International Equity: Are managed funds better than Index funds?

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JimmyJammy
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International Equity: Are managed funds better than Index funds?

Post by JimmyJammy » Sat Sep 16, 2017 4:51 pm

I've been using mutual fund screeners on Morningstar and reading about ETFS there as well.

I haven't been impressed with Vanguard's basic International index funds (VEA, VEU) and neither has Morningstar. Sure they're cheap.

But, the performance and quality of management of some mutual funds seem very attractive.

I especially like the sound of something like FMIJX which is currency hedged.

I wrote a couple of them down:

FMIJX (currency hedged)
http://www.morningstar.com/funds/xnas/fmijx/quote.html

TROSX
http://www.morningstar.com/funds/xnas/trosx/quote.html

OAKIX
http://www.morningstar.com/funds/xnas/oakix/quote.html

What do you think? If you're into the Vanguard index funds, why do you believe in them so strongly?

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Re: International Equity: Are managed funds better than Index funds?

Post by PFInterest » Sat Sep 16, 2017 6:02 pm

because nobody knows nothin.

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Re: International Equity: Are managed funds better than Index funds?

Post by nisiprius » Sat Sep 16, 2017 6:13 pm

I don't believe in international index funds "so strongly." I just don't see any compelling evidence for anything else being better.

At any given instant in time there are always actively managed funds that have beaten index funds, often by quite a lot. The amazing thing is that it is so much less than half of them. You name three funds that have outperformed the index, but what's your evidence for persistence of outperformance? You mention three funds. Here are their Morningstar ratings, and their expense ratios:

FMIJX * * * * * 0.94%
TROSX * * * * 0.84%
OAKIX * * * * * 1.00%

For comparison:

VTIAX * * * 0.11% (Vanguard Total International Stock Market Index Fund)

But Morningstar has been very upfront about acknowledging that studies, including their own, have shown no persistence for Morningstar star ratings. And what does Morningstar say their own studies show is the best predictor of future performance? Expenses!

Finally, FMIJX, a currency-hedged fund: well, of course it has done well. It has only existed for seven years, i.e. it has spent its whole life during a period of a strengthening dollar, so of course it is going to outperform a non-currency-hedged index and index fund. Can anyone doubt that it would have underperformed during the period of dollar weakening, 2000-2008?
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Re: International Equity: Are managed funds better than Index funds?

Post by nisiprius » Sat Sep 16, 2017 6:29 pm

So, three specific managed international equity funds have, in hindsight, outperformed index funds. But your subject line doesn't ask "Is it possible to find three managed funds that have outperformed index funds." It asks "Are managed funds better than index funds?"

I take that to mean "across the board." Generally better. By and large, are you better off picking a managed fund over an index fund?

SPIVA® U.S. Scorecard
Across all time horizons, the majority of managers across all international equity categories underperformed their benchmarks.
Page 7. Notice that the charts show the percentage of times the funds were outperformed by their benchmark--i.e. higher is worse. If managed funds were better than index funds, we'd expect more than half of them to beat their benchmark--and thus, they would be below the 50% line.

Image

Within the scope of the study, there was never a time when more than half of actively managed emerging markets funds beat their benchmark more than half the time. Global funds never. International funds did it only one year in fourteen. For international small-cap funds the picture is mixed.
Last edited by nisiprius on Sat Sep 16, 2017 6:32 pm, edited 2 times in total.
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Re: International Equity: Are managed funds better than Index funds?

Post by lack_ey » Sat Sep 16, 2017 6:32 pm

On average, no.

Image
https://us.spindices.com/documents/spiv ... d-2016.pdf

Now, that doesn't matter (and neither does the charts nisiprius shows) if there are persistent winners. That is, even if the average is not good, if you can pick previous winners and get above-average performance going forward (at least before taxes, whereas depending on the account you may be interested in the performance after taxes), then that's where you want to be.

