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Time to dust off the old canard about how wonderful buy-and-hold index funds are and how "foolish" actively managed mutual funds are. Please tell me how wonderful index funds are after they have lost 50% of their value twice in the span of a decade (1999 to 2009) and how wonderful they will be when they once again lose 40% to 50% in the next bear market? Then tell me how "foolish" investors are to pay 1% in fees for a skilled portfolio manager, e.g., Steven Romick of FPACX, Charles Dreifus of RYSEX, and several others all of us can name) to lose 20% to 30% in the same bear market.
Mark and Dlphic, I think you're both correct. I use a mix of index ETFs and actively managed funds. The question, for me is where to use index funds (e.g. US large cap?) and where to use actively managed funds (e.g. emerging markets?)
Under the discussion thread entitled "Efficient Sectors and Indexing", the MFO member 'fundalarm' does an excellent job of suggesting where ETFs will work best and where actively managed MFs will outperform. Worth a read. IMHO, both ETFs and actively-managed MFs have a place in a well-designed portfolio. I strognly disagree with the article from the SF Chronicle with regard to how "foolish" an investor is to use anything but an ETF.
Reply to @DlphcOracl: I've added a post to that thread with actual statistics from S&P when indices beat and when it did not. Conventional wisdom expressed by fundalarm does not very well. One category that active management is clearly best is Intl. Small caps.
Thank you for the very fine article that supports the case for mostly passive Index investing.
But I am puzzled by the dateline on the article; it’s over 5 years old. We’ve experienced a major market disruption, and significant world events since its publication. Admittedly, the overarching recommendations may not have changed, but the additional market performance since the article was released may have altered some of the observations summarized.
I took the article in terms of providing some historical context and perspective. This is useful stuff.
Along those same lines, I would highly recommend the Peter Bernstein book “Capital Ideas” for a more complete historical development. That 1992 book covers the same timeframe as the Mark Dowie piece in much greater detail. Some of the inside stories are especially revealing in terms of the slipshod manner of keeping score before 1960. In those earlier years, the “experts and gurus” feet were not held to the fire with regard to their predictions and performance standards.
Given financial incentives, the smartest money managers must be employed by institutional agencies. This smart money, on a percentage basis, invests 3 times more funds in Index products than does the private investor. They recognize and exploit every advantage they can identify. Even these institutional powerhouses have considerable difficulty in finding exceptionally gifted fund management talent that persists over time.
David Swensen was a relatively latecomer to the passive investment cadre for individual investors. His long term success managing the Yale funds is the stuff of legends. In his original outline of his 2005 “Unconventional Success” book, he planned to provide a roadmap that he followed. He soon realized that us private investors do not have access to the tools and resources needed to execute that complex strategy. He concluded that Index investing was the proper pathway for most of us, and rewrote huge segments of his book accordingly. Time has positively reinforced that decision in his mind.
It is a daunting challenge for private investors to locate outstanding fund managers. The Litman/Gregory fund series was organized to specifically address the identification of superior fund manager prospects. Their top tier goal is to find and to carefully monitor a superior set of managers, and to use only their “best ideas” in the form of focused funds. Overall, the firms results have disappointed. I have owned their Masters’ Select Equity fund since its inception without exceptional rewards. Indeed, it’s a daunting challenge.
For the record, I currently own a mix of passively and actively managed funds. Over time, I have added to my passive holding sleeves at the expense of my active positions. I anticipate that I will continue that trend. Costs matter greatly, and only an exceptional few managers earn their pay over the long haul. A few do so.
Reply to @MJG: Personal confession. I dug this out of my treasure chest of remindful investing articles. I was originally more intrigued by the Google connection then I was by the general gist of the article. I didn't believe it at the time it was written anymore than I believed it 10 years prior. I always thought that I was smart enough, knowledgeable enough and diligent enough in my research to beat this system. Frankly I suck at it.
However in 2008 I started to transform my portfolio from one of close to 30 odd mutual funds down to the five I hold today along with a mutual fund of my own making which consists nearly entirely of dividend paying individual equities in what I term my trading portfolio. Also, acting on my realization that I certainly had no problem ferreting out mo-mo mutual funds to buy, but was pretty much frozen when it came time to sell, I decided to invest those funds (via my IRA account) in the IVY Timing Portfolio http://advisorperspectives.com/dshort/updates/Monthly-Moving-Averages.php
According to M* shared portfolio data my mutual fund portfolio has outperformed 21% of all similar mutual fund portfolios over the past 5 years with a 7.79% annual return. Conversely one might note that it underperformed 79% of similar mutual funds. My stock portfolio has out performed 97% of similar mutual funds with a 19.75% annual return. The IVY portfolio is running around 12% annual returns. Not bragging, not gloating, just the facts and I sleep way better at night. As soon as Mr. Danoff, Mr. Berkowitz, Mr. McGregor, and the Matthews kids toss in their chips I expect to no longer own any mutual funds.
