Wharton MBAs & Harvard undergrads can't evaluate cheap index funds

[cute fuzzy bunny]

You could cut off that statement right after the word "of" and it'd still be valid.

[doushioukanaa]

Quote:

Originally Posted by brewer12345 UYup.* And we are probably never going to see the end of posters here trying to convince us that managed funds are a better choice.

With any product or service offering, there are always organizations that create systems that deliver the goods at a better value for the money for particular segments of the market.* I do agree with the notion that many if not most managed funds are not a better value for the money than an index fund.* I also agree with the premise that low cost index funds offer a good value for the money to a large segment.

However, if there exists a fund or fund family that has a management system that delivers a good risk/return ratio consistently, sustainably,*scalably, at reasonable cost, and with limited manager risk due to a team approach, why should they be ruled out of consideration?

In order to drill down to a specific example, if you had enough to invest in A shares of American Funds' Capital Income Builder to avoid any up front loads (and I realize that is a big "if"), why wouldn't you consider them for a big chunk of your portfolio?* Sorry to sound like a shill for a specific fund but it's actually in my own best interests to keep the fund a secret so that it doesn't get larger faster.*

Capital Income Builder (CAIBX) spits off ~4% in income per year, close to the standard SWR, while the principle goes up well in excess of inflation.* *Its annual costs are only .57%.* It has matched the total market over the past 10 years with far less volatility.* It lagged during the entire tech bubble, but went up in 2002 when the total market was down over 20%.* They never change their mandate; they have cracked the code of how to scale the business without sacrificing performance, and now all the other fund families are trying to emulate them.*

I'm paying a premium of .48% over the .09% I could get in an index fund.* I'm getting more income, comparable returns, lower volatility, international exposure, etc.* I think that .48% is well worth it.* Am I foolish to have a good chunk of my portfolio there if I was able to purchase at NAV?* I am open to the arguments and really want to hear why I should switch out into an indexing approach.*

[free4now]

Congress should require that your financial statements include an accounting of how much fees/costs/loads/etc you pay. Reading through a prospectus to seek out all the possible fees that might apply to you is difficult, but when your brokerage statement shows that 2% of your egg was lost to fees, many people will have a "hmm" moment.

[brewer12345]

Quote:

Originally Posted by doushioukanaa With any product or service offering, there are always organizations that create systems that deliver the goods at a better value for the money for particular segments of the market.* I do agree with the notion that many if not most managed funds are not a better value for the money than an index fund.* I also agree with the premise that low cost index funds offer a good value for the money to a large segment. However, if there exists a fund or fund family that has a management system that delivers a good risk/return ratio consistently, sustainably,*scalably, at reasonable cost, and with limited manager risk due to a team approach, why should they be ruled out of consideration? In order to drill down to a specific example, if you had enough to invest in A shares of American Funds' Capital Income Builder to avoid any up front loads (and I realize that is a big "if"), why wouldn't you consider them for a big chunk of your portfolio?* Sorry to sound like a shill for a specific fund but it's actually in my own best interests to keep the fund a secret so that it doesn't get larger faster.* Capital Income Builder (CAIBX) spits off ~4% in income per year, close to the standard SWR, while the principle goes up well in excess of inflation.* *Its annual costs are only .57%.* It has matched the total market over the past 10 years with far less volatility.* It lagged during the entire tech bubble, but went up in 2002 when the total market was down over 20%.* They never change their mandate; they have cracked the code of how to scale the business without sacrificing performance, and now all the other fund families are trying to emulate them.* I'm paying a premium of .48% over the .09% I could get in an index fund.* I'm getting more income, comparable returns, lower volatility, international exposure, etc.* I think that .48% is well worth it.* Am I foolish to have a good chunk of my portfolio there if I was able to purchase at NAV?* I am open to the arguments and really want to hear why I should switch out into an indexing approach.*

I guess the real problem is that you have no guarantee whatsoever that the historical performance, style, management, etc. of a managed fund will continue to persist. What if the management team at the fund you own turns over and the new crowd isn't as good? What happens if asset bloat finally weighs down the fund? What happens if the American Funds management company changes hands to new ownership that has different ideas about how to run the business? Most or all of these considerations do not apply to index funds/ETFs, plus they are ahead from day 1 on expenses, turnover and tax efficiency.