But do the winners actually tend to keep winning? See exhibit 3 here:
http://www.us.spindices.com/documents/r ... ecards.pdf

It would be better to see longer evaluation windows, and some relative performance is maybe cyclical so you shouldn't expect excess returns every year even if a fund has an edge, so it's not entirely conclusive from that. But in general, it's tough, and the evidence doesn't look that great.


As a note in general, I think a lot of the attention to group averages is unconvincing in general (except to people already attribute all performance differences to luck, and are thus already dedicated index investors) because most people deliberately investing in active funds don't think they're investing in average funds in terms of future performance. You have to look at screening strategies, performance persistence, etc. to make a real case against that.

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Re: International Equity: Are managed funds better than Index funds?

Post by reriodan » Sat Sep 16, 2017 6:44 pm

JimmyJammy wrote:
Sat Sep 16, 2017 4:51 pm
I've been using mutual fund screeners on Morningstar and reading about ETFS there as well.

I haven't been impressed with Vanguard's basic International index funds (VEA, VEU) and neither has Morningstar. Sure they're cheap.

But, the performance and quality of management of some mutual funds seem very attractive.

I especially like the sound of something like FMIJX which is currency hedged.

I wrote a couple of them down:

FMIJX (currency hedged)
http://www.morningstar.com/funds/xnas/fmijx/quote.html

TROSX
http://www.morningstar.com/funds/xnas/trosx/quote.html

OAKIX
http://www.morningstar.com/funds/xnas/oakix/quote.html

What do you think? If you're into the Vanguard index funds, why do you believe in them so strongly?
Fees. Plus I don't know enough to bet on anything other than market weight. You can cherry pick anything and remember what they say about past performance.

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Re: International Equity: Are managed funds better than Index funds?

Post by JimmyJammy » Sat Sep 16, 2017 8:20 pm

So is Morningstar just a useless company making money on people's ignorance, in the opinion of the Bogleheads?

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Re: International Equity: Are managed funds better than Index funds?

Post by livesoft » Sat Sep 16, 2017 8:27 pm

M* does more than ratings which are useless.
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Re: International Equity: Are managed funds better than Index funds?

Post by whodidntante » Sun Sep 17, 2017 7:27 am

JimmyJammy wrote:
Sat Sep 16, 2017 8:20 pm
So is Morningstar just a useless company making money on people's ignorance, in the opinion of the Bogleheads?
Not exactly. When active funds outperform, it is sometimes due to using a style of investing that currently beats the market. One fund might overweight value stocks while another overweights growth. However, style shift is hard or impossible to time correctly, and some funds don't even try.

If a fund clearly sticks to a certain style that I want to invest in, I'm more likely to buy it if it has taken a beating lately, which would also tend to reduce its star rating. For example, when China dropped 50% last year I took a large position in DFA emerging markets value when Morningstar commentary was just about ridiculing the fund. They aren't laughing anymore.

While there is some debate over exactly what DFA is, that fund definitely is not an index fund.
The same could have been applied to an active fund with a consistent style.

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Re: International Equity: Are managed funds better than Index funds?

Post by nisiprius » Sun Sep 17, 2017 8:09 am

JimmyJammy wrote:
Sat Sep 16, 2017 8:20 pm
So is Morningstar just a useless company making money on people's ignorance, in the opinion of the Bogleheads?
I love Morningstar. I use their site the time. I think they're champs. It's the best single source of investment information on mutual funds that I know about. I even worry about whether they are making enough money to keep doing what they do so well. I even read their articles. (And I have no connection them, apart from being a fan).

I think the most direct answer to your question is: if you're going to use Morningstar, go directly to their site, as you've been doing, but pay better attention to what they say.

The star ratings measure past performance in a fair way and appropriate way that takes into account risk, fund "style" among the Fama-French factors, and compares funds to their peers in a similar category.

Alas, surprisingly and contrary to what most investors assume, as with other measures of past performance, star ratings are not predictive or persistent. However, I do notice that a recent (2016) article by Morningstar,
Does the Star Rating for Funds Predict Future Performance?
came to the conclusion that
Taken together, our findings suggest that the star rating had moderate predictive ability for risk-adjusted returns in the short term. Over the long term, the event study indicates that the star rating has appeared to do more good than harm.
On the other hand, do not ignore this article--by Russel Kinnel, director of mutual-fund research at Morningstar Inc:

Fund Fees Predict Future Success or Failure
Fund fees have remarkable predictive power, and investors can put them to their advantage.