As I look at it now I am reminded of my dissertation advisor's advice on entering my oral exams "Knowing when to say that you don't know the answer will be the key to you getting through this exam."
I've read all the links provided, but I can't find "Efficient Sectors and Indexing" from Fundalarm. How do I find it? I put the title in the search box, but admittedly didn't use quotes. From my many years of misadventure, it seems clear than indexing works in developed markets, especially since my managers lost 50% of my money in the market drops (although really I lost it because I chose them), so active management didn't work for me. I rode Berkowitz down and now up, but I think I'm positive in the fund and negative against the index. Have some with Danoff, too, but don't want to think about the fees I've paid for management. I'm also in FPA Crescent with an AIP and some IRA funds, but I haven't been able to identify the stars. Perhaps M* "Managers of the Decade" are the best choices, but waiting ten years to identify them means I missed the good years and chase the hot money into their funds. The one thing this thread did was convince me to put my children's IRAs in index funds, since all the current stars will be retired or dead before they need the money. The only problem is that they need to gradually develop a bond percentage. Perhaps Vanguard target funds are the answer. (Interestingly, Jack Bogle was quoted as suggesting that Social Security met some of the bond segment needs.) Since MFO's thesis, I believe, is that good managers with small funds can beat the market, the time is approaching for this to be tested. I think a three year performance evaluation against whatever index they had chosen should be posted for the profiled funds; use longer performance times if they have them. This might also recognize sell sizes when a fund exceeds its efficient size (not sure how much data there is on that, but I came across a Bill Miller quote implying that it exists - if so, he certainly crossed it). I don't think the original article is outdated in my personal experience. I only regret that my 403b offers nothing from Vanguard.
Reply to @jerry: I was following the article until I got to the conclusion. If you know which asset classes will outperform, then use index funds. If you don't know... then you should still use index funds anyway? Didn't the rest of the article just say that active funds outperform when the asset class underperforms?
Reply to @claimui: It has been my experience that there will always be time intervals when active or passive funds outperform or underperform. I did my darndest to stay on top of the trends but just couldn't pull it off on a consistent enough basis and therefore resigned from fooling myself any longer. Life's too short. Your mileage may vary.
I still believe that active management can beat passive management within certain asset classes but I am also limited in the number of chips I can throw into the pot to take better advantage of the outperformance when it happens. My minuscule contributions or stakes just don't amount to much to the overall bottom line. Should have been born rich.
Comments
Thank you for sharing this story.
Regards,
Catch/Mark
Time to dust off the old canard about how wonderful buy-and-hold index funds are and how "foolish" actively managed mutual funds are. Please tell me how wonderful index funds are after they have lost 50% of their value twice in the span of a decade (1999 to 2009) and how wonderful they will be when they once again lose 40% to 50% in the next bear market? Then tell me how "foolish" investors are to pay 1% in fees for a skilled portfolio manager, e.g., Steven Romick of FPACX, Charles Dreifus of RYSEX, and several others all of us can name) to lose 20% to 30% in the same bear market.
Under the discussion thread entitled "Efficient Sectors and Indexing", the MFO member 'fundalarm' does an excellent job of suggesting where ETFs will work best and where actively managed MFs will outperform. Worth a read. IMHO, both ETFs and actively-managed MFs have a place in a well-designed portfolio. I strognly disagree with the article from the SF Chronicle with regard to how "foolish" an investor is to use anything but an ETF.
Here is one answer though it sort of suggests you need a macro view. http://www.cbsnews.com/8301-505123_162-57573864/when-indexing-works-and-when-it-doesnt/
This article certainly seems to suggest that now would be a good time for an active bond fund although PTTRX has not been great lately.
Thank you for the very fine article that supports the case for mostly passive Index investing.
But I am puzzled by the dateline on the article; it’s over 5 years old. We’ve experienced a major market disruption, and significant world events since its publication. Admittedly, the overarching recommendations may not have changed, but the additional market performance since the article was released may have altered some of the observations summarized.
I took the article in terms of providing some historical context and perspective. This is useful stuff.
Along those same lines, I would highly recommend the Peter Bernstein book “Capital Ideas” for a more complete historical development. That 1992 book covers the same timeframe as the Mark Dowie piece in much greater detail. Some of the inside stories are especially revealing in terms of the slipshod manner of keeping score before 1960. In those earlier years, the “experts and gurus” feet were not held to the fire with regard to their predictions and performance standards.
