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Old 03-22-2009, 04:14 PM   #21
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Mostly religion. It is an article of faith among certain mutual fund investors that no skill is ever involved. Beyond expenses, it's all luck. And luck can turn on you.
I don't think (for myself at least) that we assume there is NO skill involved. Mostly none, but there are obviously some who have more than others. Our problem is that there isn't any way we know of to recognise that skill up front, and so rather than going for broke we're just playing the odds.
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Old 03-22-2009, 04:19 PM   #22
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So, what if we had 2 hypothetical funds. Both have been above their category the majority of the time over 10 yrs. You look at 10 yr annualized total returns. Fund A's return is 10%. Fund B's return is 9%. Fund A has an expense ratio of 1.1. Fund B has an expense ratio of .6. They are both no-load. All else being equal, why would you choose Fund B?
Depends on your school of thought. If you believe that there is some aspect of "skill" in stock picking ability, you might pick Fund A. If you believe in the "efficient market hypothesis" -- the "random walk" theory where differences in performance are explainable only by luck that will eventually run out and that a monkey has a 50/50 chance of outperforming a professional stock picker -- you'd go for the lower cost alternative in just about all cases -- fund B since you believe there is no such thing as "stock picking skill." Or, at the very least, it's so difficult to identify *true* market-beating ability that you'd stick with indexing (and you aren't willing to risk underperforming the indexes).

And arguments between these two camps are often akin to debating politics or religion. They are utterly useless because both sides are often firmly entrenched in their beliefs and no one will ever be swayed by arguments from the other side no matter how cogent.

For what it's worth, my core portfolio is indexed but I do have a smattering of managed funds with good long-term track records and reasonable fees (below 1%).
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Old 03-22-2009, 04:51 PM   #23
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I don't think (for myself at least) that we assume there is NO skill involved. Mostly none, but there are obviously some who have more than others. Our problem is that there isn't any way we know of to recognise that skill up front, and so rather than going for broke we're just playing the odds.
Even those who win Nobel Prizes for their skill in developing successful economic theories can get it spectacularly wrong.

The year after Merton and Scholes received the Nobel Prize for economics in 1997 for their new method to determine the value of derivatives their hedge fund collapsed losing $4.6B in 4 months.

The Federal Reserve was so concerned about the potential impact of LTCM's failure on the financial system that it arranged for a group of 19 banks and other firms to provide sufficient liquidity for the banking system to survive. (sound familiar?)


Long-Term Capital Management - Wikipedia, the free encyclopedia


I only mention this as I am a firm believer in the inherent randomness of the markets.
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Old 03-22-2009, 05:34 PM   #24
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Let me give another instance of comparing funds. My 401(k) plan has an intermediate term bond fund in it: Calvert Income CFICX. In the 401(k) we don't pay the front-end load. So a question might be, is is better to use CFICX in my 401(k) or to use the Vanguard Intermediate-term bond index fund VBIIX in an IRA for some of my bond allocation? Also you are making this decision in January 2007.

CFICX expense ratio is about 1.16% while VBIIX has about 0.2% expense ratio.

In 2003, CFICX had a Morningstar rank of 1 (better than all funds) in its category and in 2004-2006 it was ranked 3, 10, and 18. So it was always in the top 20% from 2003-2006. However in 2008, it lost 13% and the 10-year return is about 4.7%

VBIIX was ranked 28, 10, 54, 53 from 2003-2006. In 2008 it made 4.9% and the 10-year annualized return is about 5.75%.

So given the M* information in January 2007, which of these funds would you have picked? Go by performance and ratings? Or go by expense ratio? Or go by some other information?

OK, this is like a fun little test. I'm sure I will not get an "A", but it's a good chance for me to learn some more....so....

I would want to see more years of history so I would pull the M* fund report which would show me data from 1998. Looking at 1998 thru 2006, CFICX was in the top quartile 7 of those 9 years. VBIIX was in the top quartile 5 of the 9 years (if you include top 1/2 of category, 6 of 9 yrs).

At first glance, seems like CFICX would be the way to go (given you don't have to pay a load in the 401K). Of course now with hindsight we see it did quite poorly compared to its category in 2008. Could we have predicted that by looking at other factors? Hmmmm....would the high expense ratio have predicted that it wouldn't do well in 2008 Hmmmmm...

Something I noticed is that when you look at the style box, CFICX is listed as medium quality, short duration. VBIIX is listed as high quality, long duration. So are we really comparing apples to apples here? M* has them both listed as Interm-Term bond funds...why? Why does the style box not agree with this? I'm sure I am missing something here and one of you all can enlighten me! If they aren't truly holding the same kinds of bonds, then how could you expect to compare them? I think I am starting to learn you can't just go by the M* category listing. You have to delve deeper. Gee, I thought I was doing pretty good until now!