If you've been following Morningstar's research for long, you know how important we think expense ratios are to the fund selection equation. The expense ratio is the most proven predictor of future fund returns. We find that it is a dependable predictor when we run the data. That's also what academics, fund companies, and, of course, Jack Bogle, find when they run the data.

But it's been a couple of years since I provided the proof statement, so we have updated the data to show just how strong and dependable fees are as a predictor of future success. That's not to say investors should use them in isolation. There are many other things to consider, but investors should make expense ratios their first or second screen.
Read the whole article--it's impressive, and they link to more details about their data and methodology.

So you tell me: which are you going to put more weight on in choose your funds:

--Star ratings, which "appeared to do more good than harm"

--Expense ratios, which "have remarkable predictive power... most proven predictor... dependable predictor?"
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Re: International Equity: Are managed funds better than Index funds?

Post by Doc » Sun Sep 17, 2017 8:20 am

livesoft wrote:
Sat Sep 16, 2017 8:27 pm
M* does more than ratings which are useless.
Morningstar ratings are not useless if used appropriately. Avoid funds with 1 and 2 star ratings.
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Re: International Equity: Are managed funds better than Index funds?

Post by nisiprius » Sun Sep 17, 2017 8:38 am

JimmyJammy, what would be really worthwhile for you to do--but the value only comes if you do it for yourself--is this. The Vanguard Total International Stock Index Fund, VGTSX, goes back to 1996, more than twenty years.

Do your best, Googling for yourself and choosing a source you trust yourself, and try to find mutual fund recommendations for international funds that were made ten years ago. Look for titles like "Best international funds for 2007." If there are more than a handful, try to figure out a fair way to take a representative sample. Then check for yourself how those funds performed over the last ten years compared to VGTSX.

If you don't think ten years is the right amount of time to look at, decide for yourself what you think the right time is.

You'll quickly encounter two problems. The first is that many of the mutual funds that have been attracting attention recently have only been around for a few years. The second, even more serious, is "survivorship bias." A lot of the funds that looked good twenty or even ten years ago don't exist any more. It's very, very hard to score them. You can be darned sure these are funds that did so poorly that investors abandoned them. There is a terrible problem in casual backward-looking exploration: by looking only at funds that have survived, you are guaranteed to be looking at funds that had good performance and not seeing the ones that had terrible performance.

But do your best, and do it yourself.
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Re: International Equity: Are managed funds better than Index funds?

Post by nisiprius » Sun Sep 17, 2017 8:39 am

Doc wrote:
Sun Sep 17, 2017 8:20 am
livesoft wrote:
Sat Sep 16, 2017 8:27 pm
M* does more than ratings which are useless.
Morningstar ratings are not useless if used appropriately. Avoid funds with 1 and 2 star ratings.
Indeed. You are right, I remember a study that showed that low star ratings did show persistence. However, frequently the reason why funds have 1 and 2-star ratings is because of high expense ratios, so this might be a case where a low star rating is just an indirect proxy for high expenses?
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Re: International Equity: Are managed funds better than Index funds?

Post by JimmyJammy » Sun Sep 17, 2017 9:18 am

By coincidence, Morningstar just put out an article about Vanguard's Total International fund:
http://news.morningstar.com/articlenet/ ... ?id=825361

I like Morningstar's screeners.

I just put in the following search criteria:

Brokerage: TD Ameritrade Retail
Fund Category: Foreign Large Blend
Fund Inception: Before October 2002
Expense Ratio: 1% or less
Analyst rating: Bronze or Better

This produced only one result. (I guess VXUS is a not a free fund available at TD Ameritrade)

And that is Oakmark International Investor

OAKIX .95% yield .89% Expense Ratio

If invested in 2002, $10,000 OAKIX would now have $48K and VXUS would have $34K.

