Please Review this Portfolio Proposal

[bUU]

I'm finding some other comments that are also filling in various gaps.

For example:

I read the paper cover-to-cover, with some parts more carefuly, and others less carefully.

Some thoughts and questions:

1. I think the results make sense, and do not contradict existing literature that active management generally underperforms passive indexing,

2. So among the 4 types of active funds: (a) diversified stock pickers, (b) concentrated stock pickers, (c) factor bettors / timers, and (d) closet indexers, only (a) is shown to have alpha relative to benchmarks. However, there are many caveats, such as the consistency of the diversified stock pickers, and the temporal opportunity of stock picking,

3. I believe there is no reason to expect that someone has refuted this paper. Several reasons: (i) author is building on similar research, (ii) analysis seems thorough, (iii) it is too new to be refuted any way.

4. Do I believe the results? I am tempted to. Market efficiency states that whenever there is alpha, it will be arbitraged away. Even picking better mutual funds is a source of alpha, so this paper is identifying how to consistently pick funds expected to perform better. However, consider the following: (i) the results are relative new, (ii) the alpha is relatively weak, (iii) the "Active Share" is not easily accessible for funds (while the tracking error is VERY EASILY accessible).

However, I believe that "Active Share" can be approximately computed for many / most funds without much effort.

At any rate, good paper, and thanks for sharing.

----

a good exercise for you, IMHO, would be to figure out the Active Share and Tracking Error of each of those funds listed in the OP. Similar to that spreadsheet you have posted for the non-retirement account funds, you can try to add the Active Share of each fund.

Because Acive Share is not readily available, this would require some work on your part.
Also, obtaining the Tracking Error, although easy, might not be trivial. I suggest you obtain the tracking error relative to the closest benchmark. E.g, for a fund that claims to be "Mid-cap value", you might want to determine what Mid-cap index they are following, and then determine the Tracking Error like that. Obtaining Tracking Error vs the SP500 might not be that precise for the purpose of Petajisto paper.

That second message gets to the heart of the matter: It's loads of work to figure out the Active Share and Tracking Error of each funds. The question is whether there is a way to do or buy that work without it "costing" more than it offers.

 

[Midpack]

He also tackled the tax-efficient fund placement issue, in a rather novel way:

With capital gains, you’ll have to pay the tax eventually. You could wait for retirement or reduced income when you might qualify for the 15% rate, but it’s probably better to accept the fact that the government has a 20% claim to your gains whether you take them now or in the future. The bite could even be more than 20% in the future. We hope that your investments keep growing, but if they do, the dollar amount that you have to pay the IRS grows too. It is usually better to put together the best portfolio you can, include tax efficient investments where possible, and pay what you must.

What I think he is saying here is that, essentially, he doesn't see a big benefit in strategically placing funds (at least not with regard to the value versus growth dynamic) because he sees taxes on gains going up (and that's almost surely true), and that we're probably going to get hit with worse taxes when we take the money out than if we just pay the tax now - that the compound effect may actually be smaller than the impact of taxes increasing. I'm not sure that that's true, and I'm not sure it really gets to the heart of the tax-efficient fund placement issue.

That misses the point of tax-efficient placement altogether (you decide when you pay taxes on dividends & CG in deferred accounts and at what rate to a large extent, not so in taxable accounts). Even if you don't sell anything, rebalancing alone will generate a tax liability that you can't influence timing/amount on, not so with deferred. You're getting bad advice, but if you're happy that's all that matters, though not sure why you asked here and elsewhere...

 

[travelover]

......... You're getting bad advice, but if you're happy that's all that matters, though not sure why you asked here and elsewhere...

That sums it up.

 

[gcgang]

Two more points I made in my email to him: "Something else we outlined from the start was that we would not consider changing our brokerage to yours." And: "(See a comparison of just-the-non-retirement suggestions to possible alternatives, in a chart, below.)" In most cases, I readily (okay - it took me a few hours) came up with what I would consider

This sounds like a waste of time all around.
Why is the FA spending all this time and effort if you won't invest with him? Are you paying him for his time and ideas?

 

[bUU]

That misses the point of tax-efficient placement altogether (you decide when you pay taxes on dividends & CG in deferred accounts and at what rate to a large extent, not so in taxable accounts). Even if you don't sell anything, rebalancing alone will generate a tax liability that you can't influence timing/amount on, not so with deferred.

