A Case for Active Management

Discuss all general (i.e. non-personal) investing questions and issues, investing news, and theory.
RPS
Posts: 369
Joined: Thu Sep 09, 2010 7:58 am

Post by RPS » Wed May 18, 2011 1:55 pm

rrosenkoetter wrote:Okay name one who's going to beat their appropriate index over the next 15 years...
Caveat first. Determining the appropriate index is exceedingly difficult. By my way of thinking, a strong value bias with an appropriate (to my eyes) margin of safety substantially reduces my risk (as I define and understand it). Therefore, I would be okay with performance numbers lower than what many would see as typical markers in a variety of scenarios, irrespective of what quantitative finance might say the risk-adjusted returns are. By traditional measures, Swensen under-performed during the 1990s but over 20 years beat whatever index you might what to choose. That said, I expect equal-weighted, fundamentally-weighted and value-weighted indexes to outperform cap-weighted indexes. I expect Howard Marks (Oaktree) to outperform. I expect Joel Greenblatt (Gotham) to outperform. And I expect Seth Klarman (Blaupost) to outperform. I can't invest in all of these places, but if I decide at some point during the next 15 years that my approach is wrong, I will adjust.
Random Musings wrote:When we finally get to that fork in the road where a few will thump their chests with pride (there always will be some), could we at the very least, use a risk adjusted rear view mirror? That eliminates a good portion of our headaches.
Except that I am not likely to agree with you about what "risk-adjusted" means (see above).

larryswedroe
Posts: 15627
Joined: Thu Feb 22, 2007 8:28 am
Location: St Louis MO

Matt

Post by larryswedroe » Wed May 18, 2011 3:20 pm

Matt first, what I showed you in the returns data that if you ran a regression it would be virtually impossible for it to show alpha. Any value stocks they had in the selection would have had or should have had huge premiums. And any large stocks would also be okay. It is only the small growth stocks that might have led to negative results relative to the benchmark chosen.

Second, if they are truly skilled at active management and are not constrained by asset class then they certainly should beat the market if there are asset classes that did, like value. So their best ideas certainly should have added alpha

Either way the active story in this case anyway really falls apart

User avatar
Random Musings
Posts: 5209
Joined: Thu Feb 22, 2007 4:24 pm
Location: Pennsylvania

Post by Random Musings » Wed May 18, 2011 3:58 pm

RPS said:
That said, I expect equal-weighted, fundamentally-weighted and value-weighted indexes to outperform cap-weighted indexes.
Hence, why a reasonable amount of people on this board use small-value loadings. You are not sticking your neck out on this one.....

RM

JohnniNielsen
Posts: 41
Joined: Mon Oct 18, 2010 4:52 am

Post by JohnniNielsen » Wed May 18, 2011 4:04 pm

Everytime someone here talks about active management, it is implied that a manager is active alpha-hunting either by "selection" or "timing".

Because we are looking as risk-adjusted return, a manager can also outperform risk-adjusted simply by prudent and diligent risk-management.

Further you cannot construct a portfolio by looking at assets only. You need to look at the liabilities they need to fund. A two-fund ALM framework whereby a Core portfolio is hedging your future liabilities, and a Return Enhancing Satellite Portfolio whos allocation increase as the liability funding surplus grows.

This means correlations management and risk budgeting takes central position in active management. Why dont we talk about this?
Last edited by JohnniNielsen on Wed May 18, 2011 4:16 pm, edited 1 time in total.

RPS
Posts: 369
Joined: Thu Sep 09, 2010 7:58 am

Post by RPS » Wed May 18, 2011 4:10 pm

Random Musings wrote:Hence, why a reasonable amount of people on this board use small-value loadings. You are not sticking your neck out on this one.....
I offered other suggestions, too, don't forget. Moreover, those who tilt in that way, per F&F at least, aren't gaining any alpha. So they aren't quite true believers in passive management....

matt
Posts: 2305
Joined: Sun Mar 04, 2007 3:47 pm

Re: Matt

Post by matt » Wed May 18, 2011 4:13 pm

larryswedroe wrote:Matt first, what I showed you in the returns data that if you ran a regression it would be virtually impossible for it to show alpha. Any value stocks they had in the selection would have had or should have had huge premiums. And any large stocks would also be okay. It is only the small growth stocks that might have led to negative results relative to the benchmark chosen.