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Re: International Equity: Are managed funds better than Index funds?

Post by Doc » Sun Sep 17, 2017 10:11 am

nisiprius wrote:
Sun Sep 17, 2017 8:39 am
However, frequently the reason why funds have 1 and 2-star ratings is because of high expense ratios, so this might be a case where a low star rating is just an indirect proxy for high expenses?
Morningstar Screen:

(Distinct Portfolio Only = Yes)
and (Fund Category = U.S. Equity)
and (Morningstar Rating <= Two Stars)
and (Index Funds = No)
and (Expense Ratio >= Category average)

269 distinct funds had expense ratios greater than average out of 489 total. 55%

Is a low star rating is just an indirect proxy for high expenses? eh, maybe but certainly not definitive.

But the star rating is not a simple return rating. It is a risk adjusted return rating.

I've had good success over the years choosing funds screening for star ratings greater or equal to 2 and costs less than category average. "Failures" going forward have been mainly due to style drift not performance.

(I also remember that study.)
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Re: International Equity: Are managed funds better than Index funds?

Post by Waba » Sun Sep 17, 2017 12:10 pm

First, I want to recap what is already said:
- across the board, active international funds dont beat their benchmark
- cost matters
- persistence of past performance is weak and sometimes negative
- there may be funds that will outperform but it is extremely difficult to identify them upfront

With all of that said, I think both OAKIX and TBGVX are very good managed funds for international that have a high chance of outperforming VGTSX over the next 10 years. I base this on the fact that they have both been putting in a very solid performance over the last 25 years through a variety of market cycles.

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Re: International Equity: Are managed funds better than Index funds?

Post by Waba » Sun Sep 17, 2017 12:34 pm

nisiprius wrote:
Sun Sep 17, 2017 8:38 am
Do your best, Googling for yourself and choosing a source you trust yourself, and try to find mutual fund recommendations for international funds that were made ten years ago. Look for titles like "Best international funds for 2007." If there are more than a handful, try to figure out a fair way to take a representative sample. Then check for yourself how those funds performed over the last ten years compared to VGTSX.
So I googled and the first hit I got was:
http://www.kiplinger.com/article/invest ... -2007.html

In the list of 25 there are 4 international funds. I then went to Morningstar and looked at the 10yr anualized performance on the performance tab. The results are:
VGTSX: 1.87% (the yardstick)
JETAX: -0.76%
OAKIX: 6.37%
DODFX: 3.32%
PRMSX: 2.35%

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Re: International Equity: Are managed funds better than Index funds?

Post by Waba » Sun Sep 17, 2017 12:50 pm

The same article includes 6 go-anywhere funds, who all could have done really well during the last 10yr by not going anywhere and staying in the US:
VGTSX: 1.87 (yardstick)
VTSAX: 7.87 (where they should have gone)
FAIRX: 4.47
LMOPX: 2.95
BRAIX: closed (its sister BRAGX did 3.95)
CGMFX: 1.67
MUHLX: 1.55
MERFX: 2.03

Im surprised that FAIRX still did so well after its performance in more recent years.

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Re: International Equity: Are managed funds better than Index funds?

Post by Valuethinker » Mon Sep 18, 2017 8:28 am

nisiprius wrote:
Sun Sep 17, 2017 8:39 am
Doc wrote:
Sun Sep 17, 2017 8:20 am
livesoft wrote:
Sat Sep 16, 2017 8:27 pm
M* does more than ratings which are useless.
Morningstar ratings are not useless if used appropriately. Avoid funds with 1 and 2 star ratings.
Indeed. You are right, I remember a study that showed that low star ratings did show persistence. However, frequently the reason why funds have 1 and 2-star ratings is because of high expense ratios, so this might be a case where a low star rating is just an indirect proxy for high expenses?
Yes.

And another factor, I think.

The low starred funds will have outflows from investors. The most liquid assets will be sold, often the highest quality ones. The remaining fund investors will find themselves diluted to a less liquid, lower quality portfolio (the first is true, the second characteristic is debatable).

