If not Past Performance, how do you evaluate a fund/etf?

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luckybamboo
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If not Past Performance, how do you evaluate a fund/etf?

Post by luckybamboo » Thu May 11, 2017 2:33 pm

Hello,
I am relatively new to this site and haven't invested in anything but index funds / etfs and a few stocks in the past. Though my approach was relatively disorganized, the investments did relatively well (thanks to the long lasting bull market). Now, we have established a proper AA and are working towards choosing the investments that follow the Boglehead philosophy. After I discovered this website, I have been reading the Wiki and the posts and have learnt a lot from all of you.
This might be a really 'stupid' question for all the BH experts, but I would like to tap into your wisdom on how do you go about evaluating if an investment vehicle - Fund, ETF is a good choice or not.
Some numbers come to mind are Expense Ratio, AUM, Volatility, length of the fund/etf existence.
But I am not sure if there is a systematic way for me to evaluate if I am choosing the right option.
For example, I was considering my options for Small Cap Value. I have accounts with Fidelity and Vanguard. I searched up the Bogleheads website and found so many different opinions and I was thoroughly confused.
There were conflicting opinions on the Indexes they track, size of the etf, etc.
My question is
1. Is there a framework with which I can compare various funds/etfs?
2. Or is it safe to just stick with the biggest and the most active and popular ones?
Thanks

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oldcomputerguy
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Re: If not Past Performance, how do you evaluate a fund/etf?

Post by oldcomputerguy » Thu May 11, 2017 2:49 pm

I generally look at how much the fund invests in the asset class I'm interested in owning (whether, for example, a "small-cap" fund actually contains a large portion of mid-cap), the expense ratio of the fund, and what index it follows. I don't try to compare past performance of funds. (Although that being said, you might compare the fund to its index to see how closely it tracks the index; I believe the tracking error is one of the stats that are reported for ETFs.)
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lack_ey
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Re: If not Past Performance, how do you evaluate a fund/etf?

Post by lack_ey » Thu May 11, 2017 2:52 pm

Evaluate a fund based on asset class coverage and strategy (risk exposures, factors, market cap, investment universe) and then costs. Costs include the expense ratio in addition to taxes and then those borne by the fund based on its trading and implementation of the strategy. For an ETF you'd also look at trading costs for you transacting in that ETF itself.

For an index fund you can evaluate a number of the costs together by checking the tracking relative to the index, both in terms of average lag and then the volatility of the difference. A number of funds partially offset the ER and internal trading costs with securities lending revenue; others lag by more than the ER typically.

In a taxable account you also have to consider how strategy and costs may change over time, as switching later could mean realizing capital gains (so this is not as much an issue for bond funds). Fund providers can cut expense waivers, simply increase ER, change indexes to something else with different exposures (or even more so in an active fund, changing managers or just making big moves in sector balance and so on).

You want to select the overall combination of funds that can achieve your desired allocation at as low a cost as possible (or optimizing jointly on cost and closeness to your desired allocation, if it is unachievable or the marginal benefit of getting closer is lower than the increased cost of doing so). This is constrained by your investment choices in different investment accounts (e.g. 401k) and also depends on your tax situation. Depending on your investment horizon, risk tolerance, view of investing theory, etc. you may come to a different desired allocation than others.

If you want to concentrate in small cap value stocks you should think about your beliefs in relative stock performance across parts of the market, your overall asset allocation, what factor targets you want, whether you believe in significant interaction effects between size and value, and so on. What are you trying to target, exactly, and why? And is it worth the additional cost to get the exposure closest to what you envision?
Last edited by lack_ey on Thu May 11, 2017 3:00 pm, edited 2 times in total.

livesoft
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Re: If not Past Performance, how do you evaluate a fund/etf?

Post by livesoft » Thu May 11, 2017 2:54 pm

See the links at http://www.altruistfa.com/dfavanguard.htm

Generally, if it is not found on the list(s), then it is not worth buying nor holding.