Second, if they are truly skilled at active management and are not constrained by asset class then they certainly should beat the market if there are asset classes that did, like value. So their best ideas certainly should have added alpha

Either way the active story in this case anyway really falls apart
The stock picks underperformed the market by 13%. Meanwhile, Small Caps underperformed by 26% and Foreign Stock underperformed by 54%. So it is quite easy to imagine, say, a collection of stocks that is 70% Large Cap, 15% Small Cap, and 15% Foreign Stock. That portfolio would have been assumed to underperform by 12% based on factor analysis for a modestly negative alpha.

How about 50% Large Cap, 40% Small Cap, and 15% Foreign Stock - expected underperformance of 16%. This one would actually have a positive alpha.

40% Large Cap, 40% Small Cap, and 20% Foreign Stock? Expected underperformance of 21%. Huge alpha to only trail by 13%!

So I just showed that it is clearly possible that factor exposure is the cause of the poor performance. You should have the same testing requirements when the argument is in your favor or not, but instead you revert to rationalizing instead of relying on the data. I do not buy the argument that the "best idea" should beat the market regardless of market dynamics. Sometimes the absolute best values in the market decline in value while junk stocks go up (see the tech bubble). And I will just mention the obvious points that a 2-year timeframe is not sufficient to a) measure the success of a single investment or b) measure the success of an investment manager.

I'm also not convinced by the idea that a manager would necessarily put forward his best investment idea as his ideal contest idea. They have different purposes. For example, on the Morningstar Mutual Funds forum mutual fund picking contests, I placed #1 in 2008 and something like #4 in 2009. But I did not actually own any of the funds I selected for those contests because the nature of a contest is to stand out and win on the upside, while the nature of an investment is to both win AND not lose. Again, stock selection, portfolio management, and contest entry are all very different things and the success in one of the three is not necessarily correlated to the other two. I happen to be good at all three, but we can't expect the same of everyone.

User avatar
Rick Ferri
Posts: 8375
Joined: Mon Feb 26, 2007 11:40 am
Location: Austin, TX. Twitter: @Rick_Ferri
Contact:

Post by Rick Ferri » Wed May 18, 2011 4:42 pm

JohnniNielsen wrote:Everytime someone here talks about active management, it is implied that a manager is active alpha-hunting either by "selection" or "timing".

Because we are looking as risk-adjusted return, a manager can also outperform risk-adjusted simply by prudent and diligent risk-management.
Jonnie,

This 'risk-management' you speak of is done using market timing or security selection. Also, alpha is always calculated based on a risk-adjusted formula.

Rick Ferri
Last edited by Rick Ferri on Wed May 18, 2011 4:45 pm, edited 1 time in total.
The Education of an Index Investor: starts in darkness, finds enlightenment, overcomplicates everything, accepts simplicity.

larryswedroe
Posts: 15627
Joined: Thu Feb 22, 2007 8:28 am
Location: St Louis MO

Matt

Post by larryswedroe » Wed May 18, 2011 4:44 pm

First nowhere does it say anything about international stocks so even suggesting that IMO is wrong.
Second, I showed the size premiums and one would have to assume that almost all the stocks would have to have been small to get that kind of outcome while virtually none were value. Remember value had huge premium in that period. So sure it is possible that they might have added alpha relative to benchmark, but IMO you really have to stretch to believe that happened
Third, here we totally disagree-if the idea is to pick your best idea, the one with the highest expected return, then you should certainly have been suggesting value stocks if you had abilities.
If you still feel you are right you are entitled to your opinion but IMO you are really way off base here. But just my opinion

matt
Posts: 2305
Joined: Sun Mar 04, 2007 3:47 pm

Re: Matt

Post by matt » Wed May 18, 2011 5:24 pm

Larry,
I have not seen the articles. I have no idea what stocks they picked. I see foreign stock picks in such magazines all the time, so I don't know why I'm supposed to just rule them out. I forget who it was, but an active manager once said, "The easiest way to beat an index is to buy stocks that aren't in the index". As you also know, large cap active managers tend to have a lower average market cap than the index, but they don't necessarily have a style tilt. A quick review in Principia shows me that only 6.5% of distinct Large Blend funds have a higher average market cap than the S&P 500. So it is clearly within reason to assume that many of these managers' picks have a small bias to them.