At least that is the problem, say, with the Primary Reserve money market Fund, and others that invested in (suddenly) less liquid assets during the crash. Here in the UK we have commercial property funds which are open ended, many had to close to redemptions (or apply massive "Market Value Adjustments" if you wanted to withdraw money).

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Re: International Equity: Are managed funds better than Index funds?

Post by oldcomputerguy » Mon Sep 18, 2017 9:14 am

JimmyJammy wrote:
Sat Sep 16, 2017 8:20 pm
So is Morningstar just a useless company making money on people's ignorance, in the opinion of the Bogleheads?
No, Morningstar provides much more information than just star ratings. But the star rating system is not intended to predict future returns, it is rather an indication of past performance. (And remember, past performance is no guarantee of future returns.) In fact, Morningstar themselves will tell you that expense ratios are the best predictor of future returns.

http://www.ipanema-capital.com/en/resea ... ose-a-fund
Investors believe that the number of stars earned by a mutual fund posseses predictive value. However, this is incorrect – even Morningstar says that their star rating is no reliable predictor of future outperformance.
https://www.brightscope.com/financial-p ... r-Ratings/
Have you ever wondered what to make of the one- to five-star ratings given to mutual funds by Morningstar’s analysts? These ratings are attached to nearly every retail mutual fund available, and are published on all of the major information outlets. Mutual fund managers love to highlight four- and five-star ratings in their marketing materials, so they must be worth something, right?

Morningstar itself calls the star rating system a “quantitative assessment of a fund’s past performance…” But we all know very well that last year’s top performer is almost never this year’s top performer and in many cases is actually this year’s worst performer. Plus, when you’re searching around for a mutual fund to buy in your 401k or your investment account, aren’t you more interested in what the “experts” (self-appointed future-tellers) think the mutual fund in question will perform in the future?? I mean, really, if past performance has no implications for future performance, what good is the rating to you?

Actually, it turns out the best predictor of future performance is the expense ratio of the fund. In a study of US funds, Morningstar itself found that in every asset class overevery time period, the cheapest quintile produced higher total returns than the most expensive quintile.

And straight from the horse's mouth...

http://news.morningstar.com/articlenet/ ... ?id=752485
If you've been following Morningstar's research for long, you know how important we think expense ratios are to the fund selection equation. The expense ratio is the most proven predictor of future fund returns. We find that it is a dependable predictor when we run the data.
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Re: International Equity: Are managed funds better than Index funds?

Post by dkturner » Mon Sep 18, 2017 10:44 am

nisiprius wrote:
Sun Sep 17, 2017 8:39 am
Doc wrote:
Sun Sep 17, 2017 8:20 am
livesoft wrote:
Sat Sep 16, 2017 8:27 pm
M* does more than ratings which are useless.
Morningstar ratings are not useless if used appropriately. Avoid funds with 1 and 2 star ratings.
Indeed. You are right, I remember a study that showed that low star ratings did show persistence. However, frequently the reason why funds have 1 and 2-star ratings is because of high expense ratios, so this might be a case where a low star rating is just an indirect proxy for high expenses?
A very valid, and important, point. My best guess is that the SPIVA reports put out by Standard and Poors would look quite different if they were rerun after excluding funds that had consistently bottom quartile performance. This would likely have the greatest impact with bond funds and international funds.

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Re: International Equity: Are managed funds better than Index funds?

Post by Doc » Mon Sep 18, 2017 12:20 pm

dkturner wrote:
Mon Sep 18, 2017 10:44 am
A very valid, and important, point. My best guess is that the SPIVA reports put out by Standard and Poors would look quite different if they were rerun after excluding funds that had consistently bottom quartile performance. This would likely have the greatest impact with bond funds and international funds.
An interesting corollary to this SPIVA vs. Morningstar comparison is the differences in the data sample of the two. With their "survivorship bias" correction SPIVA makes the sample all the funds that existed ten years in the past even those that no longer exist today but Morningstar's sample is only those funds that have survived for the entire ten years. (The ones that folded have no star rating.) Changing the sample to what dkturner suggest is a similar idea.

