Active vs Passive Management

[smjsl]

I seem to be missing something... It happened again today...

For years I've been reading about advantages of passive management, I read Bogle, I am reading Swedroe now. They all make sense to me. I love the strategy - it's so simple and it all so easily comes together. All the quoted studies show the same thing. Many respected investors, even those who made money from active management, recommend passive investing. And when anyone asks me how to invest, the only good advice I can make is to buy index funds... but I don't do it myself!

Every half a year or so (including today), I've been trying to force myself to switch from actively managed mutual funds in my 401k to passively managed ones. So, I go online, and I figure that with all those studies, I will surely find that all or at least most of the 5 of my funds have to be worse than corresponding benchmarks. Sure, I picked the funds after much research but it's really all based on past results, which is NOT predicitve of future, and clearly, it's pretty much luck anyway in the zero-sum game; and besides, they have to work over that extra ~1% in fees every year to just make it even with the passively managed benchmarks... Not to mention we just had some extreme market conditions - huge drop and huge rally over the past year - and so I figure I should see some clear underperformance by the actively managed funds during at least some recent unprecedented periods. So I go to morningstar.com and compare these funds with the corresponding passively managed funds. And all I see is that ALL 5 outperform their benchmarks or match them very closely in all kinds of periods from 3months to 6mnths, 1yr, 3yr. 5yr, 10yrs... I don't see any underperformance, and often some outperformance?!?!

So, then I wonder, was I just lucky again in the past year and should I switch now before the luck runs out? But how can that be? Some of these funds are now closed to new investors; perhaps that helps them? But I would not think so (again based on all the usual arguments).

So, are the charts on morningstar wrong? Are they not accounting for something?

I tried to manually make some computations for 3-4 random cases, but they only led me to conclude that morningstar was correct in most cases (there was 1 exception where they seem to have made a small mistake which I could explain, but that mistake "benefited" the passive fund).

Each time this "real" performance test raises enough doubts in me to pull the trigger and I can't seem to help it. I look at the performance and just don't see why I would switch.

Any thoughts? Similar experiences? Or even better, a simple explanation on what I missed?

 

[clifp]

I personally don't believe in the efficient market theory especially after the last 18 months.

I believe that some money managers are significantly skilled at buying and selling securities that they can overcome the additional expense they generate/charge. (i.e. generate Alpha)

Although on average I certainly believe that index funds will outperform the actively managed funds especially over long period. I also believe that some mutual fund managers/management teams will be able to beat the index even over long period of times.

Now lets be clear I am saying mutual fund managers/management teams, not mutual funds. When the star fund manager leaves, gets promoted, maybe even has a baby, the performance of the fund will suffer and over long periods performance will revert to the mean.

From a practical standpoint, I have no way of figuring out who the star managers/teams are so I don't bother and buy index funds and individual securities. However, your group of funds maybe run by a exceptionally talented team and that is why they are doing a good job. I'd suggest just stay on top of the management changes.

 

[FUEGO]

Couple of comments on benchmarks. Make sure you are looking at apples-to-apples. Make sure the funds you own are compared to the right benchmarks. Sometimes blended funds of stocks+bonds are compared to large cap growth benchmarks. Or US+Intl funds are compared to either US total market index or MSCI EAFE index benchmark. If one sector outperforms the other sector, it may show your fund under/over performs when it really is not active management causing this but rather exposure to a market sector not properly covered by a benchmark.

Also make sure you are comparing your results to the index benchmark and not the "average of all funds in this category" benchmark. Most actively managed funds are stodgy and have fees way higher than index funds, so it isn't too hard to beat the average of all actively managed funds.

Also consider taxes. If you hold funds in your taxable account, actively managed funds typically have higher taxable distributions than index funds (ST/LT cap gains distributions). Your top line performance may be marginally better than benchmarks, but the after tax numbers may not look as sweet.

Or maybe you have successfully found the five active managers that can outperform the indexes! If so, congrats!

 

[W2R]

I drank the kool-aid, and most of my nestegg is in indices.

