Critique of an actively managed fund

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jaj2276
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Critique of an actively managed fund

Post by jaj2276 »

Anyone care to opine on the following fund, FPA Crescent (FPACX - http://finance.yahoo.com/q?s=FPACX%2C+&ql=1)? I am a believer in indexing but a co-worker of mine alerted me to this fund (he holds it of course) and after looking at it and its performance from 97 to now, it really seems to be a great fund. I can't poke any holes in it from a return standpoint nor can I come up (easily) with any simple 3-fund portfolio (or 4 or 5 funds) that would beat its returns and/or beat its risk adjusted returns.

The latest holdings shows that it has a large portion in cash right now (33%) which is not what I'd want (why pay 1.16% to have 34% of your investment in cash?), but if I look at total returns, should I care that cash is being held at this moment in time? I'm not trying to convince anyone that this is a good fund nor am I even thinking of holding it, but I would like to come up with plausible alternatives and there doesn't seem to be any (right now).

I guess a side question is, regarding active vs passive investing, how long of a time frame should one care about when considering returns. I know that one can always find any number of investments that will do better than indexing in any time period and that the success doesn't last over long periods of time. It seems however that a time frame of 16 years (with a XIRR of 9.79%) for this fund - given its style of investing (i.e. not just US equities but can also hold debt, or international equities, or cash) - might be long enough make a case for it.

Basically I wonder how much underperfomance is needed by this fund over the next X years before it starts to underperform its benchmark (which to me is hard to define)?
jmg229
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Re: Critique of an actively managed fund

Post by jmg229 »

jaj2276 wrote:I guess a side question is, regarding active vs passive investing, how long of a time frame should one care about when considering returns.
I would only care about future time periods, which history has told us don't look so rosy for your average active fund.
jaj2276 wrote:Basically I wonder how much underperfomance is needed by this fund over the next X years before it starts to underperform its benchmark (which to me is hard to define)?
This I would view as an issue, because, as you said, it is hard to know what to compare it to and therefore what role it should play in your AA according to your IPS.
MindBogler
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Re: Critique of an actively managed fund

Post by MindBogler »

One of the funds top 5 holdings is a long position in US treasuries. It looks like that position has worked out well so far but I shouldn't have to explain the risk involved. If you want to compare returns, look at Wellington which has a similar return profile with substantially less risk.
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Taylor Larimore
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Re: Critique of an actively managed fund

Post by Taylor Larimore »

jaj2276:
"Using past performance numbers as a method for choosing mutual funds is such a lousy idea that mutual fund companies are required by law to tell you it is a lousy idea." -- Bill Schulthies, author of The Coffeehouse Investor
Best wishes.
Taylor
"Simplicity is the master key to financial success." -- Jack Bogle
robertalpert
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Re: Critique of an actively managed fund

Post by robertalpert »

It has an interesting performance chart, (similar to Wellington), but the objectives of this fund are to seek very short-term reward with undervalued stocks without regard for the long-term. It is a contrarian fund. I'll stick with indexing.

The fund's statement of objectives: http://www.fpafunds.com/crescent
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jaj2276
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Re: Critique of an actively managed fund

Post by jaj2276 »

jmg229 wrote:
jaj2276 wrote:I guess a side question is, regarding active vs passive investing, how long of a time frame should one care about when considering returns.
I would only care about future time periods, which history has told us don't look so rosy for your average active fund.
jaj2276 wrote:Basically I wonder how much underperfomance is needed by this fund over the next X years before it starts to underperform its benchmark (which to me is hard to define)?
This I would view as an issue, because, as you said, it is hard to know what to compare it to and therefore what role it should play in your AA according to your IPS.
Yes, I suppose this is the critique. If you feel your asset allocation should be X, then this fund, with its ability and desire to move in and out of asset classes at any time, could lead the investor to be under and/or over exposed to any and/or all asset classes.
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jaj2276
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Re: Critique of an actively managed fund

Post by jaj2276 »

MindBogler wrote:One of the funds top 5 holdings is a long position in US treasuries. It looks like that position has worked out well so far but I shouldn't have to explain the risk involved. If you want to compare returns, look at Wellington which has a similar return profile with substantially less risk.
How are you calculating risk between the two funds? Returns I can easily calculate, but I'm unsure how to assess risk.
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jaj2276
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Re: Critique of an actively managed fund

Post by jaj2276 »

robertalpert wrote:It has an interesting performance chart, (similar to Wellington), but the objectives of this fund are to seek very short-term reward with undervalued stocks without regard for the long-term. It is a contrarian fund. I'll stick with indexing.