Since none of us can buy one of those funds that don't exist I find the SPIVA report to be somewhat self serving. The more people buy index funds the more fees are obtained by the index provider.
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Re: International Equity: Are managed funds better than Index funds?

Post by rbaldini » Mon Sep 18, 2017 12:47 pm

nisiprius wrote:
Sat Sep 16, 2017 6:29 pm
I take that to mean "across the board." Generally better. By and large, are you better off picking a managed fund over an index fund?
Isn't the answer to this question *necessarily* no? No data needed? https://web.stanford.edu/~wfsharpe/art/ ... active.htm

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Re: International Equity: Are managed funds better than Index funds?

Post by lack_ey » Mon Sep 18, 2017 1:20 pm

rbaldini wrote:
Mon Sep 18, 2017 12:47 pm
nisiprius wrote:
Sat Sep 16, 2017 6:29 pm
I take that to mean "across the board." Generally better. By and large, are you better off picking a managed fund over an index fund?
Isn't the answer to this question *necessarily* no? No data needed? https://web.stanford.edu/~wfsharpe/art/ ... active.htm
No, definitely not, even if you ignore all the issues in the margins like new issuance and everything that makes "the market" change composition over time (which thereby necessitates trading, and makes frictionless holding of the market impossible, so index funds operating in the real world have to deal with these things just as other participants*)...

*and note all the actual cases of people exploiting index fund reconstitution especially in the case of non-total-market index funds by trading ahead of their moves, and other such issues

If investing skill or some other attributes give certain groups an edge over others, then actively managed funds as a group could easily be better than index funds, even the best-in-breed index funds. It just requires a group of losers who are underperforming, i.e. the active funds taking alpha from others, most probably retail investors—where there is a pretty wide range of evidence to suggest underperformance in actuality, not just in theory.

So you do need to check the data.

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Re: International Equity: Are managed funds better than Index funds?

Post by Doc » Mon Sep 18, 2017 1:37 pm

lack_ey wrote:
Mon Sep 18, 2017 1:20 pm
So you do need to check the data.
I think William Sharpe can do the math.

"If "active" and "passive" management styles are defined in sensible ways, it must be the case that

(1) before costs, the return on the average actively managed dollar will equal the return on the average passively managed dollar and

(2) after costs, the return on the average actively managed dollar will be less than the return on the average passively managed dollar

These assertions will hold for any time period. Moreover, they depend only on the laws of addition, subtraction, multiplication and division. Nothing else is required."

ibid
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Re: International Equity: Are managed funds better than Index funds?

Post by rbaldini » Mon Sep 18, 2017 1:42 pm

lack_ey wrote:
Mon Sep 18, 2017 1:20 pm
If investing skill or some other attributes give certain groups an edge over others, then actively managed funds as a group could easily be better than index funds, even the best-in-breed index funds. It just requires a group of losers who are underperforming, i.e. the active funds taking alpha from others, most probably retail investors—where there is a pretty wide range of evidence to suggest underperformance in actuality, not just in theory.

So you do need to check the data.
So by "managed fund" we're not referring to "the total collection of non-passive investors" (in which case the arithmetic would hold), but some sub-group of the active funds? E.g. those mutual funds run by professionals, thereby leaving out amateur investors as the potential losers?
Last edited by rbaldini on Mon Sep 18, 2017 1:43 pm, edited 2 times in total.

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Re: International Equity: Are managed funds better than Index funds?

Post by triceratop » Mon Sep 18, 2017 1:42 pm

Doc wrote:
Mon Sep 18, 2017 1:37 pm
lack_ey wrote:
Mon Sep 18, 2017 1:20 pm
So you do need to check the data.
I think William Sharpe can do the math.

"If "active" and "passive" management styles are defined in sensible ways, it must be the case that

(1) before costs, the return on the average actively managed dollar will equal the return on the average passively managed dollar and

(2) after costs, the return on the average actively managed dollar will be less than the return on the average passively managed dollar

These assertions will hold for any time period. Moreover, they depend only on the laws of addition, subtraction, multiplication and division. Nothing else is required."

ibid
Right, but I think the point is it's not possible to define active and passive simultaneously in the same investment universe. Due to the issues lack_ey describes, active managers have more flexibility than passive managers.
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Re: International Equity: Are managed funds better than Index funds?

