Rick Ferri on Morningstar: The Power of Passive Investing

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Rick Ferri on Morningstar: The Power of Passive Investing

Post by RJB » Sat Sep 18, 2010 10:52 am

http://www.morningstar.com/Cover/videoC ... ?id=352437

I tried to add the comment below to the article, but their scripts just would not work.

Rick does a very good job to help out investors. One of the ways he does that is through his books. I have a couple of them on my bookshelf at home and they both improved my financial education.

If that is not your cup of tea and you need to hire someone to manage your portfolio, I suggest that you contact and talk to Rick's firm. You'll be pleasantly surprised at the very low cost for that.

And evidently this threatens the hucksters. Run away from them as fast as you can. You'll keep more of your own money in your pocket that way.

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Post by bob90245 » Sat Sep 18, 2010 11:07 am

Duplicate thread. Rick already posted here:

http://www.bogleheads.org/forum/viewtop ... highlight=
Ignore the market noise. Keep to your rebalancing schedule whether that is semi-annual, annual or trigger bands.

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Post by Rick Ferri » Sat Sep 18, 2010 12:51 pm

I like this post more. The moderators can delete mine.

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Post by Mel Lindauer » Sat Sep 18, 2010 1:12 pm

Rick Ferri wrote:I like this post more. The moderators can delete mine.
Done.
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Post by tetractys » Sat Sep 18, 2010 1:21 pm

Oh, The Power of Passive Investing, as in a NEW BOOK by Rick Ferri!
Rick Ferri wrote:This book looks at the probability of winning with a portfolio of actively managed funds versus a portfolio of index funds.
:D And then there's this in the article comments:
Grasul wrote:The Rick Ferri promotion show gets off the ground, what a nightmare.
Right on Rick! -- Tet
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Post by dnaumov » Sat Sep 18, 2010 1:23 pm

I find it slightly funny that the comments to the article criticise Rick, while simultaneously failing to provide ANY actual arguments whatsoever.

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Post by Mel Lindauer » Sat Sep 18, 2010 1:45 pm

dnaumov wrote:I find it slightly funny that the comments to the article criticise Rick, while simultaneously failing to provide ANY actual arguments whatsoever.
That's the typical old "gored-ox" response. Very similar to the responses I got from the insurance industry to my Forbes columns on annuities.
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Post by Beagler » Sat Sep 18, 2010 2:01 pm

It bears repeating that Rick donates the proceeds from his books to charity.
“The only place where success come before work is in the dictionary.” Abraham Lincoln. This post does not provide advice for specific individual situations and should not be construed as doing so.

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Post by Mel Lindauer » Sat Sep 18, 2010 2:08 pm

I see that the usual Lake Woebegon suspects showed up to try to discredit Ricks interview and point of view.
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Post by kenbrumy » Sat Sep 18, 2010 2:09 pm

Mel Lindauer wrote:
dnaumov wrote:I find it slightly funny that the comments to the article criticise Rick, while simultaneously failing to provide ANY actual arguments whatsoever.
That's the typical old "gored-ox" response. Very similar to the responses I got from the insurance industry to my Forbes columns on annuities.
I'm still waiting for you to be "hit." :lol:

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Post by Mel Lindauer » Sat Sep 18, 2010 2:23 pm

kenbrumy wrote:
Mel Lindauer wrote:
dnaumov wrote:I find it slightly funny that the comments to the article criticise Rick, while simultaneously failing to provide ANY actual arguments whatsoever.
That's the typical old "gored-ox" response. Very similar to the responses I got from the insurance industry to my Forbes columns on annuities.
I'm still waiting for you to be "hit." :lol:
Actually, I fee somewhat safe since I'm currently in the witness protection program! :D
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Post by Rick Ferri » Sat Sep 18, 2010 6:52 pm

The critics certainly have the knives out today, and the full moon isn't until next week! They're all over the video that Scott Burns asked me to do. I suppose that's good. I means we're making progress because the competition appears threatened.