I am also a fence straddler, so I have 30% in Wellesley. I love my Wellesley, despite the fact that I am absolutely convinced that a primarily Boglehead, Vanguard index fund approach is the only sane way for me to go. I am not an investment guru, and I have no inside information, so I would rather just play it safe and follow the rising tide.

It helps that while actively managed, Wellesley is a Vanguard fund so fees are very low. I think that the fees can be a problem on many actively managed funds.

 

[FUEGO]

It helps that while actively managed, Wellesley is a Vanguard fund so fees are very low. I think that the fees can be a problem on many actively managed funds.

I'm guilty of owning more than one actively managed vanguard fund. All are low cost, and essentially the cheapest/easiest/most tax efficient way to get what I seek in a particular asset class.

You are right, the fees and excessive turnover with the associated tax inefficiency and trading costs are what kills returns for actively managed funds.

 

[Gone4Good]

Which funds?

One possible explanation, particularly when looking at longer periods, is that there is strong survivorship bias in the data. Poorly performing funds are shut down and/or merged into better performing funds. Over time a management company weeds out funds with a bad track record and keeps the good track records alive.

 

[Animorph]

Given the volatility of the past 10 years, I doubt that it is easy to see a 1%/year difference in performance. Also, if you picked funds by something like 10 year past performance you will need to wait 10 years beyond that before that past over-performance is flushed out of the 10 year performance number. However, when looking at those numbers, I don't see an index fund near the top. Maybe we need to wait for the 20 year numbers?

Looking at past 10 year performance, I saw many funds that performed well during the 2000-2002 dip and some that performed decently during the current dip (relatively speaking). It could be that over performance during the past 10 years is just luck in being properly positioned during one or both dips and completely average the rest of the time. AMAGX is an example. It stays away from financial stocks and so did relatively better in the latest dip. That may not help next time.

So as usual, I think there's not enough data. Even Morningstar's article said 37% of the active funds beat the risk adjusted indexes. Are these the same funds that always beat the indexes, or is it a random assortment of funds even in the 10 year performance numbers?

 

[FUEGO]

However, when looking at those numbers, I don't see an index fund near the top. Maybe we need to wait for the 20 year numbers?

VBIIX - interm. bond index - Performed better than 93% of funds over 10 yrs, almost as well over 1, 3, 5 yrs.

VGTSX (total intl), outperformed 77-81% of funds over 1, 3, 5, 10 yrs.

VTSMX (total US), outperformed roughly 60-65% of funds over 1, 3, 5, 10 yrs.

Just to pick a few broad random index funds from vanguard (with low fees and low turnover).

Index funds will guarantee you to never be at the very top, but over sufficiently long periods (5-10+ yrs), you have a pretty darn good chance of doing like the funds I just listed - somewhere near the 75th percentile mark. More importantly in terms of SWR's, firecalc, and portfolio failure/risk management, you have a low probability of landing in the bottom two quartiles over a long time period.

 

[freebird5825]

I drank the kool-aid, and most of my nestegg is in indices.

Ditto.
The majority of my long term retirement portfolio is in indices, all VG.
I still keep my hand in a few low cost actively managed funds, in VG and 2 other fund families. All exp ratios are under 0.65%.

 

[walkinwood]

Good thread. I too, am an index fan convert, who holds on to some no-load, low cost, actively managed funds that I have owned for years - before I became a convert.

My active funds are VG PrimeCap, VG Windsor II, T.Rowe Price Small Value, and Harbor International. I compared them to the VG Large Index, VG Value Index, VG Small Value Index, and VG International Value since these seemed most appropriate. I find the actively managed funds beat the indexes in the 5yr total % return, but not always in the shorter ytd and 1 year comps. I plan to keep them for now.

I've used indexes in the newer asset classes I have added in recent years - emerging markets and REITS.

 

[ER_Hopeful]

I've used indexes in the newer asset classes I have added in recent years - emerging markets and REITS.

can you give some examples of emerg. mkt and REITS index funds?

 

[Animorph]

VBIIX - interm. bond index - Performed better than 93% of funds over 10 yrs, almost as well over 1, 3, 5 yrs.