If you still have a copy of the articles and the stocks are listed there, please disclose them. Otherwise, there is not much left to debate. We both know that the only way to evaluate them is with a multi-factor model, but you insist on hand waving. Hand waving has never convinced me of anything.

larryswedroe
Posts: 15627
Joined: Thu Feb 22, 2007 8:28 am
Location: St Louis MO

matt

Post by larryswedroe » Wed May 18, 2011 6:06 pm

Why you think it is hand waving is beyond me
Given the huge underperformance it would be almost impossible to have a portfolio that underperformed picking stocks unless they all happened to choose small growth stocks. Or at least a large majority. Possible but not likely.
But more importantly as I stated it doesn't even matter because if there was stock picking skills they would avoid small growth since not limited to that asset class, they could have chosen large value for example. Why not?
Nothing more I can say

matt
Posts: 2305
Joined: Sun Mar 04, 2007 3:47 pm

Re: matt

Post by matt » Wed May 18, 2011 6:16 pm

larryswedroe wrote:Why you think it is hand waving is beyond me
Given the huge underperformance it would be almost impossible to have a portfolio that underperformed picking stocks unless they all happened to choose small growth stocks. Or at least a large majority. Possible but not likely.
I showed you various portfolio combinations which could explain the returns and they did not require a large majority in small cap growth.
larryswedroe wrote:But more importantly as I stated it doesn't even matter because if there was stock picking skills they would avoid small growth since not limited to that asset class, they could have chosen large value for example. Why not?
This is baffling. You are arguing that a good stock picker must perform tactical asset allocation and know which style is going to be in favor. Identifying good values does not mean you know when the market is going to recognize them. I could name a few securities today that I expect to have substantial alpha over a 5-year timeframe, but that doesn't mean I can promise you alpha in two years. Sometimes the market is really slow to figure things out.

User avatar
HomerJ
Posts: 11198
Joined: Fri Jun 06, 2008 12:50 pm

Post by HomerJ » Wed May 18, 2011 9:10 pm

JohnniNielsen wrote:A two-fund ALM framework whereby a Core portfolio is hedging your future liabilities, and a Return Enhancing Satellite Portfolio whos allocation increase as the liability funding surplus grows.
Your lips are moving, but I'm not hearing English... Those words sure sound pretty though.... "Return Enhancing Satellite Portfolio"? That sounds awesome.

:roll: :roll:

User avatar
doug91
Posts: 276
Joined: Tue Feb 12, 2008 5:47 pm

Post by doug91 » Wed May 18, 2011 11:53 pm

Penonmydesk wrote:Let's try this again.

Here is something you guys have all seen before, but it seems appropriate for this thread.

Article on Index Performance vs. Active Management 1910 - 2011
This is a link to a known host for viruses. If you clicked on the link, run a virus scan on your PC.

JohnniNielsen
Posts: 41
Joined: Mon Oct 18, 2010 4:52 am

Post by JohnniNielsen » Thu May 19, 2011 6:42 am

Rick Ferri wrote: Jonnie,

This 'risk-management' you speak of is done using market timing or security selection. Also, alpha is always calculated based on a risk-adjusted formula.

Rick Ferri
All Im advocating is, that a rule-based ALM risk budgeting technique is a more prudent and sustainable skill-set vis-a-vis stock picking or market timing.

Given the same needed future portfolio value, the portfolio for a client retiring in US is very different from the investor saving for retirement at Côte d'Azur. Hence we can not just create a portfolio of cap-weighted investment vehicles simply because they are lowest-cost. They could have un-prudent sector or beta tilts, but more importantly if they dont correlate with the liabilities we seek to hedge, they dont qualify.