The fund's statement of objectives: http://www.fpafunds.com/crescent
I'm not sure I see the "... seek very short-term reward ... without regard for the long term." Their first statement says "The Fund seeks to generate equity-like returns over the long-term, take less risk than the market and avoid permanent impairment of capital." What are you drawing from that leads you to your conclusion?

I'm asking only because I want to be informed about why not to choose this fund. I see with my original post and subsequent followups, it totally looks like I'm trolling here. I'm really not.
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Re: Critique of an actively managed fund

Post by bottlecap »

jaj2276 wrote:
robertalpert wrote:It has an interesting performance chart, (similar to Wellington), but the objectives of this fund are to seek very short-term reward with undervalued stocks without regard for the long-term. It is a contrarian fund. I'll stick with indexing.

The fund's statement of objectives: http://www.fpafunds.com/crescent
I'm not sure I see the "... seek very short-term reward ... without regard for the long term." Their first statement says "The Fund seeks to generate equity-like returns over the long-term, take less risk than the market and avoid permanent impairment of capital." What are you drawing from that leads you to your conclusion?

I'm asking only because I want to be informed about why not to choose this fund. I see with my original post and subsequent followups, it totally looks like I'm trolling here. I'm really not.
It's statement of objectives describes a situation that does not exist - higher return with lower risk. This statement is, at best, marketing; at worst, a lie. You need to understand that, along with the fact that past performance is not predictive of future results, before you will understand why you should not invest in this fund, assuming the expenses are high.

JT
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Re: Critique of an actively managed fund

Post by MindBogler »

jaj2276 wrote:
MindBogler wrote:One of the funds top 5 holdings is a long position in US treasuries. It looks like that position has worked out well so far but I shouldn't have to explain the risk involved. If you want to compare returns, look at Wellington which has a similar return profile with substantially less risk.
How are you calculating risk between the two funds? Returns I can easily calculate, but I'm unsure how to assess risk.
It doesn't need to be quantified because extra risk is implicit in their strategy. Trading in derivatives and options has greater potential for return but also loss. That, by definition, is riskier than simply owning stocks and bonds. One of the common tricks of active management is to float outside of the sandbox that indexes are confined to in search of alpha (but mostly they find beta through exposure to factors not in the index). That means they can't be directly compared because the comparison is oatmeal to bananas. I understand that Wellington is active but they are also using a more transparent strategy and at a much lower cost. Because of how this fund is structured, I don't even know what a valid benchmark might be. Just remember that past performance does not guarantee future results and hedging with options always works great until it doesn't.
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Re: Critique of an actively managed fund

Post by robertalpert »

jaj2276 wrote:
robertalpert wrote:It has an interesting performance chart, (similar to Wellington), but the objectives of this fund are to seek very short-term reward with undervalued stocks without regard for the long-term. It is a contrarian fund. I'll stick with indexing.

The fund's statement of objectives: http://www.fpafunds.com/crescent
I'm not sure I see the "... seek very short-term reward ... without regard for the long term." Their first statement says "The Fund seeks to generate equity-like returns over the long-term, take less risk than the market and avoid permanent impairment of capital." What are you drawing from that leads you to your conclusion?

I'm asking only because I want to be informed about why not to choose this fund. I see with my original post and subsequent followups, it totally looks like I'm trolling here. I'm really not.
.


They seek bargains rather than attractive securities. They see volatility as opportunity. Those things may be ok if balanced by quality mgmt in their investment prospects. But I think their intention when acquiring equities is short-term. I see it as strictly a quant fund that could end up with very high turnover when volatility in the market is high.
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Re: Critique of an actively managed fund

Post by Novine »

Comments from the fund manager on why he's holding cash.
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Re: Critique of an actively managed fund

Post by FNK »

There are active funds that have done better than comparable indices for a long time. There are also active funds that did that for a while, and faltered. Basically, the manager runs out of tricks, luck or just steam.

So the real question is: how long will the streak last.
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Re: Critique of an actively managed fund

Post by Bitzer »

Folks here are generally fans of indexing. There are many proponents of actively managed funds at mutualfundobserver.com and FPACX gets many favorable comments there.
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Re: Critique of an actively managed fund

Post by galeno »

There is no way we'd ever pay a 1.16% ER for ANY fund. No way. No how.