VGTSX (total intl), outperformed 77-81% of funds over 1, 3, 5, 10 yrs.

VTSMX (total US), outperformed roughly 60-65% of funds over 1, 3, 5, 10 yrs.

Just to pick a few broad random index funds from vanguard (with low fees and low turnover).

Index funds will guarantee you to never be at the very top, but over sufficiently long periods (5-10+ yrs), you have a pretty darn good chance of doing like the funds I just listed - somewhere near the 75th percentile mark. More importantly in terms of SWR's, firecalc, and portfolio failure/risk management, you have a low probability of landing in the bottom two quartiles over a long time period.

Yeah, but why go below the top 10%?

I'm not a fixed-income investor, but with the lower growth it would seem an index fund would be best.

ER Hopeful:

I like VNQ for REITs. It's an ETF, but should be based on a similar Vanguard fund.

I like EEM for emerging markets, an ETF again. An obvious choice, but decent. DGS is much smaller but covers small cap EM.

 

[samclem]

I index as often as possible, but I can accept a low-cost actively managed fund. I've owned a lot of Windsor II for many years. I'm considering a small dose of two other active funds, Wellesley and Vgd Intl Explorer (though I'd be happier if it hadn't appreciated 44% so far this year). Most of our money is in index funds and our overall ER is less than .20, so I think we're still on the Bogle bus.

 

[Gone4Good]

I'm considering a small dose of two other active funds, Wellesley and Vgd Intl Explorer (though I'd be happier if it hadn't appreciated 44% so far this year).

I bailed out of the International Explorer fund when the market tanked and swapped into the generic international index. I want to move into the new small cap international index, but the fees are kind of high. The reason for the move is that International Explorer is a tax pig. Performance is good, but they distributed out about 100% of gains. I still remember getting a 14% capital gain distribution in 2007.

Nice fund for a tax deferred account.

 

[friar1610]

I had a number of actively managed funds over the years. Some did very well; some did not. About 10 years ago I became a confirmed indexer. Would I have done better sticking with managed funds? Dunno. Is life easier with indexes. Yep!

 

[FUEGO]

I bailed out of the International Explorer fund when the market tanked and swapped into the generic international index. I want to move into the new small cap international index, but the fees are kind of high. The reason for the move is that International Explorer is a tax pig. Performance is good, but they distributed out about 100% of gains. I still remember getting a 14% capital gain distribution in 2007.

Nice fund for a tax deferred account.

VSS is available if you are interested in the ETF version of VG's small cap international fund. I'm glad I bought in when I did soon after it was issued. Nice low expense ratio and no purchase fees other than commission.

 

[FUEGO]

Yeah, but why go below the top 10%?

I'm not a fixed-income investor, but with the lower growth it would seem an index fund would be best.

I assume you are making a joke? Clearly if I could pick top 10% active funds, I'd be all over them. I index, and I just hope to not lose too much to fees.

Yes, paying, say 0.1% in fees vs. 1+% fees is key to making money, especially in bonds where yields may be a couple percent pre expense ratio. Imagine paying half your income out to cover the expense ratio. Forget that!

 

[samclem]

I bailed out of the International Explorer fund when the market tanked and swapped into the generic international index. I want to move into the new small cap international index, but the fees are kind of high. The reason for the move is that International Explorer is a tax pig. Performance is good, but they distributed out about 100% of gains. I still remember getting a 14% capital gain distribution in 2007.

Nice fund for a tax deferred account.

Thanks--if I go with VGD Intl Explorer, I'll be sure to find room in a tax deferred account for it.

I'm an indexing believer, but the concept does assume an efficient market, including the flow information. I wonder if international small cap might be testing the bounds of this. I see obscure, thinly traded companies in nations with dodgy accounting standards and no oversight. The stocks are in the fund because they are inthe index, and they are in the index because . . . well, we can't be throwing out comapnies or we'd be actively managing. Maybe there is a role for adult supervision in some cases. Anyway, I'm sure VGD and the folks on Canary Wharf have figured this all out and it's all good. But, I wouldn't take the concept as far as "Joe's African Microcap Index".