Probably true, but only "probably". This seems to be very much related to the Roth 401k vs. Traditional 401k question. For some people - reasonable people - Roth wins. Since it is his time, I can't complain. As long as he does what we are paying him for, competently and properly, whatever else he wants to do in addition is his concern.

You're getting bad advice, but if you're happy that's all that matters, though not sure why you asked here and elsewhere...

Who said anything about being happy? I even said, "I'm not sure that that's true, and I'm not sure it really gets to the heart of the tax-efficient fund placement issue." How did you get "happy" from that? I'm really wondering how you made that leap.

This sounds like a waste of time all around.
Why is the FA spending all this time and effort if you won't invest with him? Are you paying him for his time and ideas?

Anyone who uses a commission-based FA is getting bad advice. He's getting paid to review our existing financial plan. Why he chose to propose this radically different approach, instead of just doing what we asked him to do is beyond me. As long as he does what he's being paid for, competently and properly, what he does on his own time, in addition, is his own concern.

 

[Midpack]

You're getting bad advice, but if you're happy that's all that matters, though not sure why you asked here and elsewhere...

Who said anything about being happy? I even said, "I'm not sure that that's true, and I'm not sure it really gets to the heart of the tax-efficient fund placement issue." How did you get "happy" from that? I'm really wondering how you made that leap.

OK, call it "satisfied", but the word itself wasn't the point at all...best of luck.

 

[bUU]

I even said, "I'm not sure that that's true, and I'm not sure it really gets to the heart of the tax-efficient fund placement issue."

OK, call it "satisfied"

How about calling it "unsatisfied", since that's far closer to "not sure that that's true" than "satisfied".

 

[aja8888]

bUU, why not post your original posting questions over on the Bogleheads website forums and see what those folks give you for advice. They appear to have more of the "investment focus" on that site. Plus, they have an entire forum section dedicated for investment portfolio analysis.

 

[bUU]

We're already discussing the article on bogleheads.org. That's actually where I got the referral to the Vanguard document that I quoted earlier.

 

[aja8888]

I apologize if you've seen this message on other forums, but I'm seeking feedback from various sources.

I recently received a proposal from a financial adviser. Putting aside that he didn't map out how we'd get from where we are to where he proposed we go, could you please assess his recommendations based on:

a) placement of each investment for tax efficiency
b) the quality of the funds he's proposing
c) overall asset allocation for folks 5-10 years from retiring

Non-Retirement Accounts
2% Artisan Small Cap Fund Investor Shares
3% Baron Partners Fund Retail Shares
2% Baron Small Cap Fund
2% Calvert Short Duration Income Fund Class Y
2% Hartford Capital Appreciation Fund Class I
3% Hartford Dividend and Growth Fund Class I
1% Hartford Small Company Fund Class A
3% Loomis Sayles Strategic Income Fund Class A
4% Nuveen High Yield Municipal Bond Fund Class I
3% Pioneer Mid-Cap Value Fund Class Y
2% Royce Dividend Value Fund Service Class
1% Royce Global Dividend Value Fund Service Class
4% Royce Opportunity Fund Investment Class
3% Third Avenue Focused Credit Fund Institutional Class
3% Third Avenue Real Estate Value Fund Institutional Class
1% Wasatch Long/Short Fund Investor Class
2% Wasatch World Innovators
39% TOTAL Non-Retirement Accounts

Retirement Accounts
1% ALPS | Red Rocks Listed Private Equity Fund Class I
1% Artisan Mid Cap Fund Investor Class
2% Artisan Mid Cap Value Fund Investor Shares
1% Baron Partners Fund Retail Shares
1% Baron Real Estate Fund Retail Class
3% BlackRock Equity Dividend Fund Investor A Shares
1% Bridgeway Small Cap Growth Fund
2% Bridgeway Small Cap Value Fund
3%  Delaware Small Cap Value Fund Class A
2%  Dodge & Cox International Stock Fund
1%  Dodge & Cox Stock Fund
0% Fidelity Contrafund Fund
4% Goldman Sachs Growth Opportunities
3% Hartford Growth Opportunities Fund Class I
1% Hennessy Gas Utility Index Fund Investor Class
2% ING Corporate Leaders Trust Series B
1% ING Senior Income Fund Class A
3% Invesco Charter Fund Class A
3% Invesco Convertible Securities Fund Class Y
3% Ivy Small Cap Growth Fund Class A
2% Matthews Asia Dividend Fund Investor Class
4% Prudential Jennison Utility Fund Class A
2% Putnam Voyager Fund Class Y
1% T. Rowe Price Health Sciences Fund
2% The Hartford Healthcare Fund Institutional Class
3% Third Avenue Focused Credit Fund Institutional Class
1% Vanguard Developed Markets Index Fund Investor Shares
2% Wasatch Emerging Markets Small Cap
2% Wasatch International Growth Fund
1% Wells Fargo Advantage Discovery Fund Class A
61% TOTAL Retirement Accounts