Also in my humple opinion Alpha is an elusive concept outside academia, just look at the volatility of beta/factor exposure. And tell me how a regression or kalman filter can diligently determine Alpha.

pkcrafter
Posts: 12740
Joined: Sun Mar 04, 2007 12:19 pm
Location: CA
Contact:

Post by pkcrafter » Thu May 19, 2011 9:28 am

rrosenkoetter wrote:
JohnniNielsen wrote:A two-fund ALM framework whereby a Core portfolio is hedging your future liabilities, and a Return Enhancing Satellite Portfolio whos allocation increase as the liability funding surplus grows.
Your lips are moving, but I'm not hearing English... Those words sure sound pretty though.... "Return Enhancing Satellite Portfolio"? That sounds awesome.

:roll: :roll:
If anyone is interested, here's how to decode JohnniNielsen's investospeak:

http://www.fpanet.org/journal/CurrentIs ... rPlanners/

Asset-liability management (ALM) provides a risk-management technique that focuses on both sides of an investor’s balance sheet, in contrast to traditional asset allocation approaches, which tend to only emphasize investor assets.

Paul
When times are good, investors tend to forget about risk and focus on opportunity. When times are bad, investors tend to forget about opportunity and focus on risk.

User avatar
Doc
Posts: 8216
Joined: Sat Feb 24, 2007 1:10 pm
Location: Two left turns from Larry

Re: Matt

Post by Doc » Thu May 19, 2011 9:40 am

Larry, Rick, Matt
matt wrote: We both know that the only way to evaluate them is with a multi-factor model, but you insist on hand waving.
Would all three of you please try to explain why alpha in the FF3F is so often equated to "skill". We all are aware and I think Larry just mentioned that the value and or size parameters are often opposite to the long term trends. It seems obvious to me that if an active manger was able to predict a change in the direction of the size or value factors that should be considered part of his skill. If we regress out his decision to overweight or underweight those factors after the fact aren't we effectively doing statistical data mining?

It seems to me that a manager should be evaluated only relative to the style index that he adheres to. I suggest that the M* style indexes are appropriate for this measurement because they do not have "bands" which might important for an index fund bogie but not for a measurement baseline. For those managers that don't stay within a distinct style box you have to fall back to a broader index to evaluate them.

larryswedroe
Posts: 15627
Joined: Thu Feb 22, 2007 8:28 am
Location: St Louis MO

Doc

Post by larryswedroe » Thu May 19, 2011 10:14 am

if a manager has skill in tactically shifting it would show up as alpha.
BTW-the alpha is the unexplained return, it could be skill or luck. What you can look for is the statistical significance of the outcome.

pkcrafter
Posts: 12740
Joined: Sun Mar 04, 2007 12:19 pm
Location: CA
Contact:

Post by pkcrafter » Thu May 19, 2011 5:51 pm

Doc wrote:
For those managers that don't stay within a distinct style box you have to fall back to a broader index to evaluate them.
Doc, it's almost by necessity that a fund manager will move out of a specific style box because the first thing he must do is separate himself from the index. Here's the portfolio for FAIRX, a fund in the large value category. Really?

http://portfolios.morningstar.com/fund/ ... ture=en-US

Paul
When times are good, investors tend to forget about risk and focus on opportunity. When times are bad, investors tend to forget about opportunity and focus on risk.

User avatar
stratton
Posts: 11082
Joined: Sun Mar 04, 2007 5:05 pm
Location: Puget Sound

Post by stratton » Thu May 19, 2011 5:54 pm

Research paper on what hedge fund investors really earn.

http://www.bogleheads.org/forum/viewtopic.php?t=75026

Paul
...and then Buffy staked Edward. The end.

User avatar
Doc
Posts: 8216
Joined: Sat Feb 24, 2007 1:10 pm
Location: Two left turns from Larry

Post by Doc » Thu May 19, 2011 6:37 pm

pkcrafter wrote:Doc wrote:
For those managers that don't stay within a distinct style box you have to fall back to a broader index to evaluate them.
Doc, it's almost by necessity that a fund manager will move out of a specific style box because the first thing he must do is separate himself from the index. Here's the portfolio for FAIRX, a fund in the large value category. Really?

http://portfolios.morningstar.com/fund/ ... ture=en-US

Paul
Paul, you are getting too black and white in your thinking. A fund manager could decide that when sampling the say SV universe based on the same criteria of a certain index and then throwing out all the firms with new competition he would likely outperform the index before expenses. The skill might in determining those companies without running up his cost too much. No running out of the style box needed.