P.S. I did just now read the analyst report and it says the manager for Calvert strayed from his strategy a bit, increasing the risk of the fund. This surprises me, given that he has been with the fund since 1997; it's not like a he is a new manager. Maybe the other new manager that came on in 2008 influenced him? I don't know, just conjecture on my part. However, this does also point out that there is a different risk with managed funds - the risk of human error. With an index fund it is obviously going to be more predictable, eh? No straying from the guidelines?

Oh, BTW, Calvert's 15 year average is 5.68, pretty close to VBIIX's 10 yr ave of 5.75%. Over the long haul, I wonder how much difference it all makes?
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Old 03-22-2009, 05:42 PM   #25
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Depends on your school of thought. If you believe that there is some aspect of "skill" in stock picking ability, you might pick Fund A. If you believe in the "efficient market hypothesis" -- the "random walk" theory where differences in performance are explainable only by luck that will eventually run out and that a monkey has a 50/50 chance of outperforming a professional stock picker -- you'd go for the lower cost alternative in just about all cases -- fund B since you believe there is no such thing as "stock picking skill." Or, at the very least, it's so difficult to identify *true* market-beating ability that you'd stick with indexing (and you aren't willing to risk underperforming the indexes).

And arguments between these two camps are often akin to debating politics or religion. They are utterly useless because both sides are often firmly entrenched in their beliefs and no one will ever be swayed by arguments from the other side no matter how cogent.

For what it's worth, my core portfolio is indexed but I do have a smattering of managed funds with good long-term track records and reasonable fees (below 1%).
Fascinating! I love your description of this. I actually think I could be convinced either way at this point. I just am really trying to learn how to choose good funds. I didn't think about how this conversation would move into that managed vs. index funds debate until after it started. Even so, I am learning quite a bit, and I feel this thread is certainly helpful to me in learning how to evaluate funds.
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Old 03-22-2009, 05:45 PM   #26
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I only mention this as I am a firm believer in the inherent randomness of the markets.
Interesting! I guess if it were predictable it could be controlled. Oh, if only we could control it.
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Old 03-22-2009, 06:15 PM   #27
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Interesting! I guess if it were predictable it could be controlled. Oh, if only we could control it.
Like the hedge fund company I quoted above very clever people come up with formulae, theories, neural network models etc to try and beat the market and invariably they eventually fail.

There are 3 things you can try and do with the market:

1. Ignore it (stick with CD's, cash etc)

2. Beat it

3. Be it

I ignored it up 'til 14 years ago, relying on a secure pension for retirement. But after I had joined my 4th company since graduating college and was starting on my 4th pension I decided I needed something else. After some reading, some experimenting with money in taxable funds, and a night class at the local university I decided that I wanted to "Be" the market and for the last 10 years have been mostly in index funds to create an AA that matches my risk level.
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Old 03-22-2009, 06:16 PM   #28
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Well, I don't let Expenses be the only factor for my Funds.. I've had some very nice funds way out perform comparable Cheap Index Funds and paid 1-1.5% Expenses and still come out way on top..

In otherwords? "Don't be a Penny Wise, Dollar Foolish"
and to make matters more complex? I have another account with a Investment Firm that manages a Port and charges another .75% on it.. But, it also has more than paid for itself in both management of the accounts investments and providing many other services..

So, I guess it just All depends on what your looking to do..If one wants too and is Good at managing their own, etc.. More power to you..use the indexes or lower cost funds that fit your needs..

I also Go to the actual Funds Website for More accurate #'s as well as use Lipper's and 1 other ..besides M*..and don't use their Star * rating to buy or not either..
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Old 03-22-2009, 10:02 PM   #29
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In my early years of learning about investing I spent a lot of time lurking and occasionally contributing to TMF Market Screens discussion group. I was really into due to my analytical tendencies, but couldn't ever lock into anything solidly. They just seemed to be Too Good To Be True. And they were.

Sometimes I think that the Bogle Indexing theory is just another market screen theory. Other (most) times I feel like it's the opposite of one. No matter which, I feel very comfortable with it. Mostly due to the goal - Invest diversely, at low cost, and be satisfied with the market returns. This isn't an attempt to blow everyone else away, it's an attempt to do as well as most without sweating the details too much. As we've seen, matching the market can suck sometimes. But I still think in the longer run it's the best way for me to go. And as someone famous once said, of all the market factors out there, the only one we can control are the costs.
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