longer periods of time. The second part of that problem is the top two quintiles of winners roll over, the bottom three tend to stay there. This means that even if you pick a top quintile fund it may not stay there. The third part of the problem is if your chosen funds do not outperform over time you won't get the outperformance and you won't get the market return either.

Question: We can identify some active funds with good long term performance--Vanguard, Dodge and Cox, TRPrce and even American funds and some others as well. So my question is, How many reliable active funds with good long term records are there?

I really would like to hear your answers to that question. You don't need to name them, just provide your guess as to how many active funds have consistently outperformed.



Paul

How many long term active out performers are there ? Probably not a lot. And many of those are a result of early correct bets they made when the fund was much smaller. Once they become large they tend to track the market.

[pkcrafter]

Thanks JBTX. Hey, one more letter in front and you can be a mutual fund.

Anyone else care to estimate how many truly good, reliable active there are. And don't count FAIRX! I'm asking for the number so I can make a final point.


Paul

[North Texas Cajun]

As they say, all generalizations are inaccurate, including this one. "This one" meaning that index funds outperform active funds. True with total portfolios, not true with individual funds if you can pick the ones that perform best.

What I believe to be true is that the active mutual funds which have performed the best - over any period you choose - did so as a result of pure randomness. There are over 100,000 mutual funds worldwide - over 9,000 in the U.S. But that only counts the ones still in business. There have likely been at least that many that failed over the past 30 years. It is extremely likely that 1% or 2% of those 200,00 existing plus failed global funds - or 18,000 existing plus failed U.S. funds - would have outperformed their relevant indexes for almost all the years of their existence. Such outstanding performance would have nothing to do with the ability of the fund managers to pick stocks and time markets. Rather, using an expression I read in a Nassim Taleb book, these long term winners are the "lucky monkeys on typewriters'".

A major determinant of active fund performance or any fund performance is expense ratio and turnover. Randomness tends to be true over shorter time frames as you say but over longer time frames, high expenses and / or high turnover kills off most outperformers and a pattern emerges where some active funds do seem to stand the test of time.

Randomness of performance results is true over both the short term and the long term. With over ten thousand active mutual funds over 30 years (which is about the age of Primecap), there will be some very consistent high performing funds - simply due to to randomness. I don't know if Primecap is a high performing mutual fund because of the ability of its fund managers or because the fund was the "lucky monkey at the typewriter". And neither do you.

The mistake I think that gets made in evaluating active funds vs. index fund is this thought process:

1) index funds outperform active funds over long periods due to lower expenses and turnover
2) therefore, index funds are superior to active funds
3) evaluting a fund like Wellington or Primecap, it is actively managed so therefore it is inferior based on #2 above

What is lost is that funds like Wellington or Primecap meet the criteria in #1 above and so #2 doesn't really fully apply.

I agree that, on average, low expense funds will beat high expense funds over time. But that alone does not explain why Wellington and Primecap were able to exceed index funds. Randomness does explain why that is possible.

[North Texas Cajun]

Thanks JBTX. Hey, one more letter in front and you can be a mutual fund.

Anyone else care to estimate how many truly good, reliable active there are. And don't count FAIRX! I'm asking for the number so I can make a final point.


Paul

If you want an answer to your question which is meaningful, you need to be more specific. What do you mean by the words "good" and "reliable"?

IMO, there are zero active fund managers who can be relied upon to deliver above market performance for each of the next ten years. But I also believe some active fund managers will be "lucky monkeys at the typewriter".

[pkcrafter]

Your point is well taken. The funds I listed above do seem to perform reliably well--Vanguard, TRPrice Dodge and Cox, American, and all have multiple managers. Are there anymore in this select group?

Paul

[Kenkat]

As they say, all generalizations are inaccurate, including this one. "This one" meaning that index funds outperform active funds. True with total portfolios, not true with individual funds if you can pick the ones that perform best.

