Larry Swedroe: Active Isn’t All Bad

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Random Walker
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Larry Swedroe: Active Isn’t All Bad

Post by Random Walker »

https://www.etf.com/sections/index-inve ... nopaging=1

Larry starts out the article with a John Bogle quote: “Stock picking pros aren’t stupid. They’re just expensive.” The article begins with a review of recent publications from Fama French and Vanguard showing that active management overall is a loser’s game. He then reviews a more recent paper emphasizing the same result. He makes the point that index investing wins not only because of expense ratios, but also because of bid-ask spreads and market impact costs. Expense ratios are strong predictors of performance, in fact they are the best predictor according to Morningstar.

The interesting part of the recent study is where the investigator created pairs of active and passive funds with similar goals and similar expense ratios. The active funds won by a statistically insignificant amount. The reason for this is that, except for total market funds, there are some disadvantages to pure indexing. Intelligent design and patient trading of a passive fund can improve upon pure indexing. There’s active management, pure indexing, and passive (not quite indexing) management. Passive funds do no stock picking or market timing, but they can improve on pure indexing by focusing on certain factors known to drive returns, avoiding anomalies known to detract from returns, trading patiently. What should be of strong interest to Bogleheads is that Vanguard itself provides the data to support these concepts. When VG’s low cost active funds are compared to the appropriate VG comparison index fund, the VG low cost active fund wins by an average 0.3% per year.

This article strongly supports Bogle’s Cost Matters Hypothesis, but it also opens our eyes to some important subtleties beyond that. There are very smart and motivated people in the investment business, and if costs can be kept down close to index fund levels, active management can outperform. There are plenty of other problems with active management though! Perhaps the best solution is passive management that avoids some of the weaknesses of pure indexing.

Dave
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randomizer
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Re: Larry Swedroe: Active Isn’t All Bad

Post by randomizer »

As always, thanks Dave.
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nedsaid
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Re: Larry Swedroe: Active Isn’t All Bad

Post by nedsaid »

Random Walker wrote: Fri Oct 19, 2018 10:02 am https://www.etf.com/sections/index-inve ... nopaging=1

Larry starts out the article with a John Bogle quote: “Stock picking pros aren’t stupid. They’re just expensive.” The article begins with a review of recent publications from Fama French and Vanguard showing that active management overall is a loser’s game. He then reviews a more recent paper emphasizing the same result. He makes the point that index investing wins not only because of expense ratios, but also because of bid-ask spreads and market impact costs. Expense ratios are strong predictors of performance, in fact they are the best predictor according to Morningstar.

The interesting part of the recent study is where the investigator created pairs of active and passive funds with similar goals and similar expense ratios. The active funds won by a statistically insignificant amount. The reason for this is that, except for total market funds, there are some disadvantages to pure indexing. Intelligent design and patient trading of a passive fund can improve upon pure indexing. There’s active management, pure indexing, and passive (not quite indexing) management. Passive funds do no stock picking or market timing, but they can improve on pure indexing by focusing on certain factors known to drive returns, avoiding anomalies known to detract from returns, trading patiently. What should be of strong interest to Bogleheads is that Vanguard itself provides the data to support these concepts. When VG’s low cost active funds are compared to the appropriate VG comparison index fund, the VG low cost active fund wins by an average 0.3% per year.

This article strongly supports Bogle’s Cost Matters Hypothesis, but it also opens our eyes to some important subtleties beyond that. There are very smart and motivated people in the investment business, and if costs can be kept down close to index fund levels, active management can outperform. There are plenty of other problems with active management though! Perhaps the best solution is passive management that avoids some of the weaknesses of pure indexing.

Dave
Very interesting. I have toyed with the idea of individual investors utilizing an active/passive strategy. Putting perhaps 60% to 70% of stocks in index funds and the remaining 30% to 40% in low cost active funds. The idea is that individual investor does his part to keep markets efficient. A variation of this idea would be to put 60% to 70% of stocks in market cap weighted index funds and the remaining 30% to 40% in low cost, more passive factor funds such as DFA.

We see that active investing CAN work, lots of folks here swear by Vanguard's low cost active funds. Also Larry Swedroe said really nice things about T Rowe Price and American Funds. You can generate Alpha, that is if your costs are low. Problem is that in the aggregate, active management is still a loser's game even at lower costs. The odds for active management do improve with lower fees, you still have to beat the competition. I would also say that active managements "success" has come from factors. My prediction is that low-cost, low turnover factor investing will replace much of today's active investing. Margins for active management are going to have to come down.
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Re: Larry Swedroe: Active Isn’t All Bad

Post by oldcomputerguy »

Random Walker wrote: Fri Oct 19, 2018 10:02 am The interesting part of the recent study is where the investigator created pairs of active and passive funds with similar goals and similar expense ratios.
I haven't read the article yet, but I'm going to be curious to see where they found an active fund and a passive fund with similar expense ratios.
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nedsaid
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Re: Larry Swedroe: Active Isn’t All Bad

Post by nedsaid »

oldcomputerguy wrote: Fri Oct 19, 2018 10:47 am
Random Walker wrote: Fri Oct 19, 2018 10:02 am The interesting part of the recent study is where the investigator created pairs of active and passive funds with similar goals and similar expense ratios.
I haven't read the article yet, but I'm going to be curious to see where they found an active fund and a passive fund with similar expense ratios.
My foggy memory recalls funds hiring sub-advisors for maybe twenty or thirty basis points, or 0.20% to 0.30% a year. Active management doesn't cost as much as we think it does, it is just that active managers have gotten away with very high margins for years. I don't think active will ever be as cheap as passive but certainly we can get the cost gap between the two to shrink.
A fool and his money are good for business.
columbia
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Re: Larry Swedroe: Active Isn’t All Bad

Post by columbia »

Vanguard Global Equity seems to be pretty good at filtering out the dogs around the globe.
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Re: Larry Swedroe: Active Isn’t All Bad

Post by garlandwhizzer »

Vanguard offers some active funds that have truly remarkable records of long term excellence--Primecap, Wellesley, Wellington among them. These funds appear to be consistently run by skillful managers who keep costs low which are the secrets to success in active management. Also, when a successful fund like Primecap reaches a certain asset level, too much to be nimble, Vanguard closes access for most new investors which is quite rare in the financial industry. In general the financial industry is in business to make money and closing access to a popular fund reduces potential profits which is why they tend not to do this. Vanguard, owned by its own investors, does not have this conflict of financial interest. If you're looking for active management that has an optimal chance to outperform long term, I suggest you check out Vanguard first. Successful funds tend to get asset bloat from performance chasing cash. Success therefore inevitably leads to failure which Magellan and even Berkshire Hathaway demonstrate. No matter how brilliant an investor you are, opportunities to consistently produce alpha are limited. When your asset base exceeds that limited pool you revert to beta or worse.

Broadly based cap weighted funds will never be at the very top of performance, but neither will they ever be at the very bottom. What they will do reliably is beat the average of all the others over long time frames. Typically the longer the time frame the greater the percentage these cheap indexes beat all of other investment approaches in aggregate. They therefore guarantee above average results by simple mathematics, a guarantee which no other investment approach can provide. Choosing a 3 fund portfolio does not imply you're unsophisticated or dull witted, often rather the opposite.

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Wakefield1
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Re: Larry Swedroe: Active Isn’t All Bad

Post by Wakefield1 »

Do the fund managers receive/get paid the bulk of the expense ratio proceeds of the funds they manage or do middlemen such as the investors/Big Banks or insurance companies who own some of the for profit fund houses get a lion's share of those proceeds?
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