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Old 10-24-2009, 11:33 PM   #41
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Originally Posted by Free To Canoe View Post

See the link below for the Vanguard S&P 500 index (VFINX).

Vanguard 500 Index Investor (VFINX) | Performance

You will see that it's performance across all time frames listed is average, not superior. Shouldn't we see a rise in performance relative to its peer funds as the time periods lengthen?

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Two possible explanations, consider the 10 year return at 56% ranking -

1) Is survivorship bias a factor here? I think that means 56% of all *current* funds in the category, right? I think it would help to know the record of *all* the funds from ten years back. If they closed down or merged poor performing ones, those records are no longer bringing the current average down.

2) Are the better performing funds in the 10-year category the same ones each year? If they cycle in/out, it really does not help an investor much.

This all seems to be too selective, unless I am misinterpreting the data.

So I guess we could check - do the current top ten funds in the 10 year category have a consistently better 10 year record in the majority of the past ten years ( a twenty year record)?

-ERD50
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Old 10-25-2009, 12:19 AM   #42
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Very interesting discussion. Thank you all. Some responses below.

@bamsphd: Thank you very much for your input. I was hoping folks like you would respond to this thread! I am a little uneasy with coin-toss analogy since it ASSUMES as a premise that active managers are dummies and have no value beyond random picks. This of course leads to the conclusion that they are not worth paying. Now, I am not saying this is an incorrect model, but it's certainly not a proof due to this circular reasoning.

Having said this, I don't think you were trying to prove the premise itself but were just illustrating your other point on why performance in first 10 years should not matter when funds were picked already based on those years. Here is an issue though - unlike coid tosses, funds' performance varies a lot from year to year. In fact according to Bogle et al, usually it is the FIRST years that bring best results to the funds (which is why they then grow and survive) whereas during LATER years performance suffers. So, looking at years 1-10 and years 3-13 should eliminate those "best first years" and years 3-10 could actually be not THAT great. Still, since years 3-10 DID participate in original fund selection, I do agree they should not carry as much weight in further analysis, but I am just not so sure they should be completely discounted. So, I come to conclusion that while last 3 years should indeed carry quite a bit more weight, 10-year history (for years 3-13) still is somewhat relevant and could be quite different from history for years 1-10.

As an aside by the way, in your own example, it so happens that while fund A outperformed fund B during the 9 years in between (you need 11 quotes for complete 10 years, but you have 10), fund B actually outperformed fund A if you start with 3rd quote instead of 1st.

@Free to Canoe: Why would not index funds survive? I would think be definition, their value would go to 0 only if their representative market goes to 0, in which case (for diversified enough index), all the respective funds would also go to 0 (except those that might short).

Why do you say index have high fees? They have the lowest ones. Also, has tracking error really ever been a problem for these?

I think you bring up a great question: why is VFINX in 56% percentile over 10 years compared to rest of funds in its category

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Originally Posted by ERD50 View Post
Two possible explanations, consider the 10 year return at 56% ranking -

1) Is survivorship bias a factor here? I think that means 56% of all *current* funds in the category, right? I think it would help to know the record of *all* the funds from ten years back. If they closed down or merged poor performing ones, those records are no longer bringing the current average down.

2) Are the better performing funds in the 10-year category the same ones each year? If they cycle in/out, it really does not help an investor much.
The 10-year 56% ranking for VFINX is really disturbing. I agree with (1) that it is a factor. Does anyone have references to something indicating how big of a factor it is? Is there data adjusting for this? Can this account for 30-40% moving 56% to 86-96%?

I have to disagree with (2). According to the 56% figure, any investor who believes in good active managers and happened to invest 10 years ago in any of the 55% that beat the index fund, would still be ahead at the end of last 10 years - even if sometimes they underperformed. And this accounts for their bad years too! Now, going back to (1), if say half of the funds died during the 10 year period, then of course, what now seems like 55% would really be closer to 25% of available funds 10 years ago. (I am assuming the 56% percentile for the 10-year period only includes funds that existed 10 years ago; otherwise, how would they make the comparison?)

