Efficient Sectors and Indexing

greendragon71

Excuse what may be an elementary question in what I consider to be a highly experienced forum. I am 53, have a few mutual funds and have decided to do some indexing (is that a dirty word here?). I would like to lower some of my costs and have been reading continuously that indexes tend to reap higher returns over the long haul. I also read that indexing works best in "efficient " markets. What are efficient sectors?

I presently have 2 index, FUSVX, Fidelity Spartan 500, for my Large Cap sector, and PBDIX, US Bond Index. I would like to index in a couple more sectors but am unsure of what efficient refers to pr what sectors may be appropriate. My other MF are

POAGX, Primecap Aggressive Growth
CCASX, Conestoga Small Cap
FAGIX, Fidelity Capital and Income
FMIJX, FMI International
MNDFX, Manning & Napier Dividend
PRPFX, Permanent Portfolio
SFGIX, Seafarer

Any other areas above I can sell and buy a good index?

Thanks a lot for any guidance.

Mike

ron

If you have an account at Schwab, they have excellent ETF's that are no cost to buy or sell. We personally own SCHA,SCHB,SCHV,SCHX, SCHD. These I listed cover the broad market, small cap and both large value and large core and dividend stocks. We also have a couple Vanguard ETF's you can buy at Schwab, VCR and VXF.

greendragon71

I wasn't looking for recommendations as much as I was curious as to the sectors that it would be acceptable and prudent for indexing? Should one have an index for International, or would one be better off with a manager? Would it be acceptable for Small-Caps, or should one have a manager? What are the sectors where efficiency would make it OK for indexing?

fundalarm

efficient markets are mostly large cap equities, for which you have an index fund; developed countries large caps (example etf would be EFA); midcaps; US treasuries and investment grade bonds -- for which you also have a representative fund. there is a liquid subset of diversified emerging markets as well (etfs: EEM, VWO, DEM, etc).

non-efficient markets are small and micro-caps; most of fixed income/credit (high yield, loans, TIPs, EMB, non-agency mortgages, distressed debt, etc.); country specific emerging market equities, etc.

you probably could increase your allocation to the S&P500 fund at the exense of your agressive equity fund (or replace that portion with QQQ or some large cap growth index fund). you could replace MNDFX with some dividend ETF or a value index. Both of these deal in US large caps. You can find a passive replacement for your developed international exposure, and if your current manager keeps some cash to protect on the downside, you can just reinvest, let's say 90% into an index fund/etf (which don't have cash) and keep the remainder in cash as part of your asset allocation. in terms of small cap exposure and the seafarer fund -- these are dealing in inefficient markets, so you're better off with active management, in my opinion. permanent porfolio is quite passive and not expensive for the asset classes it represents. you need to understand whether you want such representation within your asset allocation. you can probably mimic some of PRPFX with existing ETFs (i am recalling that such things have been discussed), but i am not sure you'll ultimately save. ETFs carry trading fees -- every time you trade and/or rebalance, GLD has a certain tax treatment you will need to follow, etc. ....

Just some food for thought.

greendragon71

Thanks fund alarm, exactly what i was looking for.

Investor

Reply to @fundalarm: You have echoed the conventional wisdom. It is reasonable, in theory, there is more opportunity in the less researched areas for active managers to excel. Having said that the reality is a bit more complex. There is good research at S&P site:

http://www.standardandpoors.com/indices/spiva/en/us

Here is the S&P report on active vs indices.

http://us.spindices.com/documents/spiva/spiva-us-year-end-2012.pdf?force_download=true

The year 2012 marked the return of the double digit gains across all the domestic and global equity benchmark indices. The gains passive indices made did not, however, translate into active management, as most active managers in all categories except large-cap growth and real estate funds underperformed their respective benchmarks in 2012. Performance lagged behind the benchmark indices for 63.25% of large-cap funds, 80.45% of mid-cap funds and 66.5% of small cap funds.

However, it looks like best opportunities for active management doing better than indices lies in International Small Caps. Further in the report the number is given that index beat only 21.05% of active managers in International Small Caps category in the last 5 years. 1 year and 3 year results are even better for Active Management. Either the active managers are really taking advantage of the opportunities or the index is not constructed right. Whatever it is it pays to go active in that area.

Among international equity categories, 66.26% of global funds, 56.27% of international funds and 57.62% of emerging markets funds were outperformed by benchmarks over the past three years. A large percentage of international small-cap funds, on the other hand, continue to outperform the benchmark regardless of the period being measured, indicating that active management opportunities are still present in this space.