What I believe to be true is that the active mutual funds which have performed the best - over any period you choose - did so as a result of pure randomness. There are over 100,000 mutual funds worldwide - over 9,000 in the U.S. But that only counts the ones still in business. There have likely been at least that many that failed over the past 30 years. It is extremely likely that 1% or 2% of those 200,00 existing plus failed global funds - or 18,000 existing plus failed U.S. funds - would have outperformed their relevant indexes for almost all the years of their existence. Such outstanding performance would have nothing to do with the ability of the fund managers to pick stocks and time markets. Rather, using an expression I read in a Nassim Taleb book, these long term winners are the "lucky monkeys on typewriters'".

A major determinant of active fund performance or any fund performance is expense ratio and turnover. Randomness tends to be true over shorter time frames as you say but over longer time frames, high expenses and / or high turnover kills off most outperformers and a pattern emerges where some active funds do seem to stand the test of time.

Randomness of performance results is true over both the short term and the long term. With over ten thousand active mutual funds over 30 years (which is about the age of Primecap), there will be some very consistent high performing funds - simply due to to randomness. I don't know if Primecap is a high performing mutual fund because of the ability of its fund managers or because the fund was the "lucky monkey at the typewriter". And neither do you.

The mistake I think that gets made in evaluating active funds vs. index fund is this thought process:

1) index funds outperform active funds over long periods due to lower expenses and turnover
2) therefore, index funds are superior to active funds
3) evaluting a fund like Wellington or Primecap, it is actively managed so therefore it is inferior based on #2 above

What is lost is that funds like Wellington or Primecap meet the criteria in #1 above and so #2 doesn't really fully apply.

I agree that, on average, low expense funds will beat high expense funds over time. But that alone does not explain why Wellington and Primecap were able to exceed index funds. Randomness does explain why that is possible.

Low expenses keep funds like Wellington and Primecap within striking distance of the indexes. You may be correct that randomness then explains which ones will beat them. Here is a link to a good study by Carhart that shows that almost all mutual fund performance is explainable by factor exposure (size, value, etc.) and expenses:

https://faculty.chicagobooth.edu/john.c ... nds_jf.pdf

[pkcrafter]

Vanguard's active funds benefit from lower cost vs other active funds, but there is something more, and it doesn't explain TRPrice or American. What I find odd is that there are about 10,000 funds, but some are different classes of the same fund, so lets say there are 5000 different funds. Again, how many are good, reliable ones? Are there even 100? I don't know 100, but if there are that many then we have 2%. The big question is why only 2%, or 5% or even 10%. Can all the other funds be doing something different, and wrong? Are they just badly managed, or chasing investors instead of long term results? I think the funds I've mentioned stick with a strategy, even when the market goes against them. No star managers here, just consistency that pays off.

Yes, half of the active funds must be outperforming index funds at any give time, but most sink over time because of fees, but maybe it just isn't because of higher fees. Anyway, the fact that there appears to be a very low percentage of active funds that are consistently good seems a bit bewildering. Actually if all active funds are super, then the index return is super, so no matter what, you can't go wrong with indexing. I'll take it over the risk of active management every time.

[North Texas Cajun]

Low expenses keep funds like Wellington and Primecap within striking distance of the indexes. You may be correct that randomness then explains which ones will beat them. Here is a link to a good study by Carhart that shows that almost all mutual fund performance is explainable by factor exposure (size, value, etc.) and expenses:

https://faculty.chicagobooth.edu/john.c ... nds_jf.pdf

If I wrote that randomness explains why some funds are have persistently high performance, I apologize. What I meant to write - and what I thought I wrote - is that randomness COULD account for such performance. We do not really know whether it is fund managers' abilities or simple randomness.

I confess that I don't understand everything written by the author of that study you referenced. But I'd like to point out a couple of things:

1. The funds performance period he was analyzing covered the period 1962 to 1993. I think that's rather old data for the mutual fund industry. I don't think it covers much of the period of the mutual fund explosion. As I understand it, the rise of no-load funds changed the way expenses are collected. I also think the sheer size of the mutual fund industry today - one estimate was that it is over 200 times the size it was at the end of the 1970s - could have caused some significant changes in how the factors he studied are related.

2. As I understand it, the method used in that study would explain the overall variation of performances by the funds studied. But saying that X% is explained only means that X% the total variation of all funds studied are explained. My work with multiple regression studies showed that the extreme outliers - such as the tiny percentage of funds which beat the index - are usually not well-explained by the factors deemed to be significant for the overall population.