Thanks again for all contributions again! And by the way, I am NOT an active management proponent and do invest a lot in passively managed funds... I am just looking for more proof that those managers with great past records are really just dummies throwing coins. :-)
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Old 10-25-2009, 12:49 AM   #43
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2) Are the better performing funds in the 10-year category the same ones each year? If they cycle in/out, it really does not help an investor much.
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I have to disagree with (2). According to the 56% figure, any investor who believes in good active managers and happened to invest 10 years ago in any of the 55% that beat the index fund, would still be ahead at the end of last 10 years - even if sometimes they underperformed. And this accounts for their bad years too!
True, but that only affirms that buying the fund ten years ago (and holding through any troughs) was a good thing. But, ten years ago what led us to buy the fund, and hold it through troughs? If it was a dog (or even mediocre) 10 years ago, we wouldn't have bought it on this basis. So that is why I say it is important to know if the fund cycles in/out. We don't have a crystal ball or a time machine. I need to buy the fund that does well the next ten years -and you want to base that on how it did the past ten years. We need to know if there is correlation there (it may be an inverse correlation, actually).

And I may not have been clear - I'm not talking about their annual performance cycling in/out over the past ten years - I mean their 10 year performance reviewed for each of the past ten years ( 10 data points with 10 years each, going back a total of twenty years). If that isn't reasonably consistent, what does it tell us? IOW, can we get 10 snapshots of the top 20 funds (measured by their 10 year performance), one snapshot for each year 1998 to 2008? Would the winners in 1998 be winners in 2008?

Look back at bamsphd's post with the 10 year made up numbers for fund A &B. If you bought Fund A 10 years ago, you are good. But if you bought it 3 years ago at 170 (based on a seven year stellar record), you did poorly. Same fund, same great 10 year record. Glancing at some charts from M*'s top rated 10 year funds, I saw some charts like that. Who's to know?

-ERD50
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Old 10-25-2009, 11:11 AM   #44
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The 10-year 56% ranking for VFINX is really disturbing. I agree with (1) that it is a factor. Does anyone have references to something indicating how big of a factor it is? Is there data adjusting for this? Can this account for 30-40% moving 56% to 86-96%?
S&P does this report semi-annually . . .

http://www2.standardandpoors.com/spf...09_Midyear.pdf

They obviously have a dog in this fight, so some may not consider their analysis objective. But their results do at least track with what nearly all academic research on the subject has also said. Indexes outperform.

According to the report, the S&P 500 outperformed 51.52%, 52.37% 62.95% of domestic large cap funds for 1 yr, 3 yr, and 5 yr periods ending June 30, 2009 (they don't compare 10 yr performance).

A possible reason for the difference between the S&P findings and Morningstar is that they do adjust for survivorship bias, among other things. According to the report, only 65% of the Domestic Large Cap Funds that started the period survived 5 years. I assume that dropping 35% of the worst performing funds would skew the data pretty heavily.

One other thing. All of these numbers reflect a single point in time, which may not represent the broader sweep of history. Here are the results from the same S&P report released six months earlier (December 31, 2008)

Quote:
Over the five year market cycle from 2004 to 2008, S&P 500 outperformed 71.9% of actively managed large cap funds, S&P MidCap 400 outperformed 79.1% of mid cap funds and S&P SmallCap 600 outperformed 85.5% of small cap funds. These results are similar to that of the previous five year cycle from 1999 to 2003.
. . . A nearly 900bp improvement for the S&P by shifting the date six months.
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Old 10-25-2009, 06:07 PM   #45
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I know this discussion will never end , managed vs passive but the last 2 years not to mention 2000-2001 should make you look for something else.