An ER = 1.16% will reduce the success rate of your SWR by 25%! For a 30 yr retirement, this effectively reduces your 4% SWR to 3%.
KISS & STC.
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Re: Critique of an actively managed fund

Post by Dandy »

the fund performance is amazing. I guess when you buy into low cost indexing you make a trade off -- you accept close to market returns and give up getting the best or near best performance. There will always be an amazing active fund compared to the "average" index fund. Studies seem to show that it is very hard for a superior performing active fund to stay superior. They have to constantly make bets different than the market (otherwise they are an index fund). Usually, as their performance gets noticed their assets grow - now the portfolio manager/team has to either own "too much" of their best ideas, invest in some of their "B" ideas, or make large unusual bets. When he owns too much he affects the price when he starts selling (or buying for that matter).

A ways back Fidelity Magellean fund was all the rage. It once had the most assets of an equity fund. When Peter Lynch left (at the top) others had to try to get superior results with billions more than they could really invest. Fidelity should have closed the fund. Finally, one manager made a huge bet -- and it didn't work out. He was replaced and all the kings horses and all the kings men couldn't make it superior again. This is not just a one off. Success often kills performance since most funds don't shut down the funds
when assets get larger than they can handle. PIMCO' Total Return fund may be going through the same thing now. Bill Gross is thought of as a bond guru. He has made large bets recently that have not gone well. Last year I understand $41 Billion left the fund that started the year at something like $270 Billion. He might have faced the choice of being a closet index fund or taking large bets to justify higher fees.

So higher fees, higher assets to invest and constantly having to try to out smart the market eventually blunts performance even when the fund is run by a Rock Star that stays instead of leaving to run a hedge fund.
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Re: Critique of an actively managed fund

Post by robertalpert »

FNK wrote:There are active funds that have done better than comparable indices for a long time. There are also active funds that did that for a while, and faltered. Basically, the manager runs out of tricks, luck or just steam.

So the real question is: how long will the streak last.
While this fund has a 20 year history, I would only consider using active funds with longer timeframes ---- perhaps 40+ years of good performance. Wellington has 80+ years. A mere 20 years is just not long enough to prove it's performance is substantially better than random good fortune.
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Re: Critique of an actively managed fund

Post by ogd »

I will not critique this active fund. I will critique the active fund lifestyle in general.

So, suppose you're really convinced on this fund's performance and you plop your money in there tomorrow. Then, suppose it underperforms for half a decade, and another co-worker points you to this new fund, NEWX, which just completed a stellar decade. But, as luck would have it, this one too underperforms after you buy. So you switch again, to NEWRX, and so on.

Everytime you buy, you buy expensive shares. Everytime you sell, you sell cheap shares (relatively speaking -- underperforming since you bought). You perpetually buy high and sell low.

This is what most active fund investors (that you hear from, at least) seem to be doing all the time. Tracking performance, watching managers and deciding when to switch to the new star. This is also why they on aggregate underperform the very funds they invest in by 1-3% depending on which study you read.

But, you say, what if it doesn't underperform? What if this is it, the final fund to end all funds, that I'll never switch from? I assure you, that's what every performance chaser wants. Somehow, it just doesn't happen.

(For the record, I don't even buy the notion that the size of a fund affects its performance. I think it's the other way around: small funds perform or die, and the ones that make it and attract a lot of money and inevitably revert to average look like "formerly great funds which grew too big". It would be interesting to see a serious exploration of the size effect vs survivorship bias).
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FPA Crescent

Post by Hank Moody »

Reigniting this thread on FPA Crescent. An active colleague told me about it and so out of curiosity, I obtained monthly returns back to inception (1993). I then regressed it against the FF 3-factor model using the DFA Returns program.

Here are the results:

Alpha (monthly) 0.28%, T=2.5
Market 0.54, T=20
Small 0.10, T=2.8
Value 0.23, T=6.2

Correct me if I'm wrong, but doesn't a T of 2.5 imply that the monthly alpha of 0.28% is probably not random?




robertalpert wrote:
FNK wrote:There are active funds that have done better than comparable indices for a long time. There are also active funds that did that for a while, and faltered. Basically, the manager runs out of tricks, luck or just steam.