Thank you all for your friendly comments.

During the roaring 60s, when PhDs such as Fama, Sharpe, Treyner, Jensen and others where examining mutual fund performance, they weren't doing it to prove the markets were efficient. Far from it. They were looking for ways to beat the market. Their endeavors proved unsuccessful. While they all found that some managers did beat the market, they could not differentiate luck from skill in the mutual fund industry, and couldn't predict winners in the future. They still can't do it today.

This is still the problem with mutual funds. We all known there will be managers who beat their benchmarks in the future, the problem is recognizing who they are before it happens. In my book, I discuss many attempts to solve this mystery over the decades, with no success. It's an unsolvable riddle at the highest levels of economics and financial academia.

Give the failure of the best and brightest PhDs in the country to figure out which managers have skill and which do not, I find it odd that individual investors and many investment advisors who are doing this type of research part-time by using very rudimentary measures think they have found a way to select top managers. It just isn't so. It's only wishful thinking.

This is a behavioral finance flaw in investors and advisors, and it's a difficult one to cure. I try to cure this ill with my research and writings, Bogle tries, Bernstein tries, Swensen tries, Malkeil tries, Swedroe tries, Ellis tries, and dozens of other authors and researchers try to help with the cure. But none of us can help those who refuse to accept the facts.

The facts of passive beating active are irrefutable. When it comes to investing; the more active you get, the more behind you get. It doesn't get any simpler than that.

Rick Ferri
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Post by DA » Sat Sep 18, 2010 6:54 pm

Well what do you know ... Superman is a passive investor!


Image

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Post by bob90245 » Sat Sep 18, 2010 7:11 pm

If I ever write an investing book, I'm hiring DA to do the cover. :lol:
Ignore the market noise. Keep to your rebalancing schedule whether that is semi-annual, annual or trigger bands.

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Post by Rick Ferri » Sat Sep 18, 2010 7:13 pm

That cover is going to change some, unfortunately. We couldn't get permission to use the design unless we paid about half what the national debt is. That being said, where there's a setback, there's opportunity. I don't know exactly what Passivepowerman will look like, but he might look something like a Marine Corps fighter pilot. :wink:

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Post by tetractys » Sat Sep 18, 2010 10:06 pm

Just don't use the initials PP, ok?

Question for Rick: Have any consistant statistical differences in fund performance been found between single manager and multiple manager active funds? How do passive index funds perform measured against only multiple manager funds, that is with all the single manager funds excluded.

I'm curious if this has been looked at.

Best regards, Tet
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Post by Rick Ferri » Sat Sep 18, 2010 10:12 pm

These aren't questions that I've looked at, Tet. Sorry. Perhaps someone else has that information.

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Post by Ed 2 » Sat Sep 18, 2010 10:40 pm

Good interview.
I remember was so much noise that "buy and hold is dead" as early as two month ago on MSNBC.
In 2007-2008 - " Time of Index Funds is over".
So much disinformation and lies about passive investing out there, hard to filter the truth for beginners.
Thank you Rick.
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Post by saurabhec » Sun Sep 19, 2010 9:51 am

Rick Ferri wrote: Give the failure of the best and brightest PhDs in the country to figure out which managers have skill and which do not, I find it odd that individual investors and many investment advisors who are doing this type of research part-time by using very rudimentary measures think they have found a way to select top managers. It just isn't so. It's only wishful thinking.
I have a perpetual aversion to apeal-to-authority type of arguments, even though I am very sympathetic to your central argument and currently have no active equity funds. To be fair though, the best and brightest don't even consider Buffet to be skilled and would say he is a lucky winner of the monkey coin flipping contest.

What I am interested in is what happens to your results when you add controls for size of fund and time in existence? The mutual fund industry is notorious for churning out lots of funds that never gain critical mass and are shut down.