Next, I want LOTS of other people to own shares. If there are not a lot of shares outstanding and if they are not traded (say at least 200,000 shares a day), then I don't want to own it. This criteria will eliminate all but about 20 different ETFs. I make exceptions for VSS and DGS.
luckybamboo wrote:2. Or is it safe to just stick with the biggest and the most active and popular ones?
Yes.
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David Jay
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Re: If not Past Performance, how do you evaluate a fund/etf?

Post by David Jay » Thu May 11, 2017 3:06 pm

Because index funds track indexes, it doesn't really mean anything to compare past performance between funds. The past performance of Fidelity Index 500, Schwab Index 500, Vanguard Index 500, Black Rock SP500, and so on will all be essentially the same (except ER, which may vary a bit).

If you have "bought into" Boglehead philosophy, you may well end up with a lot fewer funds than other people. A total stock market, a total international stock and a total bond market is a good starting point. This is called the 3-fund portfolio and many people stay with it over their entire investing lifetime.

Others what to do some factor investing, so they add funds after they have researched the various factors. What is important is that you understand why you have added the factors and that you believe in the factor(s) enough to convince yourself to stay the course when the selected factor underperforms for 5 or 10 years.

I have a small company value tilt plus international small company tilt. So I hold 4 stock funds, with the biggest being Vanguard Total Stock Market Vanguard Total International as my base funds and then small allocations to my personal factors. Even this is likely to change as I simplify going into retirement. I will likely end up leaving everything in a single LifeStrategy fund for my wife.
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Re: If not Past Performance, how do you evaluate a fund/etf?

Post by ruralavalon » Thu May 11, 2017 3:14 pm

I prefer very broadly diversified, low expense, total market type index funds, so not there is not much to look at normally.

In a 401k, 403b or 457 where fund choices are limited you may have to look at other types of funds and other factors.

For a stock fund I look for
1) low expense ratio
2) broad diversification
3) low turnover rate
4) long fund history
5) high reputation of fund firm

For a bond fund I also look for
6) intermediate average effective duration
7) good average credit quality
8) how well the fund held up in 2000 and 2008
Last edited by ruralavalon on Thu May 11, 2017 3:18 pm, edited 1 time in total.
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Re: If not Past Performance, how do you evaluate a fund/etf?

Post by knpstr » Thu May 11, 2017 3:18 pm

I don't evaluate, that's why I just hold the market index.
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TX_Man
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Re: If not Past Performance, how do you evaluate a fund/etf?

Post by TX_Man » Thu May 11, 2017 3:22 pm

Wouldn't correlation to the index it is tracking be another way to evaluate performance?

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Re: If not Past Performance, how do you evaluate a fund/etf?

Post by ruralavalon » Thu May 11, 2017 3:26 pm

You specifically asked about small-cap value funds at Fidelity and Vanguard.

Fidelity does not offer any small-cap value fund.

At Vanguard there is Vanguard Small-cap Value Index Fund Investor Shares (VISVX) or Admiral Shares (VSIAX) or ETF (VBR). Other small-cap value options have significantly higher expense ratios.
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Re: If not Past Performance, how do you evaluate a fund/etf?

Post by vesalius » Thu May 11, 2017 3:42 pm

ruralavalon wrote:You specifically asked about small-cap value funds at Fidelity and Vanguard.

Fidelity does not offer any small-cap value fund.

At Vanguard there is Vanguard Small-cap Value Index Fund Investor Shares (VISVX) or Admiral Shares (VSIAX) or ETF (VBR). Other small-cap value options have significantly higher expense ratios.
I suspect he meant to choose among the litany of funds available from both brokers for little to no trading cost and not just limit himself to those funds specifically managed by Fidelity or Vanguard. I could definitely be wrong though.

Theoretical
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Re: If not Past Performance, how do you evaluate a fund/etf?