So the real question is: how long will the streak last.
While this fund has a 20 year history, I would only consider using active funds with longer timeframes ---- perhaps 40+ years of good performance. Wellington has 80+ years. A mere 20 years is just not long enough to prove it's performance is substantially better than random good fortune.
-HM
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Re: FPA Crescent

Post by Hank Moody »

Anyone?

I was hoping to get a little insight into whether we have a statistically meaningful measure to real alpha. If not, why?

Hank Moody wrote:Reigniting this thread on FPA Crescent. An active colleague told me about it and so out of curiosity, I obtained monthly returns back to inception (1993). I then regressed it against the FF 3-factor model using the DFA Returns program.

Here are the results:

Alpha (monthly) 0.28%, T=2.5
Market 0.54, T=20
Small 0.10, T=2.8
Value 0.23, T=6.2

Correct me if I'm wrong, but doesn't a T of 2.5 imply that the monthly alpha of 0.28% is probably not random?




robertalpert wrote:
FNK wrote:There are active funds that have done better than comparable indices for a long time. There are also active funds that did that for a while, and faltered. Basically, the manager runs out of tricks, luck or just steam.

So the real question is: how long will the streak last.
While this fund has a 20 year history, I would only consider using active funds with longer timeframes ---- perhaps 40+ years of good performance. Wellington has 80+ years. A mere 20 years is just not long enough to prove it's performance is substantially better than random good fortune.
-HM
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Taylor Larimore
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Alpha ?

Post by Taylor Larimore »

I was hoping to get a little insight into whether we have a statistically meaningful measure to real alpha. If not, why?
Hank:

I doubt if there is any way we can forecast mutual fund returns--especially managed funds where managers change. This post by Ozark explains:
PREDICTING THE PAST

If you feel you can improve your portfolio's asset allocation by running the portfolio through various computer programs, measuring and grading various risk/reward relationships, feel free. It's okay with me. Honest. For myself, I'm not interested.

I'm also not interested in running reams of data through a computer program in order to discover how much I can withdraw yearly from my portfolio and never go broke.

Without having studied it, I'm willing to assume the Risk Grades deal is similar to the well known Efficient Frontier concept: Invest in a mix of assets that will give the best return for the least risk.

Wonderful. The problem in execution is this; both these approaches would seem to be limited to looking at PAST risk/return relationships, in order to predict FUTURE such relationships.

This approach hasn't worked very well and it never will.

There's lots of stuff we can learn by studying the past. One thing we can't learn, though, is how much the future will resemble the past.

There really is an Efficient Frontier. There really is a withdrawal rate that will allow my wife and I to spend all our money during our life times, but never go broke.

But these things are unknown and unknowable, going forward. Such things are only knowable looking backward.

Given that such things are only knowable looking backward, academics with more letters after their names than I have money in the bank, have spent unconscionable amounts of time goobering through the past. They thus invented Modern Portfolio Theory---Beta, Alpha, R-Squared, and the crowning achievement, Sharpe Ratio. These accomplishments were celebrated and awards were given. Yes.

And then...a funny thing happened on the way to the bank. These numbers turned out to have little or no predictive value, regarding returns. And since they couldn't predict returns, they also failed to predict risk/return ratios.

Joining in the fun, M* invented their first Star Rating system, a system that graded...yep...risk- adjusted, past performance.

I wish I had 10 bucks for every post I've read where the poster said, essentially, "I have a balanced portfolio, made up entirely of 4 and 5 star funds." Too late, these jokers discovered what M* eventually discovered; past risk-adjusted performance doesn't predict future risk-adjusted performance.

I don't want to discover the Sharpe Ratio of my portfolio. I don't want to discover its Beta. I don't want to discover its Risk Grade. I have absolutely no confidence that adjusting the portfolio so that these numbers become more favorable will improve future risk/reward.

If others do want to do that, that's okay with me. I seriously doubt, though, that many successful mutual fund managers select securities in that manner. If any do, or if any money managers set their asset allocations in that manner, I'd be interested in their long-term results---results over periods of, say, 10 years, or more.

In short, computers are wonderous tools, but that's all they are. Every computer on Earth, all linked up and working 24/7, from now on, won't tell me my survival withdrawal rate. Neither will they tell me what asset allocation would give me the best risk/reward ratio.