I think a lot of arguments against active management boild down to:
1. No skill
2. No added return after cost and taxes
3. One can't identify outperformers, and there is no guarantee of continued outperformance

#1 and #2 should lead one directly to index funds. #3 is sort of too sweeping. While the best advice for most investors might be to accept that they can't identify skill, I am not sure there aren't folks who can't identify skilled managers.

I happen to believe there is skill, and it can be identified by some savvy professionals, but the problem is that one needs to invest over several decades and there is no guarantee that the structure and investment process you select will survive for that time period. If you have to liquidate your active fund in a taxable account after 10-20 years, there is a big chance the capital gains might wipe out the outperformance. One really needs like 4-5% type outperformance on an annualized basis to protect against this kind of risk.

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Post by pkcrafter » Sun Sep 19, 2010 10:15 am

tetractys wrote:Just don't use the initials PP, ok?

Question for Rick: Have any consistant statistical differences in fund performance been found between single manager and multiple manager active funds? How do passive index funds perform measured against only multiple manager funds, that is with all the single manager funds excluded.

I'm curious if this has been looked at.

Best regards, Tet
Tet, this is an interesting question. There are some very good team and multi-managed funds that have been around for a long time. Dodge and Cox comes to mind as well as several of the Vanguard funds. This seems to dispel the idea that an outstanding individual manager is necessary for good performance. Multi-managed funds can do well because of low cost and a commitment to the best interest of the investors. These are qualities I think the mentioned funds posses. As you might guess, they are rather rare qualities. It might suggest that the general failure of active funds is not due to lack of skill, but is due to focus on self interest, which is self-destructive.



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Post by sschullo » Sun Sep 19, 2010 10:18 am

Passivity ROCKS!
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Post by Rick Ferri » Sun Sep 19, 2010 10:56 am

saurabhec wrote:What I am interested in is what happens to your results when you add controls for size of fund and time in existence? The mutual fund industry is notorious for churning out lots of funds that never gain critical mass and are shut down.

I think a lot of arguments against active management boild down to:
1. No skill
2. No added return after cost and taxes
3. One can't identify outperformers, and there is no guarantee of continued outperformance

#1 and #2 should lead one directly to index funds. #3 is sort of too sweeping. While the best advice for most investors might be to accept that they can't identify skill, I am not sure there aren't folks who can't identify skilled managers.
No one has ever said that there are no active managers with skill. The augment centers around identifying the skill managers ex-ante (before they outperform), not ex-post (after they do so, such as Buffett). I go into this topic at length in the book. I also include information on who are these very special people who have a higher probability to identify skill are, and how they do it. These people are not anyone who you could hire to manage your money.

Rick Ferri

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Post by pkcrafter » Sun Sep 19, 2010 11:48 am

saurabhec wrote:
I think a lot of arguments against active management boil down to:
1. No skill
2. No added return after cost and taxes
3. One can't identify outperformers, and there is no guarantee of continued outperformance

#1 and #2 should lead one directly to index funds. #3 is sort of too sweeping. While the best advice for most investors might be to accept that they can't identify skill, I am not sure there aren't folks who can't identify skilled managers.

I believe there are a few individual investors who are skilled enough to use active funds, but the criteria they use isn't so much the manager's skill as it is qualities of the fund itself--cost, size, turnover, philosophy, and possibily a few others.

I happen to believe there is skill, and it can be identified by some savvy professionals, but the problem is that one needs to invest over several decades and there is no guarantee that the structure and investment process you select will survive for that time period.

I also believe fund managers have skill, but there is still no advantage. Holding an actively managed fund over decades is almost a guarantee of facing failure. I've noticed that best fund lists change about 20% of their picks each year, and you can take that for what it might be worth.

Here is how I am approaching manager skill in the new update of my online book:
Many studies have concluded that active fund managers show no persistent skill, and any noticeable outperformance is due to luck. But that may not be correct. It may be more accurate to say all fund managers have excellent skills and are therefore indistinguishable from each other. They are all top of their class and the best available. They make a lot of money because they are talented. The skill level is high, but the competition is extremely tough and it tends to cancel out any outstanding manager. The end result is the same: fund managers don't appear to demonstrate skill beyond the market average before costs.