Having said that, I've no doubt that some managers can consistently beat the market/deliver aplha. Its just that it tends not to persist for various reasons. Add in the cluelessness of most retail investors, and you have an ugly situation where the investors can't pick the best managers and the best managers tend to go elsewhere over time even when the retail schmoe does manage to stumble into a good fund. After all, hedge funds pay far better than mutual funds, so anyone with skill and ambition has had to at least think about hopping the fence.

[doushioukanaa]

Quote:

Originally Posted by brewer12345 I guess the real problem is that you have no guarantee whatsoever that the historical performance, style, management, etc. of a managed fund will continue to persist.* What if the management team at the fund you own turns over and the new crowd isn't as good?* What happens if asset bloat finally weighs down the fund?* What happens if the American Funds management company changes hands to new ownership that has different ideas about how to run the business?* Most or all of these considerations do not apply to index funds/ETFs, plus they are ahead from day 1 on expenses, turnover and tax efficiency. Having said that, I've no doubt that some managers can consistently beat the market/deliver aplha.* Its just that it tends not to persist for various reasons.* Add in the cluelessness of most retail investors, and you have an ugly situation where the investors can't pick the best managers and the best managers tend to go elsewhere over time even when the retail schmoe does manage to stumble into a good fund.* After all, hedge funds pay far better than mutual funds, so anyone with skill and ambition has had to at least think about hopping the fence.

All really good points.

I guess my inside information about the fund by knowing one of the fund managers is the X Factor that gives me the confidence that key staff retention is good and that their team approach is for real. This obviates the risk of a star manager departing and impacting the fund.* The acquisition risk is something I hadn't thought of.* I could lose out on some big tax deferred gains if I lose confidence and need to trade into an index fund.

Now, everybody, ignore what I said and don't buy CAIBX -- I don't want to expedite their path to bloat!* ;-)

[justin]

Instead of CAIBX, why not buy 65% VG Equity Income fund with a 2.82% yield and 35% Intermediate term investment grade Bond fund with a 5.53% yield. Half the annual expense, no up-front sales charge, and 30 basis points more yield.

[doushioukanaa]

A couple of reasons...

The dollar is going down the toilet and your suggested mix provides insufficient international exposure.* CAIBX finds the best opportunities including the US, and irrespective of geography.* That's part of the reason their 5 year return trounces Vanguard Equity Income.*

Also, the Vanguard fund has a single manager, John Ryan.* Who knows how long he will be on board?* CAIBX has a team of managers with great track records.* If one of them gets hit by a bus, the fund will carry on. What happens if John Ryan gets hit by a bus?

[cute fuzzy bunny]

I'd have to go look and i'm too lazy to do it, but i'm pretty sure the vanguard equity income fund is partially managed by about a bazillion people...I think the wellington management folks and the vanguard quant group is involved, among others?

[justin]

Quote:

Originally Posted by Cute Fuzzy Bunny I'd have to go look and i'm too lazy to do it, but i'm pretty sure the vanguard equity income fund is partially managed by about a bazillion people...I think the wellington management folks and the vanguard quant group is involved, among others?

Correct. And I looked at the fund total holdings - $4.4 billion in assets under management, versus the bloated Capital Income Builder with 10x the assets under management.

I own a fair amount of CAIBX from my days with Edward Jones, but given the high front end loads, I wouldn't buy it again today when there are cheaper options (and since I don't care much about current income).

[cute fuzzy bunny]

I'm not super fond of either, I like windsor II in place of the equity income fund, although its taken on a lot of money lately and that usually doesnt end well...

[Nords]

Quote:

Originally Posted by brewer12345 I guess the real problem is that you have no guarantee whatsoever that the historical performance, style, management, etc. of a managed fund will continue to persist.

No refunded management fees for bad years, either!

[doushioukanaa]

Quote:

Originally Posted by justin I own a fair amount of CAIBX from my days with Edward Jones, but given the high front end loads, I wouldn't buy it again today when there are cheaper options (and since I don't care much about current income).

I agree one should not buy CAIBX unless you have enough in American Funds to buy at NAV or one of the lower breakpoints.* 5.75% is highway robbery, but it means the onesey twosey investors subsidize the returns of people who can hit the breakpoints.

The point about scale is very well taken.* It's going to be more challenging to manage going forward, but I think they have the systems to do it.

One other factor I thought about is that the annual fee applies to the bond portion as well, which means effectively the equity fee is higher than the sticker price when you consider fixed income fund costs are usually lower.