As far as the FAIRX types go, maybe we need to add a style "purity" factor to our screen. (Which I do when I am carrying out this type of exercise for real instead of just for discussion purposes.) Certainly a fund that has 75% financials in its portfolio is hard to compare to anything. I also tend to stay away from five star funds because asset bloat is a real phenomena except in special circumstances.

pkcrafter
Posts: 12740
Joined: Sun Mar 04, 2007 12:19 pm
Location: CA
Contact:

Post by pkcrafter » Thu May 19, 2011 7:37 pm

Paul, you are getting too black and white in your thinking.
You're right, but we have to keep you on your toes. I'll add some grey. But wait, there's some gray area on how to spell this word. Maybe I'll add a little taupe. :)


Paul
When times are good, investors tend to forget about risk and focus on opportunity. When times are bad, investors tend to forget about opportunity and focus on risk.

User avatar
Random Musings
Posts: 5209
Joined: Thu Feb 22, 2007 4:24 pm
Location: Pennsylvania

Post by Random Musings » Fri May 20, 2011 2:50 pm

pkcrafter wrote:
If anyone is interested, here's how to decode JohnniNielsen's investospeak:

http://www.fpanet.org/journal/....rPlanners/

From the article:
The risk-management goal of ALM is to stabilize or enhance the balance of an investor’s assets over liabilities, which are both affected by market performance and investor circumstances. However, one practical challenge associated with establishing an ALM framework relates to the costs of implementation, particularly in a low interest rate environment.
RM

User avatar
floydtime
Posts: 410
Joined: Sat Feb 26, 2011 10:09 pm
Location: A book

Post by floydtime » Fri May 20, 2011 3:20 pm

I'm still waiting to hear who is going to outperform the market over the next 15 years so I can put in my buy order. Anyone?
"Do not value money for any more nor any less than its worth; it is a good servant but a bad master" - Alexandre Dumas

matt
Posts: 2305
Joined: Sun Mar 04, 2007 3:47 pm

Post by matt » Fri May 20, 2011 3:29 pm

floydtime wrote:I'm still waiting to hear who is going to outperform the market over the next 15 years so I can put in my buy order. Anyone?
I am going to outperform, but you can't order me.

User avatar
floydtime
Posts: 410
Joined: Sat Feb 26, 2011 10:09 pm
Location: A book

Post by floydtime » Fri May 20, 2011 3:34 pm

matt wrote:
floydtime wrote:I'm still waiting to hear who is going to outperform the market over the next 15 years so I can put in my buy order. Anyone?
I am going to outperform, but you can't order me.
Aww man. Does anybody besides Matt know the future here?? Even better, someone who manages a public fund? Surely there must be someone!
"Do not value money for any more nor any less than its worth; it is a good servant but a bad master" - Alexandre Dumas

matt
Posts: 2305
Joined: Sun Mar 04, 2007 3:47 pm

Post by matt » Fri May 20, 2011 3:43 pm

floydtime wrote:
matt wrote:
floydtime wrote:I'm still waiting to hear who is going to outperform the market over the next 15 years so I can put in my buy order. Anyone?
I am going to outperform, but you can't order me.
Aww man. Does anybody besides Matt know the future here?? Even better, someone who manages a public fund? Surely there must be someone!
So you want an equity fund that is going to outperform the U.S. stock market? Sure. Fairholme (FAIRX). Buy it now while it's struggling and forget about it for 15 years.