The only place you do find persistence is in the two bottom quintiles where the less talented managers, or those saddled with restrictive company requirements, remain. All others in the upper quintiles fight for high rankings. Changes in position can be due to something as simple as changing market conditions or problems the fund managers must deal with that they themselves did not create. So, yes, noticeable winning streaks from the ranks of equally talented managers must involve a little luck.


If you have to liquidate your active fund in a taxable account after 10-20 years, there is a big chance the capital gains might wipe out the outperformance. One really needs like 4-5% type outperformance on an annualized basis to protect against this kind of risk.

Yes, and that's not going to happen. I would never use an active fund in taxable.


Paul
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Post by desertdug08 » Sun Sep 19, 2010 12:48 pm

Rick,

Great interview. My kids now have an easy Christmas present for Dad. Will Passivepowerman be sporting a "High and Tight"? :) Nice tie by the way.

DUG

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Post by StoneReader » Sun Sep 19, 2010 12:52 pm

This is a variation of the old gambling rule on how to bet when the odds are against you. Your best chance is with a single one-time bet with all of your money. This is the least risky betting strategy though people persist in thinking that they are better off betting smaller amounts more times to give them a "better chance".

However, splitting your money to make more bets makes your results more accurately reflect the real odds (which are against you in both roulette and active mutual fund investing).

With active mutual funds, the passage of time is in effect just additional bets. Similarly, the more active funds in your portfolio, the more simultaneous bets that you are making on the same spin of the wheel.

There have been a number of apocryphal stories about desperate but knowledgable people who went to Las Vegas and put all of their remaining money down on one spin of the roulette wheel. They correctly wanted to avoid the statistical fate of many smaller bets on the same spin of the wheel (holding more than one active fund) and of many smaller bets on multiple spins of the wheel (holding active funds for multiple time periods).

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Post by Rick Ferri » Sun Sep 19, 2010 1:03 pm

StoneReader

:lol: I agree with you. But I don't think 'the big bet' is how most people should fund their retirement!

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Las Vegas & Active Funds

Post by StoneReader » Sun Sep 19, 2010 1:30 pm

Rick,

You're right! As you point out, they would only have a 33% chance in the best case with a single active mutual fund.

Better to go to Las Vegas and use the roulette wheel a single time where the odds are much better (but still against you).

Maybe if their spouses knew that that their active-fund investing partners were, in effect, handling their money like amateur convention gamblers in Las Vegas, they would insist on a change of tactics or a knowledgable advisor instead.

Stone ':D'

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Post by tetractys » Sun Sep 19, 2010 1:52 pm

pkcrafter wrote:
tetractys wrote:Just don't use the initials PP, ok?

Question for Rick: Have any consistant statistical differences in fund performance been found between single manager and multiple manager active funds? How do passive index funds perform measured against only multiple manager funds, that is with all the single manager funds excluded.

I'm curious if this has been looked at.

Best regards, Tet
Tet, this is an interesting question. There are some very good team and multi-managed funds that have been around for a long time. Dodge and Cox comes to mind as well as several of the Vanguard funds. This seems to dispel the idea that an outstanding individual manager is necessary for good performance. Multi-managed funds can do well because of low cost and a commitment to the best interest of the investors. These are qualities I think the mentioned funds posses. As you might guess, they are rather rare qualities. It might suggest that the general failure of active funds is not due to lack of skill, but is due to focus on self interest, which is self-destructive.

Paul
Thanks for your response, Paul.

This should all be quantified of course. And there might be better ways to expand or broaden the question's categorization. It might make a good master's thesis for someone.