But is there a combination of index funds that can sorta emulate CAIBX, including the international component at a far lower cost?* I'm interested to try and back test it and see how it performed, especially in 2002.

Also, is there a way to find out to what extent fund managers have their own personal investments within their funds?

Actually I was kinda shocked this year...CAIBX and Capital World Growth and Income both had "special" dividends at the end of the year in addition to the normal dividend.* It seemed kind of weird, and I'm guessing it's just a way to mask a fee decrease so that they don't need to make it permanent.

[unclemick]

Duh

We've been down this road before - what's wrong with those MBA cats.

John C Bogle explains how to beat index funds the old fashioned way in his Nov. 12, 1997 speech to The Assoc. For Investment Management and Research.

William Bernstein quantifies your odds of doing so in with his 15 Stock Diversification Myth article in Efficient Frontier.

The Norwegian widow just smiles and collects her dividends.

I'll leave Fama and French, the value premium, etc to the academics.

Send them to Chicago School of Finance.

heh heh heh - first cup of coffee - and I confess my male hormones cause me to peek at stock holdings of 'good' value funds for ideas from time to time.

[justin]

Quote:

Originally Posted by doushioukanaa I agree one should not buy CAIBX unless you have enough in American Funds to buy at NAV or one of the lower breakpoints. 5.75% is highway robbery, but it means the onesey twosey investors subsidize the returns of people who can hit the breakpoints... ...But is there a combination of index funds that can sorta emulate CAIBX, including the international component at a far lower cost? I'm interested to try and back test it and see how it performed, especially in 2002.

The onesey twosey investors aren't subsidizing the returns of the breakpoint buyers. They are lining the wallets of their brokers. The sales loads go to compensate brokers and not into the fund's general accounts.

As to emulating CAIBX with index funds, I'm sure one could data mine until they found an optimal combination of funds. CAIBX is heavily tilted towards international, large cap and value. If I wanted to emulate their returns using low cost funds, I'd try 28% VIVAX (VG Value index), 37% VTRIX (VG International Value), and 35% VBISX (VG Short Term bond index).

That combination is based on CAIBX's current portfolio allocations. Not sure how they were positioned historically over the last 5-10 years. I seem to recall they had a smaller allocation to international investments a few years ago.

I'd be interested to see how a mix of the 3 VG funds would have done over the 2000-2006 period. FYI, the VG funds have a composite expense ratio of 0.31% and zero sales loads.

And as always, past results will not necessary be repeated in the future.

[doushioukanaa]

Thanks for the ideas on emulation!* I didn't realize 100% of the loads go to the brokers.* Learn something new every day.

I guess that leaves me with a .26% annual premium paid for CAIBX versus the basket you recommend.* That is 83% more, which sounds large when you think about it, but could be dwarfed by just one year of outperformance.

So it comes down to whether the research resources and sustainability of the the American Funds management structure are worth that 83% premium.* I think I will continue to bet that I get a good value for the money even though the funds are becoming very large.* Does that make me as silly as those Harvard undergrads and Wharton MBAs?* *

We shall see I guess...At least I will take comfort in not having paid any up front loads.

[2soon2tell]

Take a look at T. Rowe Price PRWCX. *5* rating, no load, reasonable ER
good returns

2soon

[doushioukanaa]

Thanks for the recommendation!

Actually, it looks like PRWCX's expense ratio is quite a bit higher than CAIBX.* It is also very highly weighted to US stocks.* Also, managed by Stephen W. Boesel.* What happens if he gets hit by a bus?* I don't think the fund family or this particular fund is for me.

[justin]

Quote:

Originally Posted by doushioukanaa We shall see I guess...At least I will take comfort in not having paid any up front loads.

If you have $1,000,000 or more with american funds, it's probably not a bad fund choice. Compared to most actively managed funds, CAIBX's expense ratio is great! For the rest of us suckers with less than $1,000,000 to invest, we'll be paying an up front sales fee that is hard to justify when you have good alternatives available elsewhere for less money.

CAIBX does have a really high yield, presumably from high-dividend stocks, based on its extreme value tilt.

[doushioukanaa]

Thanks for the feedback and reassurance on the pick.

One point of information...I just checked with a friend who used to work for Edward Jones. He said about 85%-90% of the loads for American Funds go to the broker, so about 10%-15% goes toward the fund company. It varies by fund company I guess.