It dosen't matter very much is management expenses are .45 vs .89 if the funds your money are down 30-40% over the course of a year. I can't tolerate that kind for drawdown and do I care if a manger beats their benchmark if the fund is still down 30%.

Since 1999 I have attempted to be more proactive and move to the sidelines, managed to get out in summer 2000 and back in 2003. We were out January of 2008 and started putting money back in June of 2009.
It's been discussed many places using simple moving averages can help you side step much of the volitility we have seem especially if using index funds.

Market timing yeah I guess it is but its worked for me take a look.

dshort.com - Financial Life Cycle Planning
SSRN-A Quantitative Approach to Tactical Asset Allocation by Mebane T. Faber
Tactical Asset Allocation For The Masses
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Old 10-25-2009, 06:14 PM   #46
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@Yrs To Go

Thank you! That's exactly what I was asking about. Interesting reports. I looked through them and put together attached summary table. It lists percentages of active funds that corresponding benchmark outperformed. I picked overall domestic equities, S&P500, and lrg/mid/small value indexes since people often pick those.

Per S&P, this includes survivorship bias and fund fees (but not loads). Does not include index fund fees, but I guess they are pretty small.

Observations:
(1) Overall, if you randomly picked an active fund (between 1998 and 2004), you would outperform index in 40% of cases over the next 5 years! (Yes, mid cap indexes appears to be an exception for some reason - probably there are exceptions in opposite direction too since this 40% applies to all domestic equities.)

(2) For some reason, all Value indexes were changing from year to year. First "BARRA" ones were quoted, then "Citigroup", finally just plan value ones without additional qualifier. Is this related to some indexes in fact disappearing?? (Perhaps FreeToCanoe had a point that indexes can also disappear along with their funds then??)

Unfortunately, I think these numbers can be looked at both ways - on the one hand, you are probably not going to be doing too badly, "on average" beating 60% of funds; on the other, there are still a huge number of active funds that outperform indexes.

I was really hoping to see 90% kind of outperformance. (Interestingly, many bond indecies at the end of some of these reports in fact do report 90-100% outperformances! But I did not study that part in more details.)

Passive investor may say: This is 5-year data, what about 10-20 years? Active investor may then reply: Why does not S&P list the 10 year data? Is it "bad"? Or do they not have it? If they do not have it, then why would anyone else have it?

Now, I guess the big question is, as ERD50 pointed out, if you pick a fund where manager has been there for a long time and has a long history of both long and short-term outperformance, do you get a better than the random-pick 40% chance of outperforming the index??
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Old 10-26-2009, 11:32 AM   #47
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I am a passive investor. By just following the index, this avoids the situation where I might have a lot of money in an actively mananged fund, and then the fund manager leaves. By being passive, that is one less variable to have to react to.

I just follow the index in good times as well as bad.
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Old 10-26-2009, 12:00 PM   #48
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Now, I guess the big question is, as ERD50 pointed out, if you pick a fund where manager has been there for a long time and has a long history of both long and short-term outperformance, do you get a better than the random-pick 40% chance of outperforming the index??
Even more interesting....... If you pick a fund where the manager has been there for a long time and has a long history of both long and short-term outperformance, do you get a better than the random-pick 60% chance of underperforming the index, perhaps substantially?

I really don't need more variables in my RE portfolio. Therefore the bulk (close to 70%) of my domestic equity exposure is through TSM. I do have some small positions in actively managed funds but I treat these like individual equities and keep them to small percentages.

I'm busy enough trying to make my allocation decisions without needing to pick fund managers and monitor their performance trying to anticipate how they will perform in the future.
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Old 10-26-2009, 12:05 PM   #49
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So I'd like to extend a special thanks to everyone who's paying full fare on the actively managed funds, because without you, I wouldn't be able to get a basically free ride buying the index. Cheers.
Free ride in an index fund? Uh ok........
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Old 10-26-2009, 12:06 PM   #50
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Heck, when business/economic cycles and probably some sector rotations run longer than 10 years, and each peak and trough happens for different reasons, 10 years of data isn't enough to get a feeling about how a fund might perform for the next 50 years, or even the next economic event. The managers probably had one or two big economic events to handle in the past 10 years and some of them must surely have lucked into the right choices. Just a single good sector weighting in one downturn can look great in the long term results. That is not enough data for us to tell whether they were good or lucky.