Given financial incentives, the smartest money managers must be employed by institutional agencies. This smart money, on a percentage basis, invests 3 times more funds in Index products than does the private investor. They recognize and exploit every advantage they can identify. Even these institutional powerhouses have considerable difficulty in finding exceptionally gifted fund management talent that persists over time.
David Swensen was a relatively latecomer to the passive investment cadre for individual investors. His long term success managing the Yale funds is the stuff of legends. In his original outline of his 2005 “Unconventional Success” book, he planned to provide a roadmap that he followed. He soon realized that us private investors do not have access to the tools and resources needed to execute that complex strategy. He concluded that Index investing was the proper pathway for most of us, and rewrote huge segments of his book accordingly. Time has positively reinforced that decision in his mind.
It is a daunting challenge for private investors to locate outstanding fund managers. The Litman/Gregory fund series was organized to specifically address the identification of superior fund manager prospects. Their top tier goal is to find and to carefully monitor a superior set of managers, and to use only their “best ideas” in the form of focused funds. Overall, the firms results have disappointed. I have owned their Masters’ Select Equity fund since its inception without exceptional rewards. Indeed, it’s a daunting challenge.
For the record, I currently own a mix of passively and actively managed funds. Over time, I have added to my passive holding sleeves at the expense of my active positions. I anticipate that I will continue that trend. Costs matter greatly, and only an exceptional few managers earn their pay over the long haul. A few do so.
Thanks once again for the reference.
Best Wishes.
However in 2008 I started to transform my portfolio from one of close to 30 odd mutual funds down to the five I hold today along with a mutual fund of my own making which consists nearly entirely of dividend paying individual equities in what I term my trading portfolio. Also, acting on my realization that I certainly had no problem ferreting out mo-mo mutual funds to buy, but was pretty much frozen when it came time to sell, I decided to invest those funds (via my IRA account) in the IVY Timing Portfolio http://advisorperspectives.com/dshort/updates/Monthly-Moving-Averages.php
According to M* shared portfolio data my mutual fund portfolio has outperformed 21% of all similar mutual fund portfolios over the past 5 years with a 7.79% annual return. Conversely one might note that it underperformed 79% of similar mutual funds. My stock portfolio has out performed 97% of similar mutual funds with a 19.75% annual return. The IVY portfolio is running around 12% annual returns. Not bragging, not gloating, just the facts and I sleep way better at night. As soon as Mr. Danoff, Mr. Berkowitz, Mr. McGregor, and the Matthews kids toss in their chips I expect to no longer own any mutual funds.
As I look at it now I am reminded of my dissertation advisor's advice on entering my oral exams "Knowing when to say that you don't know the answer will be the key to you getting through this exam."
From my many years of misadventure, it seems clear than indexing works in developed markets, especially since my managers lost 50% of my money in the market drops (although really I lost it because I chose them), so active management didn't work for me.
I rode Berkowitz down and now up, but I think I'm positive in the fund and negative against the index. Have some with Danoff, too, but don't want to think about the fees I've paid for management. I'm also in FPA Crescent with an AIP and some IRA funds, but I haven't been able to identify the stars. Perhaps M* "Managers of the Decade" are the best choices, but waiting ten years to identify them means I missed the good years and chase the hot money into their funds.
The one thing this thread did was convince me to put my children's IRAs in index funds, since all the current stars will be retired or dead before they need the money. The only problem is that they need to gradually develop a bond percentage. Perhaps Vanguard target funds are the answer. (Interestingly, Jack Bogle was quoted as suggesting that Social Security met some of the bond segment needs.)
Since MFO's thesis, I believe, is that good managers with small funds can beat the market, the time is approaching for this to be tested. I think a three year performance evaluation against whatever index they had chosen should be posted for the profiled funds; use longer performance times if they have them. This might also recognize sell sizes when a fund exceeds its efficient size (not sure how much data there is on that, but I came across a Bill Miller quote implying that it exists - if so, he certainly crossed it).
I don't think the original article is outdated in my personal experience. I only regret that my 403b offers nothing from Vanguard.
Here is the MFO link:
http://www.mutualfundobserver.com/discuss/index.php?p=/discussion/7079/efficient-sectors-and-indexing/p1
Search via Wordpress/MFO is a very weak function. I used only the word "index".
Take care,
Catch
I still believe that active management can beat passive management within certain asset classes but I am also limited in the number of chips I can throw into the pot to take better advantage of the outperformance when it happens. My minuscule contributions or stakes just don't amount to much to the overall bottom line. Should have been born rich.