In my opinion, these things can't be calculated. We have to forge ahead without knowing these things. Deal with it."
Best wishes.
Taylor
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Re: FPA Crescent

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Hank Moody wrote:Reigniting this thread on FPA Crescent. An active colleague told me about it and so out of curiosity, I obtained monthly returns back to inception (1993). I then regressed it against the FF 3-factor model using the DFA Returns program.

Here are the results:

Alpha (monthly) 0.28%, T=2.5
Market 0.54, T=20
Small 0.10, T=2.8
Value 0.23, T=6.2

Correct me if I'm wrong, but doesn't a T of 2.5 imply that the monthly alpha of 0.28% is probably not random?
The problem here is that you did many different experiments. If you flip a coin 10,000 times, the standard deviation of the number of heads is 50. Thus there is only a 0.6% probability that the coin will flip more than 5125 heads (2.5 standard deviations), and you might suspect that the coin is weighted. But if you flip 1000 coins, you expect six of them to be more than 2.5 standard deviations above the mean, so it doesn't make sense to pick those six and say that they are weighted.

Similarly, if you look at 1000 mutual funds, you expect six to have an alpha with T at least 2.5, even if you are using the correct model. The reason you are interested in this fund is that it had good returns; you did not select it randomly in 1993, and you did not even look at the other funds in existence in 1993 which had poor returns and have closed.
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Hank Moody
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Re: FPA Crescent

Post by Hank Moody »

Then what statistical measure and result is necessary refute the coin toss?
grabiner wrote:
Hank Moody wrote:Reigniting this thread on FPA Crescent. An active colleague told me about it and so out of curiosity, I obtained monthly returns back to inception (1993). I then regressed it against the FF 3-factor model using the DFA Returns program.

Here are the results:

Alpha (monthly) 0.28%, T=2.5
Market 0.54, T=20
Small 0.10, T=2.8
Value 0.23, T=6.2

Correct me if I'm wrong, but doesn't a T of 2.5 imply that the monthly alpha of 0.28% is probably not random?
The problem here is that you did many different experiments. If you flip a coin 10,000 times, the standard deviation of the number of heads is 50. Thus there is only a 0.6% probability that the coin will flip more than 5125 heads (2.5 standard deviations), and you might suspect that the coin is weighted. But if you flip 1000 coins, you expect six of them to be more than 2.5 standard deviations above the mean, so it doesn't make sense to pick those six and say that they are weighted.

Similarly, if you look at 1000 mutual funds, you expect six to have an alpha with T at least 2.5, even if you are using the correct model. The reason you are interested in this fund is that it had good returns; you did not select it randomly in 1993, and you did not even look at the other funds in existence in 1993 which had poor returns and have closed.
-HM
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Re: FPA Crescent

Post by grabiner »

Hank Moody wrote:
grabiner wrote:The problem here is that you did many different experiments. If you flip a coin 10,000 times, the standard deviation of the number of heads is 50. Thus there is only a 0.6% probability that the coin will flip more than 5125 heads (2.5 standard deviations), and you might suspect that the coin is weighted. But if you flip 1000 coins, you expect six of them to be more than 2.5 standard deviations above the mean, so it doesn't make sense to pick those six and say that they are weighted.

Similarly, if you look at 1000 mutual funds, you expect six to have an alpha with T at least 2.5, even if you are using the correct model. The reason you are interested in this fund is that it had good returns; you did not select it randomly in 1993, and you did not even look at the other funds in existence in 1993 which had poor returns and have closed.
Then what statistical measure and result is necessary refute the coin toss?
You have to multiply the level of significance by the number of experiments you do. If you find a result which has probability 1 in 100,000, and you have done 1000 experiments, the probability that this will happen at random is 1 in 100.

This is particularly difficult to do with mutual funds, because you don't expect performance to be consistent. If there is actually a manager with the ability to outperform the market, he is likely to have left the fund before his ability becomes statistically significant. If a manager can outperform in bear markets while matching the market in bull markets, you need to have a long bear market for the performance to stand out.
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Re: Critique of an actively managed fund

Post by bberris »

MindBogler wrote:One of the funds top 5 holdings is a long position in US treasuries. It looks like that position has worked out well so far but I shouldn't have to explain the risk involved. If you want to compare returns, look at Wellington which has a similar return profile with substantially less risk.
Risk? US Treasuries? (actually more like T-bills) I may be dense but please explain the risk.
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