I thought one of my funds, AMAGX, performed pretty well during this downturn. But that is probably because it does not invest in financial stocks, a good allocation for the past couple of years. So its past record looks good, but the next recession probably won't ding financials quite so badly and AMAGX may be an average performer then.

I'd feel better statistically with 50-year past performance data, but then the management team would be totally different for the next 50 years. So I don't think we'll ever be able to definitively answer this question.
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Old 10-26-2009, 12:26 PM   #51
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I don't think we'll ever be able to definitively answer this question.
Sure we can........ Pick an actively managed fund giving it your best shot. Bet the farm on it. Then add to your will the stipulation that your main heir must hire a FA to do a comparison of how your pick performed vs. the appropriate index and publish the results here. If this forum is still here, and if the interested participants are still alive, they'll then know the answer as to whether you beat the odds and your pick outperformed or not!

Of course, that will be totally irrevalent to the active or passive fund question going forward from that point on........
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Old 10-26-2009, 12:35 PM   #52
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So I don't think we'll ever be able to definitively answer this question.
It's been studied a lot by academics without a vested interest. Indexing wins. Of course, hope springs eternal ("yeah, but that study didn't include the new tactic that uses 216 day moving averages and a go-no go based on lunar illumination data. In back testing, it bested indexing by 7% per year!"), so the quest will continue.
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Old 10-26-2009, 04:51 PM   #53
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@bamsphd: Thank you very much for your input. I was hoping folks like you would respond to this thread!
You are welcome.

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I am a little uneasy with coin-toss analogy since it ASSUMES as a premise that active managers are dummies and have no value beyond random picks. This of course leads to the conclusion that they are not worth paying. Now, I am not saying this is an incorrect model, but it's certainly not a proof due to this circular reasoning.
I agree.

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Having said this, I don't think you were trying to prove the premise itself but were just illustrating your other point on why performance in first 10 years should not matter when funds were picked already based on those years.
Correct.

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Here is an issue though - unlike coid tosses, funds' performance varies a lot from year to year. In fact according to Bogle et al, usually it is the FIRST years that bring best results to the funds (which is why they then grow and survive) whereas during LATER years performance suffers. So, looking at years 1-10 and years 3-13 should eliminate those "best first years" and years 3-10 could actually be not THAT great. Still, since years 3-10 DID participate in original fund selection, I do agree they should not carry as much weight in further analysis, but I am just not so sure they should be completely discounted. So, I come to conclusion that while last 3 years should indeed carry quite a bit more weight, 10-year history (for years 3-13) still is somewhat relevant and could be quite different from history for years 1-10.
No. You are biasing your sample, then claiming your bias proves your case.

Suppose you were testing new super anti-cancer drug X against doing nothing. You accept lots of people into your trial. You decide that your doing nothing group will consist of every person in the trial who's last name begins with I. Among everyone who's last name does not begin with I, you ask "have you ever been diagnosed with cancer in the past ten years?" You eliminate from the trial everyone who answers yes. You give drug X to everyone who answers no. Three years later, you announce that in your clinical trials, people who took drug X three years ago had less cancer over the past TEN years than your control group who's names began with I.

That would be a perfectly accurate statement, but it does not tell us very much about drug X.

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As an aside by the way, in your own example, it so happens that while fund A outperformed fund B during the 9 years in between (you need 11 quotes for complete 10 years, but you have 10), fund B actually outperformed fund A if you start with 3rd quote instead of 1st.
Oops. Pretend the first year both funds tied with a 0% return.