User avatar
floydtime
Posts: 410
Joined: Sat Feb 26, 2011 10:09 pm
Location: A book

Post by floydtime » Fri May 20, 2011 4:05 pm

Thanks. After reading certain previous predictions, I...think I'll hold off for now.
"Do not value money for any more nor any less than its worth; it is a good servant but a bad master" - Alexandre Dumas

User avatar
Doc
Posts: 8216
Joined: Sat Feb 24, 2007 1:10 pm
Location: Two left turns from Larry

Post by Doc » Fri May 20, 2011 7:04 pm

floydtime wrote:I'm still waiting to hear who is going to outperform the market over the next 15 years so I can put in my buy order. Anyone?
Can you tell me which index fund is going to underperform the market by approximately it's e/r over the next 15 years? How about the last 15 years?

Hint, excluding large blend you can count the ones that even existed for 15 years without taking off your shoes. You will need a barefoot friend to count them all. And some of them have changed there index if not their name so you shouldn't count them - surviorship bias right. :lol:

User avatar
floydtime
Posts: 410
Joined: Sat Feb 26, 2011 10:09 pm
Location: A book

Post by floydtime » Fri May 20, 2011 8:44 pm

Doc wrote:Can you tell me which index fund is going to underperform the market by approximately it's e/r over the next 15 years?
With certainty, of course not. With a reasonable expectation and with a well-established index fund, yes.
How about the last 15 years?
I could, yes. It's public information.
Hint, excluding large blend...
If you count TSM as large blend (which it essentially is), then I would agree - there aren't very many non large-blend funds that are very well established.

In my case, TSM is one of my core holdings, and I can be (again, reasonably confident) that it will continue to underperform the market by its ER over the next 15 years.
"Do not value money for any more nor any less than its worth; it is a good servant but a bad master" - Alexandre Dumas

User avatar
Doc
Posts: 8216
Joined: Sat Feb 24, 2007 1:10 pm
Location: Two left turns from Larry

Post by Doc » Sat May 21, 2011 8:45 am

floydtime wrote:
Doc wrote:Can you tell me which index fund is going to underperform the market by approximately it's e/r over the next 15 years?
With certainty, of course not. With a reasonable expectation and with a well-established index fund, yes.
The irony is that you and others are perfectly comfortable using past performance as in "well-established index fund" to conclude that index funds will perform the same in the future but at the same time many reject the same argument when applied to active funds. The case against active management takes many tracks in support of the thesis but if you apply many of the same arguments to index funds the index funds don't pass muster either.

For example, if you define "well-established" as a minimum of ten years performance the only well-established small value index fund is Vanguard Small Cap Value and it changed its index during those ten years which to me means that you restart the clock and therefore there are none. :cry:

User avatar
fundtalker123
Posts: 883
Joined: Tue Feb 27, 2007 4:18 am

Post by fundtalker123 » Sat May 21, 2011 9:14 am

If they really believe they arent monkeys, why dont active managers just guarantee they will beat certain indexes or else pay you the difference?

Oh, wait, I guess that's what Madeoff did!

User avatar
norookie
Posts: 3016
Joined: Tue Jul 07, 2009 1:55 pm

Post by norookie » Sat May 21, 2011 9:30 am

floydtime wrote:
matt wrote:
floydtime wrote:I'm still waiting to hear who is going to outperform the market over the next 15 years so I can put in my buy order. Anyone?
I am going to outperform, but you can't order me.
Aww man. Does anybody besides Matt know the future here?? Even better, someone who manages a public fund? Surely there must be someone!
:D I'd suggest anyone that considers what people need rather than what their led to believe they need might in fact be on to something. People need CStaples, Healthcare, REITs, and a few other needs like energy. As has been discussed here before a equity % made up of these sectors, all equally weighted, might in fact be a good "guess" as to what might beat the Wilshire5k index. Or a global index. In plain engrish. :wink:
" Wealth usually leads to excess " Cicero 55 b.c

User avatar
floydtime
Posts: 410
Joined: Sat Feb 26, 2011 10:09 pm
Location: A book

Post by floydtime » Sat May 21, 2011 2:21 pm

Doc wrote:
floydtime wrote:
Doc wrote:Can you tell me which index fund is going to underperform the market by approximately it's e/r over the next 15 years?
With certainty, of course not. With a reasonable expectation and with a well-established index fund, yes.
The irony is that you and others are perfectly comfortable using past performance as in "well-established index fund" to conclude that index funds will perform the same in the future but at the same time many reject the same argument when applied to active funds. The case against active management takes many tracks in support of the thesis but if you apply many of the same arguments to index funds the index funds don't pass muster either.