Post by rbaldini » Mon Sep 18, 2017 1:49 pm

triceratop wrote:
Mon Sep 18, 2017 1:42 pm
Right, but I think the point is it's not possible to define active and passive simultaneously in the same investment universe. Due to the issues lack_ey describes, active managers have more flexibility than passive managers.
I think you can define them just fine. E.g. passive = "the total amount invested in market indexes", active = "everything else"
lack_ey's point is that mutual funds are only a sub-group of "everything else", which means their mean return can be greater than the total market return. This just requires that there is some other group of active investors (e.g. my day-trading friends) who are doing worse, so that the total average among actively invested dollars equals the market.

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Re: International Equity: Are managed funds better than Index funds?

Post by lack_ey » Mon Sep 18, 2017 1:58 pm

rbaldini wrote:
Mon Sep 18, 2017 1:42 pm
So by "managed fund" we're not referring to "the total collection of non-passive investors" (in which case the arithmetic would hold), but some particular class of the active funds? E.g. those mutual funds run by professionals, thereby leaving out amateur investors as the potential losers?
If the context is investing in active vs. passive funds, that is the group (actively managed mutual funds) we're referencing when we talk about active funds. Usually. More broadly we say there are other active investors. These include sovereign wealth funds, university endowments, hedge funds, other institutions, family offices managing money on behalf of the UHNW, investment advisors running portfolios for clients, and retail investors/amateurs. Any particular active group could outperform at the expense of some of the others.

Though under Sharpe's definition, index funds following anything other than the total market are active too.

Actually, Sharpe's formulation has other issues, when you look in the margins at what actually being passive would entail. It's impossible to passively own the market over the long term, so the definitions and assumptions are contradictory. Just to reinvest dividends you have to transact on the market. If weightings in the market change from new issuance, buybacks, etc., or there are IPOs, suddenly your existing X shares (would be 0 for an IPO, where you don't have any yet) no longer represent the same Y% of that security and you need to buy or sell stocks to keep up. Thus total market index funds are not even completely passive and frictionless in the strictest sense, even those that can manage full replication—and the total market funds do not do full replication anyway, as it is cost prohibitive to maintain exact weights within micro caps. In any of the transactions, the active investors could be taking money from an index fund (though more like high-frequency traders and others like that, and not the actively managed mutual funds, who generally lose much more here). And in fact, on average, you should expect them to. You should also expect the effect to be relatively small most of the time, especially for total market funds. There are also details such as securities lending whereby some funds can earn returns outside of the stock market. Pesky definitions strike again.

The formulation leads to the useful intuition that the passive part of the market owns the market return (minus very small costs), and the active part of the market collectively owns the market return (minus higher costs), among other things. But it is not exact in reality. Just close enough for many purposes.

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Re: International Equity: Are managed funds better than Index funds?

Post by Doc » Mon Sep 18, 2017 2:21 pm

lack_ey wrote:
Mon Sep 18, 2017 1:58 pm
Though under Sharpe's definition, index funds following anything other than the total market are active too.
William Sharpe wrote:If "active" and "passive" management styles are defined in sensible ways
I guess the hangup here is "sensible ways". I'm not sure how lack_ey got where is but I would guess that he is using a different meaning than Sharpe.
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Re: International Equity: Are managed funds better than Index funds?