[JBTX]

Vanguard's active funds benefit from lower cost vs other active funds, but there is something more, and it doesn't explain TRPrice or American. What I find odd is that there are about 10,000 funds, but some are different classes of the same fund, so lets say there are 5000 different funds. Again, how many are good, reliable ones? Are there even 100? I don't know 100, but if there are that many then we have 2%. The big question is why only 2%, or 5% or even 10%. Can all the other funds be doing something different, and wrong? Are they just badly managed, or chasing investors instead of long term results? I think the funds I've mentioned stick with a strategy, even when the market goes against them. No star managers here, just consistency that pays off.

Yes, half of the active funds must be outperforming index funds at any give time, but most sink over time because of fees, but maybe it just isn't because of higher fees. Anyway, the fact that there appears to be a very low percentage of active funds that are consistently good seems a bit bewildering. Actually if all active funds are super, then the index return is super, so no matter what, you can't go wrong with indexing. I'll take it over the risk of active management every time.

I've always understood the theory and reality of why index funds are superior but somebody recently quoted Buffet as saying that if 50% is active (active funds, individual stock pickers and institutional non indexers) and 50% is index then by definition the index is going to to track the active. Except the active then add a fee on top. By that definition on average index will beat active.

[pkcrafter]

I've always understood the theory and reality of why index funds are superior but somebody recently quoted Buffet as saying that if 50% is active (active funds, individual stock pickers and institutional non indexers) and 50% is index then by definition the index is going to to track the active. Except the active then add a fee on top. By that definition on average index will beat active.

What it means is if you have investors using active options then half must outperform the average and half will be below the average before costs. Then an investor using an index fund joins the party and he will get the average, but his costs will be slightly lower, so he's actually doing a bit better than the average after costs. That small advantage grows over time. The other thing that happens is the active funds don't stay in a single ranking, they rise and fall in the sea of funds constantly. The index fund can perform well or sometimes not so well depending on the snottyness of the mercurial Mr. Market.

Paul

[alex_686]

Anyone else care to estimate how many truly good, reliable active there are. And don't count FAIRX! I'm asking for the number so I can make a final point. l

And

I've always understood the theory and reality of why index funds are superior but somebody recently quoted Buffet as saying that if 50% is active (active funds, individual stock pickers and institutional non indexers) and 50% is index then by definition the index is going to to track the active. Except the active then add a fee on top. By that definition on average index will beat active.

I think you are asking the wrong question. Many funds are not trying to beat the index, either in absolute or in risk adjusted terms. A easy group to pick on is the Social Responsible Investing (SRI) mutual funds. There is no good index for what they are trying to do. If they miss hitting the S&P 500 would it have failed their investors in being a good reliable fund? No. They are using a different yardstick. A yardstick that can't be measured so I have serious questions about SRI but that is a different story.

There are others out there. Defensive funds for example. This makes answering your question very hard.

[Alex GR]

This morning I was thinking exactly the same thing as the OP. Thanks to this forum which I have been reading without registering for many years my portfolio is currently ~80% Boglehead. However there are some exceptions that comprise the other 20%. For example, I "aint letting go" of PONDX. I also have mutual funds for International because the returns from Index funds are just too low(high this year but low historically). My portfolio currently has 8 positions. I have read over and over on this forum that it should be 3 or 5 but I can't find anything I want to get rid of One idea I came up with is when it's time to rebalance once a year I will reduce the stake in those mutual funds until they are completely gone. Is this a good idea?

[JBTX]

This morning I was thinking exactly the same thing as the OP. Thanks to this forum which I have been reading without registering for many years my portfolio is currently ~80% Boglehead. However there are some exceptions that comprise the other 20%. For example, I "aint letting go" of PONDX. I also have mutual funds for International because the returns from Index funds are just too low(high this year but low historically). My portfolio currently has 8 positions. I have read over and over on this forum that it should be 3 or 5 but I can't find anything I want to get rid of One idea I came up with is when it's time to rebalance once a year I will reduce the stake in those mutual funds until they are completely gone. Is this a good idea?

If thy are in taxable funds and have some capital gains perhaps not if the fund is pretty good and reasonably low fees. If it is retirement account then it is judgment call.