Post by Theoretical » Thu May 11, 2017 3:57 pm

Past performance is not good for evaluating the merits of a strategy, but for an index fund or factor/quant fund, past performance is valuable to determine whether the implementation of said strategy has been successfully executed. This is where the concept of tracking error comes into play.

If the fund strives to replicate or closely match the returns of an index, you want it to have the same returns or same returns less expenses as its parent index. With some active funds, many will target a specific tracking error to a particular index (like 2% or 4% within its index).

Note, this includes investment-appropriate periods of BAD performance for the asset class. For example, if a long government bond fund has a history of strong performance in the 1970s, then it's likely done something to juice the returns.

luckybamboo
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Re: If not Past Performance, how do you evaluate a fund/etf?

Post by luckybamboo » Thu May 11, 2017 4:29 pm

livesoft wrote:See the links at http://www.altruistfa.com/dfavanguard.htm

Generally, if it is not found on the list(s), then it is not worth buying nor holding.

Next, I want LOTS of other people to own shares. If there are not a lot of shares outstanding and if they are not traded (say at least 200,000 shares a day), then I don't want to own it. This criteria will eliminate all but about 20 different ETFs. I make exceptions for VSS and DGS.
luckybamboo wrote:2. Or is it safe to just stick with the biggest and the most active and popular ones?
Yes.
This list is very nice and concise. But the list doesn't recommend any Vanguard / Ishares ETFs. Is it safe to assume to find the equivalent ETF for Vanguard Mutual Fund mentioned in the list?

I am very clear about the following ETFs that I currently hold.
Total Market - VTI / ITOT --- Funds (FSTVX/VTSAX)
s&p 500 - VOO / IVV
Total Bond - BND/AGG
International - VXUS/IXUS. I also like VEU, IEFA ---- Funds (VTIAX/FTIPX)
Small Caps - IJS/VB/VBR

Now, the place I am confused about is how to choose the value funds I want to hold some value funds/ETF but there are just too many different choices.

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Re: If not Past Performance, how do you evaluate a fund/etf?

Post by luckybamboo » Thu May 11, 2017 4:45 pm

lack_ey wrote:Evaluate a fund based on asset class coverage and strategy (risk exposures, factors, market cap, investment universe) and then costs. Costs include the expense ratio in addition to taxes and then those borne by the fund based on its trading and implementation of the strategy. For an ETF you'd also look at trading costs for you transacting in that ETF itself.
David Jay wrote:Because index funds track indexes, it doesn't really mean anything to compare past performance between funds. The past performance of Fidelity Index 500, Schwab Index 500, Vanguard Index 500, Black Rock SP500, and so on will all be essentially the same (except ER, which may vary a bit).

If you have "bought into" Boglehead philosophy, you may well end up with a lot fewer funds than other people. A total stock market, a total international stock and a total bond market is a good starting point. This is called the 3-fund portfolio and many people stay with it over their entire investing lifetime.
I thought that index funds would hold all the securities in the underlying index that they track. But that's not true. SCHB, VTI and ITOT have almost identical returns but SCHB holds only about 2000 securities. That would mean that the fund manager arbitrarily chooses the stocks that he feels best represents the market, which doesn't make them much better than the active fund managers.
To me, ideally index needs to hold each and every security in the benchmark index 'blindly' and not try to engineer the returns, kind of like SPY (too bad there isn't a place to trade that commission free). And on top of that, it can only be as good as the underlying index it tracks and the efficiency with which it does that.
I find practices of security lending and leverage too shady.
When you hold a stock, you clearly know that you are just owning that company. But with Mutual Funds and ETFs, not so much. The enormous pressure to perform makes them do things that to me are 'pure evil'. The fine print that i read recently in many prospectus revealed to me the freedom the ETFs/Funds have to do things which aren't necessarily 'straightforward' or 'passive'.

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Re: If not Past Performance, how do you evaluate a fund/etf?

Post by retiredjg » Thu May 11, 2017 5:06 pm

If not Past Performance, how do you evaluate a fund/etf?
By cost. You determine the cost by looking at the expense ratio.