If this is what you posted at Bogleheads, I can't find it there.

 

[bUU]

If this is what you posted at Bogleheads, I can't find it there.

I'm sorry you're having such a hard time following the discussion.

 

[aja8888]

I'm sorry you're having such a hard time following the discussion.

About as hard a time as I am having following your investment proposal from your FA. You come across as a real wise guy sometimes (I'll be the first to say it).

 

[bUU]

I've been called worse than "wise".

Search on Active Share and Mutual Fund Performance - Antti Petajisto. That's what we're discussing now. If you buy into Petajisto's research, then you apparently buy into the portfolio. If you don't buy into Petajisto's research, then the portfolio is irrelevant. While I'm very skeptical and unlikely to find merit in Petajisto's research, I'm withholding judgement until I have firm proof that I can present cogently to others.

 

[travelover]

About as hard a time as I am having following your investment proposal from your FA. You come across as a real wise guy sometimes (I'll be the first to say it).

You are not the first.

 

[Gatordoc50]

I've been called worse than "wise".

Search on Active Share and Mutual Fund Performance - Antti Petajisto. That's what we're discussing now. If you buy into Petajisto's research, then you apparently buy into the portfolio. If you don't buy into Petajisto's research, then the portfolio is irrelevant. While I'm very skeptical and unlikely to find merit in Petajisto's research, I'm withholding judgement until I have firm proof that I can present cogently to others.

If you decide that the research is valid, then choosing an actively managed fund may be appropriate. But why would you then choose multiple active funds? Like previous posters, I believe your FA is trying to get the benefit of index diversity for you and the benefit of active management for himself.

 

[bUU]

Except he knows that he's not getting anything more than he's already got. Regardless, I'm sure he'll have a chance to explain all these things when I meet with him next. Hopefully he'll have reasonable explanations, and if not, that's still actionable data for me.

 

[redduck]

I apologize if you've seen this message on other forums, but I'm seeking feedback from various sources.

I recently received a proposal from a financial adviser. Putting aside that he didn't map out how we'd get from where we are to where he proposed we go, could you please assess his recommendations based on:

a) placement of each investment for tax efficiency
b) the quality of the funds he's proposing
c) overall asset allocation for folks 5-10 years from retiring

Non-Retirement Accounts
2% Artisan Small Cap Fund Investor Shares
3% Baron Partners Fund Retail Shares
2% Baron Small Cap Fund
2% Calvert Short Duration Income Fund Class Y
2% Hartford Capital Appreciation Fund Class I
3% Hartford Dividend and Growth Fund Class I
1% Hartford Small Company Fund Class A
3% Loomis Sayles Strategic Income Fund Class A
4% Nuveen High Yield Municipal Bond Fund Class I
3% Pioneer Mid-Cap Value Fund Class Y
2% Royce Dividend Value Fund Service Class
1% Royce Global Dividend Value Fund Service Class
4% Royce Opportunity Fund Investment Class
3% Third Avenue Focused Credit Fund Institutional Class
3% Third Avenue Real Estate Value Fund Institutional Class
1% Wasatch Long/Short Fund Investor Class
2% Wasatch World Innovators
39% TOTAL Non-Retirement Accounts