 

[rsingh6675]

Not a reply but a QUESTION?

Does anyone have PTTDX, DODGX,DODFX, CGMFX?
I have the last three. I am seriously considering putting money in PTTDX.

 

[walkinwood]

can you give some examples of emerg. mkt and REITS index funds?

I use index funds from Vanguard - their emerging market index fund and their REIT Index fund.

 

[charlie]

I have read Bogle, Swedroe and Bernstein, et. al. and understand the
arguments for index funds ..... intellectually that is.

But I challenge you to name two better preforming funds than Vanguard's
Wellington and Wellesley over the long haul. Both are low cost managed
funds.

Wellington is Vanguard's flagship balanced fund. It has done better
than all other Vanguard's balanced funds of similar AA over all time
periods.

Cheers,

charlie

 

[REWahoo]

But I challenge you to name two better preforming funds than Vanguard's
Wellington and Wellesley over the long haul.

I know, I know: "Past Performance Is Not Indicative of Future Results".

In this case, I certainly hope that it is - 55% of my portfolio is in these two managed funds.

 

[Animorph]

According to Morningstar for 15 year performance these are the top 4 funds:

GMCDX 16.57% annualized (emerging markets bond)
CGMRX 16.27% (real estate)
BRUSX 15.97% (small growth)
BRUFX 15.95% (moderate allocation)

Wellington and Wellesley:
VWELX 9.35% (moderate allocation)
VWINX 8.59% (conservative allocation)

I didn't screen for no loads or anything else, but still that looks better for past performance in about as long term as I can easily check on.

 

[Dennis]

Well, Just from a Early Retired guy..

1. In the First place, listening to Boggle and Vanguard has gotten you to where they/you are today.. So, if your happy with that way of Investing? Stay the course..

2. If your not? The Modertate approach to Active management is in order.. Using Market Momentum so to speak..

3. And Owning Nothing but about 80% Bonds and 20% in a 40/60 or 20/80 Balanced Fund such as a PRPFX and HSTRX..or VWINX at the Most.. ( and they all said to move into Treasuries in 08' and now into Corp. & Global Bonds for 09' , they have their hands ties to only be able to move their Specified % allowed, you can go alot more on your own )

4. And , eventhough Vanguard doesn't talk about them, since They Don't have them? Global and EMD Bond Funds, like TGBAX or TEGBX and FNMIX or PREMX.funds

5. For added Income & Ylds ? PTTDX

Just go back to the past 10 yrs and compare these to whatever else you have going "against" you and see for yourself..
and Contrary to Popular Advices? Kids don't need more than a 50/50 Mix and Seniors more than 20/80... IF they have enough that a 5% WDR will be enough to live off of.
Owning More In Equities only Lines the Pockets Of Fund families , Brokers and Wall Street..to fund THEIR Retirement and steal it from us..

Can start education with M* Bond Squad Articles and Ck out PIMCO letters..his Bond Funds handle More Tot $ than Vanguards Indexes..so what is that telling you?

and if you Don't have enough $ to retire On? Then you just have to Go for broke and follow traditional Aggressive Investing methods and be Hands On and Hope for the best.

 

[Free To Canoe]

I use index funds from Vanguard - their emerging market index fund and their REIT Index fund.

Good questions by the OP.
I use both of the above Vanguard funds.

I started into emerging markets (EM) MF investing by finding seasoned managers that have good metrics such as low turnover and good performance for long periods regardless of the fees that I had to pay. With two of the four funds that I was into in the past 3 years, the managers went away. One was fired /take over. The other was promoted / replaced. On the two (SSEMX, LZOEX) that were left, I was suprised to learn that one was barely keeping up with the EAFE EM index and the other was underperforming the index. I am paying high fees for both of these.
The one that is underperforming the index is kind of following it, too.

I am surprised to conclude that in this new arena of investment, I can not find a reason to having active management. I am moving to the Vanguard EM index fund (VEIEX).

In the more traditional markets, I find index fund performance failing to the actively managed funds.

Free to canoe