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@Free to Canoe: Why would not index funds survive? I would think be definition, their value would go to 0 only if their representative market goes to 0, in which case (for diversified enough index), all the respective funds would also go to 0 (except those that might short).
The Bernie Madoff index fund. He only invests in a proprietary index of stocks which always go up.

More seriously, an index fund like any other fund can disappear without going to 0 value. If it is not making enough money, the sponsor can close it. Given that index fund costs are especially sensitive to assets under management, it is hard for a small operator to compete with Vanguard. So while the big Vanguard funds are likely to stay open, a small operator might close their fund because it was not profitable.

Even if the fund does stay open, the sponsor may change what index they follow, or the index may be redefined. Vanguard had done that to a number of the index funds I'm invested in. The changes have been evolutionary, rather than revolutionary, but they have been changes. For example, if I recall correctly, the emerging market fund did not invest in China or India when I first opened my account. They have also changed some indexes to only include the number of shares of a stock that actually trade in their calculations, which applies to some foreign companies that are majority owned by governments for example. I believe Vanguard also generally has to pay a licensing fee to use an index, so I think they will change precise indexes in part just to get a better licensing deal.

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I think you bring up a great question: why is VFINX in 56% percentile over 10 years compared to rest of funds in its category
That result is very sensitive to the start/end dates selected, and can to some extent be blamed on style-drift by other funds in the same "large blend" category. When in this case "large blend" is out performing all the other categories, you will see the "large blend" index funds beat a very high percentage of their "large blend" managed competition. However, when "large blend" lags the other categories, the index funds will beat a much lower percentage of their "large blend" competition. Basically, many "large blend" managed funds might invest 95+% in "large blend" stocks, but still have a few percent in say small-cap or emerging market stocks. That style drift can hurt or help performance depending on how the asset class is doing.

This is a problem if you are trying to carefully control your asset allocation, but otherwise it is basically a wash in my opinion.

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@Yrs To Go
Now, I guess the big question is, as ERD50 pointed out, if you pick a fund where manager has been there for a long time and has a long history of both long and short-term outperformance, do you get a better than the random-pick 40% chance of outperforming the index??
That is not the question I worry about. A better than random chance of beating the index is not sufficient reason for me to select an investment, unless I can also diversify away or otherwise largely eliminate the possibility of being stuck in that bottom 25% or so for an extended period of time. First worry about the return OF ASSETS, then worry about the return ON ASSETS. Basically, I can probably do OK if I can avoid shooting myself in the foot by investing in a stinker. How can I avoid the real stinkers?

Sure, there will always be Warren Buffets investing, as well as Bernie Madoffs, and a gazillion basically honest, but more or less average investment managers. If I could predict in advance the Warren Buffets, or the Apple, Dell, Google and Starbucks stocks, I wouldn't be investing in index funds. Regardless of how efficient the market may or may not be, I don't believe that I can use publicly available information to pick stocks or managers that will out-perform a combination of very broadly diversified index funds on an after fees, after taxes, risk adjusted basis over the multiple decades my portfolio needs to last.

Heck, "my portfolio" will probably be supporting my wife long after I'm dead. I can tell her to stick with some fixed percentage index fund allocations and to not withdraw more than 4% a year with some hope that she will do OK. However, having her watch for changes in fund managers, and pick replacement funds seems unlikely to work out well. My father solved that problem by putting my parent's money in a bank managed revocable trust. I'm just too cheap to pay the management fee such a trust would involve. I would far rather retire-early!!!!!
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Old 10-26-2009, 10:43 PM   #54
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It's been studied a lot by academics without a vested interest. Indexing wins. Of course, hope springs eternal ("yeah, but that study didn't include the new tactic that uses 216 day moving averages and a go-no go based on lunar illumination data. In back testing, it bested indexing by 7% per year!"), so the quest will continue.
I haven't seen a study that says indexing beats all active funds over any long period of time. Until that happens, I think their reasoning is suspect. Was there a study that showed 10-year perfomance (roughly the best we can do for now) failed to identify above average funds for the next 10 years? I've seen studies with relatively short time periods, but that would look more random. That latest risk-adjusted Morningstar study was particularly unconvincing. There were still plenty of active funds that beat the indexes, even risk-adjusted. It may even have been easy to pick those "winning" funds, but they didn't go into that.