Best regards, Tet
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Post by DickBenson » Sun Sep 19, 2010 4:57 pm

Rick Ferri wrote:No one has ever said that there are no active managers with skill. The augment centers around identifying the skill managers ex-ante (before they outperform), not ex-post (after they do so, such as Buffett). I go into this topic at length in the book. I also include information on who are these very special people who have a higher probability to identify skill are, and how they do it. These people are not anyone who you could hire to manage your money.
Rick, could you give us a little more detail about "who are these very special people who have a higher probability to identify skill are, and how they do it". I'm reading this to mean that there are some very special people who have a high probability of identifying a skillful manager such as Buffett ex-ante, but that they would be of little use to a typical investor.

Also, if an active manager with skill, such as Buffett, is identified ex-post, is there any data showing how investing with this subset of active "skilled" managers compare with passive investing?

Dick

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Post by Rick Ferri » Sun Sep 19, 2010 5:20 pm

DickBenson wrote:Rick, could you give us a little more detail about "who are these very special people who have a higher probability to identify skill are, and how they do it". I'm reading this to mean that there are some very special people who have a high probability of identifying a skillful manager such as Buffett ex-ante, but that they would be of little use to a typical investor.
There are a few academic studies that delve into ways the may reduce the probability of selecting poor managers, and David Swensen from Yale provides good insight on this topic in both his books, Unconventional Success and Pioneering Portfolio Management.

In general, only the most skilled investment consultants have the knowledge and skill to potentially recognize manager who have skill. According to Swensen, a vast majority of endowment and foundation trustees don't have this skill, and neither do most people who sit on ERISA pension funds.

Accordingly, for a vast majority of these institutions, and for all individual investors, a diversified portfolio of low-cost index funds is the best choice.
Also, if an active manager with skill, such as Buffett, is identified ex-post, is there any data showing how investing with this subset of active "skilled" managers compare with passive investing?
The problem is that these managers are not available for hire. They restrict access. They don't want to manage your money. If they do, it means the large institutions don't want them, and that means something's not right.

You can't hire Buffett, but you can buy Berkshire Hathaway (BRK). That's about the closest any individual is going to get to hiring a known top manager. Ironically, when I ask people who believe in active management if they own BRK, most say no. I don't understand that. Even I own BRK.

Rick Ferri

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Post by saurabhec » Sun Sep 19, 2010 5:47 pm

Rick Ferri wrote:The problem is that these managers are not available for hire. They restrict access. They don't want to manage your money. If they do, it means the large institutions don't want them, and that means something's not right.

You can't hire Buffett, but you can buy Berkshire Hathaway (BRK). That's about the closest any individual is going to get to hiring a known top manager.i
That's not exactly a fair comment. While I agree with you that the top talent in active management works in hedge funds or institutional client only funds and is not accessible through the retail channel, some are well known and available. Sequoia, Bruce Berkowitz at Fairhome,and Bill Nygren at Oakmark come to mind for one.

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Post by Rick Ferri » Sun Sep 19, 2010 6:02 pm

It's true that there have been a few top mutual fund managers out of thousands who tried. Did you buy into those top managers years ago before they outperformed? Have all your active managers outperformed? Not likely. So, your PORTFOLIO of funds likely didn't outperform even if a couple of your funds did.

Investing isn't about one fund or one stock. It's a question of PORTFOLIO return. That's the point of my interview and the point of my book. Portfolios of active funds underperform portfolios of index funds.

Rick Ferri

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Post by pkcrafter » Sun Sep 19, 2010 7:07 pm

saurabhec wrote: That's not exactly a fair comment. While I agree with you that the top talent in active management works in hedge funds or institutional client only funds and is not accessible through the retail channel, some are well known and available. Sequoia, Bruce Berkowitz at Fairhome,and Bill Nygren at Oakmark come to mind for one.
The active fund crowd is now dumping Oakmark balanced. It's returns were 78 percentile for 2009 and 95th for 2010. Gotta jump into hotter funds.


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Post by DickBenson » Sun Sep 19, 2010 7:15 pm

Rick Ferri wrote:.... David Swensen from Yale provides good insight on this topic in both his books, Unconventional Success and Pioneering Portfolio Management.