Retirement Accounts
1% ALPS | Red Rocks Listed Private Equity Fund Class I
1% Artisan Mid Cap Fund Investor Class
2% Artisan Mid Cap Value Fund Investor Shares
1% Baron Partners Fund Retail Shares
1% Baron Real Estate Fund Retail Class
3% BlackRock Equity Dividend Fund Investor A Shares
1% Bridgeway Small Cap Growth Fund
2% Bridgeway Small Cap Value Fund
3%  Delaware Small Cap Value Fund Class A
2%  Dodge & Cox International Stock Fund
1%  Dodge & Cox Stock Fund
0% Fidelity Contrafund Fund
4% Goldman Sachs Growth Opportunities
3% Hartford Growth Opportunities Fund Class I
1% Hennessy Gas Utility Index Fund Investor Class
2% ING Corporate Leaders Trust Series B
1% ING Senior Income Fund Class A
3% Invesco Charter Fund Class A
3% Invesco Convertible Securities Fund Class Y
3% Ivy Small Cap Growth Fund Class A
2% Matthews Asia Dividend Fund Investor Class
4% Prudential Jennison Utility Fund Class A
2% Putnam Voyager Fund Class Y
1% T. Rowe Price Health Sciences Fund
2% The Hartford Healthcare Fund Institutional Class
3% Third Avenue Focused Credit Fund Institutional Class
1% Vanguard Developed Markets Index Fund Investor Shares
2% Wasatch Emerging Markets Small Cap
2% Wasatch International Growth Fund
1% Wells Fargo Advantage Discovery Fund Class A
61% TOTAL Retirement Accounts

It's a good start.

 

[Midpack]

So what did you think of this https://pressroom.vanguard.com/nonindexed/active_management.pdf?

 

[M Paquette]

It's a good start.

Yah. My first thought was "Did the advisor run out of funds?"

If I had a day or so where I was totally bored, I would have pounded the portfolio into Morningstar's X-Ray tool, looked at the resulting stock mix and bond weightings, and duplicated the whole thing (tuned for similar weightings) by starting with a total stock market fund or ETF, and a total bond market fund or ETF. Add in one international, one small cap value (which tend to be rich in REITs and other such 'nontraditional' goodies), perhaps a shorter duration bond fund, and tweak. Five funds, way less expenses, and much easier to manage come rebalancing time.

Alas, it's probably not complex enough for the 'sophisticated investor'. (I LOVE that term. http://www.forbes.com/2009/03/24/ac...ance-financial-advisor-network-net-worth.html )

 

[Htown Harry]

Pretty much. Someone on another forum was nice enough to enter the portfolio and backtracking it to 2000. I'm not sure it means anything, but it's a pretty graph. (Attached.)

One potential issue is that all three lines start at the same point.

If these funds average a 4.9% front end load, shouldn't the portfolio value line start 4.9% below the indexes at year zero?

 

[Russman]

I concur with the other responses. Seems like far too many funds to keep track of. Don't see how anyone can actually manage it either. Clearly an overkill attempt at diversification. Like someone mentioned before, the expenses to buy these funds and manage them over time will surely add up....

 

[bUU]

So what did you think of this https://pressroom.vanguard.com/nonindexed/active_management.pdf?

I sent it to him to see what he says. Of course, remember that it actually implicitly ratifies Active Share: "... combined with careful qualitative judgment regarding the health of the investment manager’s firm and the depth of its analytical team, active share can be a useful addition to the investor’s toolkit of portfolio evaluation measures." I suspect that that is probably where he'll hang his hat.

One potential issue is that all three lines start at the same point. If these funds average a 4.9% front end load, shouldn't the portfolio value line start 4.9% below the indexes at year zero?

Among the non-retirement picks only two out of the 17 had loads.

 

[target2019]

Yah. My first thought was "Did the advisor run out of funds?"

If I had a day or so where I was totally bored, I would have pounded the portfolio into Morningstar's X-Ray tool, looked at the resulting stock mix and bond weightings, and duplicated the whole thing (tuned for similar weightings) by starting with a total stock market fund or ETF, and a total bond market fund or ETF. Add in one international, one small cap value (which tend to be rich in REITs and other such 'nontraditional' goodies), perhaps a shorter duration bond fund, and tweak. Five funds, way less expenses, and much easier to manage come rebalancing time.

Alas, it's probably not complex enough for the 'sophisticated investor'. (I LOVE that term. The Sophisticated Investor Farce - Forbes.com )

Also of note is the amount of stock overlap in that mess of 48 funds. I think the premium M* tool would show the stock overlap.

Your approach of starting from an indexed array of the total market, and then tilting to the amount of risk necessary for the expected outcome, makes a lot of sense.