It is fine to favor one or the other approach, but the data is nowhere near conclusive as far as I'm concerned.
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Old 10-26-2009, 10:56 PM   #55
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I haven't seen a study that says indexing beats all active funds over any long period of time.
And you never will.

Good luck!
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Old 10-26-2009, 11:31 PM   #56
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I read an article using the analogy of comparing passive vs active investing to the life expectancy of women and men. I think this analogy is a good one.

The article went, statistics show that overall women live longer then men. But there are some men who live to a very old age. Using this analogy, the active investor's job would be to identify these men who live longer. But the passive investor would be happy with the average life expectancy of all the women.

In otherwords, if the market is like men and women's life expectancy, in a group of men, can you confidently predict who will live longer and who will not and who will live longer than the average woman?
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Old 10-26-2009, 11:32 PM   #57
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Great points bamsphd. I agree that for people that do not want to do the work of selecting managers, etc. index funds are great. The whole question of selecting managers comes into picture if you DO want to try to pick the winners. Now, the truth is, in my own retirement I do NOT want to worry about picking winners or even following the markets; so I know I will switch to passive investments then.

I guess I am still struggling with the idea that "more work = worse results" which is counter-intutitive to everything else in life. In other words, the idea that the work of trying to select good talent produces worse results than going with average would be considered nonsense in any other field. I think I understand the logic and the arguments; but the results I found so far are not as convincing as I would have hoped as I mentioned in earlier post.

You do mention additional possible explanation for "poor" performance of indexes, i.e. the style drift. That's an interesting thought.

Now, I understand that it's impossible to pick the next Buffett, but I tend to think that there is a whole spectrum between Buffett and total dummies. There are probably plenty of better than average managers (well ~49.999% of them actually hehe), and their results should on average be better than average, would not you agree . (ok, yes, they also have to beat their fees - true). But overall, you don't have to find next Buffett, but just someone in the upper 3rd of all managers...

I'll agree with you on my biased sampling. I was hoping that assigning lower weights for intermediate periods would account for that but perhaps not as much as I would like to believe.

Also interesting comments on the fund closings / changes.

In closing, I just want to mention that my arguments here are mostly for questioning purposes. This thread will in fact make me think more critically of active management and will make me move faster to passive alternatives. Thank you for good discussion!
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Old 10-27-2009, 09:12 AM   #58
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And you never will.

Good luck!
Or they are biased, I've heard the latest compares S&P index to
active fund managers. So if you have the freedom to buy any
stocks (international, small or mid caps, etc), if you can't beat
the S&P index in last 10 yrs, you need to find a new job.
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Old 10-27-2009, 09:36 AM   #59
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Posts: 337
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Originally Posted by smjsl View Post
You do mention additional possible explanation for "poor" performance of indexes, i.e. the style drift. That's an interesting thought.
That i
s known as Dunn's Law. See When Indexing Fails.

When talking about indexing, I also especially like How to Beat the Benchmark.

If that wets your appetite, almost everything on the
site is good, though the best part is definitely http://www.efficientfrontier.com/ef/index.shtml.
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Old 10-27-2009, 09:37 AM   #60
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Join Date: Aug 2006
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Originally Posted by teejayevans View Post
Or they are biased, I've heard the latest compares S&P index to
active fund managers. So if you have the freedom to buy any
stocks (international, small or mid caps, etc), if you can't beat
the S&P index in last 10 yrs, you need to find a new job.
TJ
The S&P 500 is becoming a lame index, why not use the Wilshire 5000?
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