In general, only the most skilled investment consultants have the knowledge and skill to potentially recognize manager who have skill. According to Swensen, a vast majority of endowment and foundation trustees don't have this skill, and neither do most people who sit on ERISA pension funds.

Accordingly, for a vast majority of these institutions, and for all individual investors, a diversified portfolio of low-cost index funds is the best choice.
David Swensen also happens to be the chair of TIAA's Investment Committee.
TIAA Investment Committee

This committee sets policy for, and approves, all of the investments that TIAA makes, including those in commercial mortgage loans, real estate investments, investments in publicly traded bonds, and individually negotiated business loans (also known as private placements or direct loans).

The current members of this committee are David F. Swensen *** (chair), Lisa W. Hess**, Maureen O'Hara**, Donald K. Peterson***, David L. Shedlarz***, Marta Tienda*** and Rosalie J. Wolf***.
Not sure how familiar you would be with the skills of these committee members and/or how much influence Swensen has on the decisions the committee makes, but would be interested if you think that TIAA might be one of those few institutions where active management would be appropriate and successful?

The examples of the investments for which the committee is responsible does not include the newly created actively managed mutual funds,... even though it states that this "committee sets policy for, and approves, all of the investments that TIAA makes". (TIAA-CREF's governance, and power structure, is a bit confusing. These funds are not part of CREF. For bookkeeping purposes at least, they seem to be under TIAA jurisdiction). However, assuming that the committee also is responsible for these funds, should Swensen's participation make one less nervous about these funds not being passive?

Dick

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Post by Rick Ferri » Sun Sep 19, 2010 9:14 pm

Dick,

Perhaps, but I honestly couldn't answer that question. In none of his books, writings, interviews, or on-line videos does Swensen disclose which investment committees he believes are talented and which are not, whether he is on them or not. Also, not all of Swensens active managers outperform. Yale has had some disasters, just like other foundations. They've just had fewer.

Rick Ferri

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Post by saurabhec » Sun Sep 19, 2010 9:34 pm

pkcrafter wrote:
saurabhec wrote: That's not exactly a fair comment. While I agree with you that the top talent in active management works in hedge funds or institutional client only funds and is not accessible through the retail channel, some are well known and available. Sequoia, Bruce Berkowitz at Fairhome,and Bill Nygren at Oakmark come to mind for one.
The active fund crowd is now dumping Oakmark balanced. It's returns were 78 percentile for 2009 and 95th for 2010. Gotta jump into hotter funds.


Paul
What fund is Oakmark balanced? Nygren manages Oakmark, Oakmark Select and Oakmark Global Select. The performance of each has been stellar.

I am not sure what your point is? If you have a specific criticism of the portfolio managers I mentioned, then by all means lets have it. Where they rank in a popularity contest with dumb money right now is rather irrelevant to their skill and both near-term and long-term performance. Or perhaps that was what you were commenting on?

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Post by jsnbrnd » Sun Sep 19, 2010 9:59 pm

Rick Ferri wrote:That cover is going to change some, unfortunately. We couldn't get permission to use the design unless we paid about half what the national debt is. That being said, where there's a setback, there's opportunity. I don't know exactly what Passivepowerman will look like, but he might look something like a Marine Corps fighter pilot. :wink:

Rick Ferri
How about the gloved fist of a prizefighter?

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Post by Avo » Sun Sep 19, 2010 11:09 pm

Rick Ferri wrote:Have all your active managers outperformed?
Well, yes, actually, they have. In the mid 90s I began investing in Dodge & Cox Stock, Mairs & Power Growth, Third Avenue Value, Fidelity Low Priced Stock, and Fidelity Contrafund:
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Post by Rick Ferri » Mon Sep 20, 2010 8:58 am

Avo

Your funds are a range of several investment styles, i.e. small and mid cap stocks, and value stocks. To get an accurate idea of their true performance to appropriate passive benchmarks, I suggest comparing the returns of each fund to the theFama-French Three Factor Model. This model will factor out the small-cap tilts and the value tilts of the fund that could have been accomplished passively and at lower cost. The remaining manager alpha, if there is any, will then become clear.