For the most part, I want broad funds, not tiny slices of the market. Once you decide what assets you want to hold, the cost is the only thing to look at for a 401k or IRA.

Edited to add....oftentimes you have to just pick the lowest cost funds in a 401k and build the portfolio around that in the other available accounts.

For a taxable account, cost still comes first but you need to also consider tax-efficiency. For example, a REIT fund may have a rock bottom cost, but I would not hold it in taxable because it is very in-efficient tax wise. This also relates to cost because paying unnecessary taxes adds to the cost of holding a fund.
Last edited by retiredjg on Thu May 11, 2017 5:15 pm, edited 1 time in total.

livesoft
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Re: If not Past Performance, how do you evaluate a fund/etf?

Post by livesoft » Thu May 11, 2017 5:13 pm

luckybamboo wrote:This list is very nice and concise. But the list doesn't recommend any Vanguard / Ishares ETFs.
Sure they do. I consider this a user error. Try again.
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Re: If not Past Performance, how do you evaluate a fund/etf?

Post by Random Walker » Thu May 11, 2017 5:41 pm

Depending on the types of asset classes an individual wants, this can be a complicated question. For tilters to SV, it's not just costs, it's costs per unit factor exposure. And core funds are more efficient with internal rebalancing. For tilters makes sense to make a cheaper Core /TSM fund mainstay of portfolio and more expensive asset class funds in smaller amounts. A slightly more expensive asset class fund might be the better choice because it takes less of it to gain the same factor exposure as a less expensive but also less small or less valuey fund. Also, for those interested in diversifying across factors, one can achieve same factor tilts with less market beta exposure when they possibly use less of a more expensive asset class fund.

Dave

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Re: If not Past Performance, how do you evaluate a fund/etf?

Post by lack_ey » Thu May 11, 2017 5:43 pm

luckybamboo wrote:I thought that index funds would hold all the securities in the underlying index that they track. But that's not true. SCHB, VTI and ITOT have almost identical returns but SCHB holds only about 2000 securities. That would mean that the fund manager arbitrarily chooses the stocks that he feels best represents the market, which doesn't make them much better than the active fund managers.
To me, ideally index needs to hold each and every security in the benchmark index 'blindly' and not try to engineer the returns, kind of like SPY (too bad there isn't a place to trade that commission free). And on top of that, it can only be as good as the underlying index it tracks and the efficiency with which it does that.
I find practices of security lending and leverage too shady.
When you hold a stock, you clearly know that you are just owning that company. But with Mutual Funds and ETFs, not so much. The enormous pressure to perform makes them do things that to me are 'pure evil'. The fine print that i read recently in many prospectus revealed to me the freedom the ETFs/Funds have to do things which aren't necessarily 'straightforward' or 'passive'.
If you're that bothered by index sampling on the micro caps (when the first several hundred largest stocks are fully followed according to the index), I don't know what to say. You'd prefer the funds waste money trying to do full replication and trading every last stock no matter how much it costs them?

And you do know that a lot of what is in the prospectus defines what a fund may do but will not actually do in any meaningful capacity, right?

How much leverage and in which forms do you think are in these funds? What do you think the risks of the securities lending programs are?

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Re: If not Past Performance, how do you evaluate a fund/etf?

Post by TheJoker » Thu May 11, 2017 6:19 pm

Don't evaluate. Just buy and hold the market in stocks and bonds indexes according to your AA. Don't try to make this complex. You need to read a book or two written by Bogle. He has been investing for some 60 years. He and Buffett have seen it all and have spent their lives investing.

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Re: If not Past Performance, how do you evaluate a fund/etf?

Post by luckybamboo » Thu May 11, 2017 6:45 pm

livesoft wrote:
luckybamboo wrote:This list is very nice and concise. But the list doesn't recommend any Vanguard / Ishares ETFs.
Sure they do. I consider this a user error. Try again.
I see now. :) I like your sense of humor 8-)

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