Post by lack_ey » Mon Sep 18, 2017 2:33 pm

Doc wrote:
Mon Sep 18, 2017 2:21 pm
lack_ey wrote:
Mon Sep 18, 2017 1:58 pm
Though under Sharpe's definition, index funds following anything other than the total market are active too.
William Sharpe wrote:If "active" and "passive" management styles are defined in sensible ways
I guess the hangup here is "sensible ways". I'm not sure how lack_ey got where is but I would guess that he is using a different meaning than Sharpe.
You have to align the investment universe with what the actively managed funds can own, at least in this context, comparing actively managed funds and index funds. If you have a S&P 500 index fund or Russell 1000 index fund, you don't get the market return. It's not passive within the investment universe of US stocks. When people think about index funds in most contexts, they tend to include these kinds of funds, and perhaps funds following more specialized indexes as well. Sure, you can define the investment universe around the index, such as the stocks in the S&P 500, but the active funds don't actually fall into these.

Moreover there is no "sensible way" to define things such that you can own the total market frictionlessly and passively over time. That is an issue with assumptions in the formulation. That is, unless you define your market as your initial weightings, adjusted for price movements, even as the real market changes around it.

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Re: International Equity: Are managed funds better than Index funds?

Post by Doc » Mon Sep 18, 2017 2:40 pm

lack_ey wrote:
Mon Sep 18, 2017 2:33 pm
Moreover there is no "sensible way" to define things ...
I read the Sharpe quote a couple of times every year and I always get a laugh out of "sensible'.
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Re: International Equity: Are managed funds better than Index funds?

Post by rbaldini » Mon Sep 18, 2017 3:25 pm

lack_ey wrote:
Mon Sep 18, 2017 1:58 pm
The formulation leads to the useful intuition that the passive part of the market owns the market return (minus very small costs), and the active part of the market collectively owns the market return (minus higher costs), among other things. But it is not exact in reality. Just close enough for many purposes.
Sure. But even if it were exact, it could still be that active mutual funds on average beat the market (before costs), because they are not the entirety of active investors. Correct? (Making sure I understand.)

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Re: International Equity: Are managed funds better than Index funds?

Post by lack_ey » Mon Sep 18, 2017 3:32 pm

rbaldini wrote:
Mon Sep 18, 2017 3:25 pm
lack_ey wrote:
Mon Sep 18, 2017 1:58 pm
The formulation leads to the useful intuition that the passive part of the market owns the market return (minus very small costs), and the active part of the market collectively owns the market return (minus higher costs), among other things. But it is not exact in reality. Just close enough for many purposes.
Sure. But even if it were exact, it could still be that active mutual funds on average beat the market (before costs), because they are not the entirety of active investors. Correct? (Making sure I understand.)
Yup, exactly.


Though from an investor's point of view, what matters is the performance of a subset of active mutual funds (the subset from which you might select funds). The data shows that the average fund loses after costs, but you don't have to pick a fund randomly and sample from the whole population. Hence there's the eternal search for potential screening criteria and other ways to try to select superior funds in terms of future—not past—performance. If nothing else, screening out the most expensive funds will leave you with a subset that outperforms the average active fund reasonably consistently.

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Re: International Equity: Are managed funds better than Index funds?

Post by JBTX » Mon Sep 18, 2017 3:33 pm

Haven't waded through all the posts, but FMI has 14% in US.

almost all of TROSX outperformance is in last year. Otherwise it mostly hugs the index.

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Re: International Equity: Are managed funds better than Index funds?

Post by jalbert » Mon Sep 18, 2017 4:10 pm

If you look at historical returns of active funds, the likelihood is that they will be distributed in some way due to random chance even if the managers lack the capability to beat the market. Thus, on the basis of random chance, some will always beat the market.

The question then is if the historical data is strong enough to reject the notion that the effect is just an artifact of random chance, or whether it is a significant indication of skill of the manager. This is a very difficult question to answer. An index fund investor takes the position of not being able to answer the question, and is thus content to get market returns without taking much risk of getting below market returns.

There are financial advisory firms whose purpose in life is to identify portfolio managers with a strong track record that is believed to be sustainable and durable, so there are investment professionals who believe it is possible to identify superior portfolio managers.

But the higher one's expenses, the higher the bar for beating the market, and the more risk you are likely to need to take to do it. The risk of choosing the wrong manager and getting below market returns, and the need to take extra risk to overcome higher expenses are risks an index fund investor chooses not to take.
Risk is not a guarantor of return.

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