For example, if you define "well-established" as a minimum of ten years performance the only well-established small value index fund is Vanguard Small Cap Value and it changed its index during those ten years which to me means that you restart the clock and therefore there are none. :cry:
Ehh, I wasn't part of that discussion, and I don't really care about non-large-blend, but I'll bite.

"Survivorship bias" doesn't really matter if all the funds in the class being measured (such as "all index funds following index X") have effectively identical results, minus their ER. Index funds are like this...boring and predictably the same.

So if my index fund goes away, I'll switch to another that tracks the same index. (yes, I'm sure you can find exceptions when the fund manager has "gone soothsayer", but you'd be reaching)

But if my managed fund goes away, I can't switch to "another one" since they are unique. (and, I'd add, they often go away because their luck ran out)
"Do not value money for any more nor any less than its worth; it is a good servant but a bad master" - Alexandre Dumas

User avatar
Doc
Posts: 8216
Joined: Sat Feb 24, 2007 1:10 pm
Location: Two left turns from Larry

Post by Doc » Sat May 21, 2011 5:27 pm

floydtime wrote:
So if my index fund goes away, I'll switch to another that tracks the same index. (yes, I'm sure you can find exceptions when the fund manager has "gone soothsayer", but you'd be reaching)
Five year returns for several small value index funds or ETFs with different indexes:

2.34, 2.37, 2.64, 3.88, 4.47, 5.48

Which one do you choose for the next 15 years? And if by chance you took one of the three on the left and it disappeared in 5 or 10 years how would you feel about index funds being "boring and predictably the same"?

BTW you may not be able to pick one that follows the same index because the index might no longer exist and would you really want to anyway? And then there's the tax cost.

I am not trying to argue for active management. I'm just trying to point out that many of the arguments that index advocates apply against active management also apply to index funds as well. The biggest of course is "past performance is no guarantee ...".

matt
Posts: 2305
Joined: Sun Mar 04, 2007 3:47 pm

Post by matt » Sat May 21, 2011 6:18 pm

Doc wrote:Five year returns for several small value index funds or ETFs with different indexes:

2.34, 2.37, 2.64, 3.88, 4.47, 5.48

Which one do you choose for the next 15 years? And if by chance you took one of the three on the left and it disappeared in 5 or 10 years how would you feel about index funds being "boring and predictably the same"?

BTW you may not be able to pick one that follows the same index because the index might no longer exist and would you really want to anyway? And then there's the tax cost.

I am not trying to argue for active management. I'm just trying to point out that many of the arguments that index advocates apply against active management also apply to index funds as well. The biggest of course is "past performance is no guarantee ...".
I agree with this sentiment. I have commented in the past that the only type of indexing of stocks that makes sense is of the total market. That is an achievable passive strategy.

The theory behind capturing the small and value premiums through indexing strategies has been a big hit or miss so far. As can be seen with Vanguard Small Cap Value, the performance has been unimpressive relative to the theoretical expectations and they've changed the benchmark at least once. DFA's slightly more active approach has been pretty successful over the long run, but of course is not available to most investors and their small value fund hasn't looked too hot in the past five years (imitation may be flattering, but it doesn't help when so many are now trying to capture these premiums). A few ETFs seem to do a decent job right now, but who can say for sure that they will continue to do so? As for the small premium, quite a few here tried their hand with Bridgeway Ultra-Small Company Market based on prior success and have been thoroughly disappointed for about 5 years.

So to capture broad stock market exposure, absolutely go the index route. But I see the same problem as Doc when it comes to tilting to small, value or whatever floats your boat. It's quite challenging to figure out which method is actually going to deliver going forward and is not all that different from the problem of selecting active managers. My personal preference in attempting to capture value exposure is to use active managers, not passive or quants. I put my faith in the brains of some good managers instead of handing my money over to a computer that is solely focused on historical data.

Post Reply