Rick Ferri

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Post by tetractys » Mon Sep 20, 2010 9:12 am

Rick Ferri wrote:These aren't questions that I've looked at, Tet. Sorry. Perhaps someone else has that information.
Rick,

Maybe another more generalized question more relevant to this thread: Has the evidence in favor of passive investing been expanded or broadened lately, or is there new evidence for or against; and will this be covered in your book?

Thanks, Tet
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Post by Rick Ferri » Mon Sep 20, 2010 9:29 am

tetractys wrote:
Rick Ferri wrote:These aren't questions that I've looked at, Tet. Sorry. Perhaps someone else has that information.
Rick,

Maybe another more generalized question more relevant to this thread: Has the evidence in favor of passive investing been expanded or broadened lately, or is there new evidence for or against; and will this be covered in your book?

Thanks, Tet
Ironically, Tet, the evidence in favor of passive investing hasn't changed in 80 years. That was when the first study on active versus passive was conducted by Alfred Cowles. During the 1960s, dozens of in-depth studies were conducted by PhDs and PhD students, some who would go on to win the Nobel Prize for their work. Since that time, almost every important academic study on this issue favors passive investing.

So, nothing has change. The academic passive versus active debate was over years ago, and passive easily won. Now what we're seeing is the battle for the hearts and minds of investors. In that fight, the active side has a big advantage because they have billions of dollars in client fees that they use to brainwash the public into believing that there's hope.

Rick Ferri

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Post by rustymutt » Mon Sep 20, 2010 9:34 am

DA wrote:Well what do you know ... Superman is a passive investor!


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The dynamic duo also follows a passive plan. This allows them time to fight crime wherever they find it, and still maintain the Mansion.
I'm amazed at the wealth of Knowledge others gather, and share over a lifetime of learning. The mind is truly unique. It's nice when we use it!

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Post by KarlJ » Mon Sep 20, 2010 10:09 am

The vested interest in active management is understandable and I think it extends to what investors want to hear. For instance, I am wondering who would pay for an investment newsletter that did not claim to identify investments that would offer vastly superior returns.

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Post by bob90245 » Mon Sep 20, 2010 11:13 am

KarlJ wrote:The vested interest in active management is understandable and I think it extends to what investors want to hear. For instance, I am wondering who would pay for an investment newsletter that did not claim to identify investments that would offer vastly superior returns.
Sure, a newsletter can list the one-third that outperformed. But there is no assurance for continued outperformance.
Ignore the market noise. Keep to your rebalancing schedule whether that is semi-annual, annual or trigger bands.

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Post by bschultheis » Mon Sep 20, 2010 12:05 pm

Interesting article in today's WSJ regarding books by financial advisors, and Rick's work was highlighted and complemented. Nice going Rick.

I got a sneak peek at Power of Passive Investing, and really enjoyed it, a nice history lesson and insights on the evolution of passive investing, covering the entire topic of this unique investment philosophy - everything from A to Z. I know you will enjoy it. I will write a full review when it is released.

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Post by Avo » Mon Sep 20, 2010 12:22 pm

Rick Ferri wrote:Avo

Your funds are a range of several investment styles, i.e. small and mid cap stocks, and value stocks. To get an accurate idea of their true performance to appropriate passive benchmarks, I suggest comparing the returns of each fund to the theFama-French Three Factor Model. This model will factor out the small-cap tilts and the value tilts of the fund that could have been accomplished passively and at lower cost. The remaining manager alpha, if there is any, will then become clear.
My funds do have small and value tilts. The chart below shows my best and worst funds---Fidelity Low Price Stock (purple) and Dodge & Cox Stock (yellow)---and the Vanguard Value Index (green), the Vanguard Small Cap Index (blue), and (from its inception in 5/98 ) the Vanguard Small Cap Value Index (orange).

As you can see, my worst performing fund (Dodge & Cox Stock) outperformed the best performing index (Small Value, with Small used before its inception).

So, while I'm not able to do a full FF 3-factor regression, it's still absolutely clear that my portfolio of actively managed funds had large and highly significant alpha.

And before someone brings up International, please note that the chart in my first post showed both Vanguard Total Stock Market and Vanguard Total International; Total International was a much worse performer than Total Market over this period. Thus including International in a regression analysis would only serve to increase the alpha of my portfolio.

Bottom line: 15 years ago, it was not very hard to pick a portfolio of actively managed funds that outperformed the appropriate Fama-French benchmark. I did it just using info from "investment porn" sources like Money and Worth. Today, I think it's much harder. But this is why I'm highly skeptical of academic studies on how hard it is to pick winning actively-managed funds.

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Last edited by Avo on Mon Sep 20, 2010 12:39 pm, edited 2 times in total.

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Post by Rick Ferri » Mon Sep 20, 2010 12:34 pm

Avo,

OK, but I could make a good argument that the Vanguard Small Cap Index (blue) and the Vanguard Value index (green) were not the best benchmarks to compare performance nor the best index funds to be invested in. For example, the Vanguard Small Cap had a history of poor performance during the first 8 (?) years or so because it followed the inefficient Russell 2000 index rather than a 'better' benchmark.

That being said, there have been and will always be active funds that beat their benchmarks. However, selecting them in advance is more a matter of luck than skill. The odds are low, the payouts for being right are typically far below a fair game, and the persistence of performance doesn't last due to a variety of reasons. There are a handful of people who will win the active bet. But not many.

Rick Ferri

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Post by Avo » Mon Sep 20, 2010 12:46 pm

Rick Ferri wrote:OK, but I could make a good argument that the Vanguard Small Cap Index (blue) and the Vanguard Value index (green) were not the best benchmarks to compare performance nor the best index funds to be invested in. For example, the Vanguard Small Cap had a history of poor performance during the first 8 (?) years or so because it followed the inefficient Russell 2000 index rather than a 'better' benchmark.
Fine, but what other low-cost index funds were available in 1995 to the retail DIY investor??

I do agree that, today, the odds are strongly against picking good actively-managed funds, partly because the available index funds are now much better. I still try to do it to some extent though.

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Post by tetractys » Mon Sep 20, 2010 2:07 pm

Rick Ferri wrote:Ironically, Tet, the evidence in favor of passive investing hasn't changed in 80 years. That was when the first study on active versus passive was conducted by Alfred Cowles. During the 1960s, dozens of in-depth studies were conducted by PhDs and PhD students, some who would go on to win the Nobel Prize for their work. Since that time, almost every important academic study on this issue favors passive investing.

So, nothing has change. The academic passive versus active debate was over years ago, and passive easily won. Now what we're seeing is the battle for the hearts and minds of investors. In that fight, the active side has a big advantage because they have billions of dollars in client fees that they use to brainwash the public into believing that there's hope.
Rick,

Thank you very much for that. And I'm looking forward to reading your new book this December. -- Tet

P.S. How about an unstoppable locomotive for the new cover?
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Post by Rick Ferri » Mon Sep 20, 2010 2:19 pm

Avo wrote:Fine, but what other low-cost index funds were available in 1995 to the retail DIY investor??

I do agree that, today, the odds are strongly against picking good actively-managed funds, partly because the available index funds are now much better. I still try to do it to some extent though.
There was MDY, but that's a mid-cap ETF, not a small-cap index funds. So, to answer your question, there weren't any alternatives back then, but there are many today! And we make investment decisions today based on what's available today.

Rick Ferri
How about an unstoppable locomotive for the new cover?
I think the superhero figure is going to win. But the jury is still out. Thanks!

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