Is a high ER ever 'worth it'?

[BBQ-Nut]

So, I've been reading a lot about the lazy/couch potato portfolio strategy with the thought of simplifying my accounts across after tax, 401k, rollover IRA, and Roths.

And, I've been re-examining the approach of just using low expense ratio ETFs as well.

Now - when it comes to picking candidate funds I'm currently in, I've compared the returns and in some cases the managed funds have done exceedingly better using a 1, 3, and 5 yr comparison.

For example....

The lazy portfolio strategy is to use a total overseas market index ETF, such as Vanguard's VXUS.

I have been holding Fidelity's Worldwide Fund (FWWFX) for "international" equity exposure for several years (and prior to my serious contemplations of early retirement and deep diving into planning).

It has a high expense ratio, but when comparing it to the VXUS, it crushes.

To the crux of my question - is it ever 'worth it' to just hold your cards, not churn the portfolio and keep a high performing managed fund despite it having high ER?

 

[Totoro]

To the crux of my question - is it ever 'worth it' to just hold your cards, not churn the portfolio and keep a high performing managed fund despite it having high ER?

Well, what valid reasons do you have to be able to confidently forecast continued outperformance for the managed fund above the higher ER? I'm sure you know past outperformance is not a valid reason, it may have been luck.

One could be that you know the manager's style and have a solid reason to assume he will stay and continue with his style. In addition, you need to understand why his style works and will continue working. That's a high bar to clear, but it can happen.

Another more mundane reason could be exit fees or tax implications.

That's pretty much it I think.

 

[Animorph]

It's worth it if it out performs in the future. I'm fine with active funds and paying more for something I like, but I'd like a much longer look back than 5 years unless that's all the track record there is. I usually ignore 1 year returns. An ER can reasonably be high if the fund's asset level is small. Or it could just indicate a fund company out to screw you.

Just read this at M*: Making Contrarian Investing Work

It shows you could time things by buying the worst 5 year performers and beat the market.

"Key Takeaways

• Betting on assets with poor recent performance is a bad idea. In the short term, momentum dominates, which means that recent laggards often continue to disappoint and recent leaders remain aloft.
• However, assets that underperform over longer periods (four to five years) eventually become cheap and poised to offer better returns.
• Investors can take advantage of these long-term reversals with a contrarian strategy using ETFs. This strategy may work better when investors consider valuations together with the contrarian signals."

 

[BBQ-Nut]

It's worth it if it out performs in the future. I'm fine with active funds and paying more for something I like, but I'd like a much longer look back than 5 years unless that's all the track record there is. I usually ignore 1 year returns. An ER can reasonably be high if the fund's asset level is small. Or it could just indicate a fund company out to screw you.

Just read this at M*: Making Contrarian Investing Work

It shows you could time things by buying the worst 5 year performers and beat the market.

"Key Takeaways

• Betting on assets with poor recent performance is a bad idea. In the short term, momentum dominates, which means that recent laggards often continue to disappoint and recent leaders remain aloft.
• However, assets that underperform over longer periods (four to five years) eventually become cheap and poised to offer better returns.
• Investors can take advantage of these long-term reversals with a contrarian strategy using ETFs. This strategy may work better when investors consider valuations together with the contrarian signals."

"recent laggards often continue to disappoint"

Ain't that the truth!

One reason I'm within a hair's width of dumping VWO - talk about a drag down....

 

[BBQ-Nut]

Well, what valid reasons do you have to be able to confidently forecast continued outperformance for the managed fund above the higher ER? I'm sure you know past outperformance is not a valid reason, it may have been luck.

One could be that you know the manager's style and have a solid reason to assume he will stay and continue with his style. In addition, you need to understand why his style works and will continue working. That's a high bar to clear, but it can happen.

Another more mundane reason could be exit fees or tax implications.

That's pretty much it I think.

Thanks for reply - valid points.

I don't have any confidence to answer your first question. I can say in hindsight (which is always perfect)...sure glad I had a stake in FWWFX vs FXUS.

Sure wish I didn't take some advice on VWO.....

Maybe the total index/low ER ETF is the 'middle ground' - it might be enough and cover the bases as someone else posted in the Monte Carlo thread between alien invasions and breathing gold plated oxygen.

 

[LOL!]

I am not sure why one would even compare FWWFX to VXUS (or FSGDX). FWWFX is 50% US equities and ONLY 46% international equities. Although still not a good comparison, FWWFX is closer to an S&P500 fund than it is to an international fund.

I will say that I am glad that I had US equities and international equities in my portfolio and that I rebalanced between them so that my portfolio did great.

 

[BBQ-Nut]

I am not sure why one would even compare FWWFX to VXUS (or FSGDX). FWWFX is 50% US equities and ONLY 46% international equities. Although still not a good comparison, FWWFX is closer to an S&P500 fund than it is to an international fund.

I will say that I am glad that I had US equities and international equities in my portfolio and that I rebalanced between them so that my portfolio did great.

Ok..fair enough...although one could argue semantics that "International" can include US equities...whatever...

To the crux of my question - high ER funds are poo poo'd - would tend to agree. But - if the track record is there, can/should they be considered at all, or summarily dismissed?

 

[David1961]

Keep in mind that if you have held a high ER fund for many years and it has appreciated a lot, there will be tax consequences if you just sell it. Overall, I recommend going with low ER funds, though.

 

[David1961]

Also, back in the 80's when Peter Lynch managed the Fidelity Magellan fund, most investors probably thought it was worth it (although I'm not sure what the funds ER was back then). But managers like that don't come around often and many funds have high turnover of fund managers.

 

[LOL!]

Keep in mind that if you have held a high ER fund for many years and it has appreciated a lot, there will be tax consequences if you just sell it. Overall, I recommend going with low ER funds, though.

Maybe not. It is possible that the annual distributions of dividends and cap gains were something that you were paying taxes on all along. it is even possible that your cost basis is HIGHER than the current value, so that you could sell at a loss. This is something that happens with actively-managed funds with high turnover.

 

[BBQ-Nut]

If one were to consider just the cold hard numbers - if a managed fund were to always outperform a passive ETF by more than the difference of the ERs, is it 'worth it' to hold the managed fund?

Or, are there other factors that need to be accounted for to see which is 'better' - purely from a $$ perspective?

 

[LOL!]

One reason I'm within a hair's width of dumping VWO - talk about a drag down....

Several successful trades of VWO were noted in the LOL!'s Market Timing Newletter Thread. It's been an awesome performer.

 

[BBQ-Nut]

Maybe not. It is possible that the annual distributions of dividends and cap gains were something that you were paying taxes on all along. it is even possible that your cost basis is HIGHER than the current value, so that you could sell at a loss. This is something that happens with actively-managed funds with high turnover.

Very good point.

Another question I had was that in the lazy/couch potato strategy, one is to hold "total index" type of ETFs.

Might not these ETFs also generate distributions and incur taxes contributing to one's AGI?

 

[LOL!]

If one were to consider just the cold hard numbers - if a managed fund were to always outperform a passive ETF by more than the difference of the ERs, is it 'worth it' to hold the managed fund?

Or, are there other factors that need to be accounted for to see which is 'better' - purely from a $$ perspective?

If in a taxable account, after-tax results are important, so taxes may be a factor.

 

[BBQ-Nut]

Several successful trades of VWO were noted in the LOL!'s Market Timing Newletter Thread. It's been an awesome performer.

Beg to differ when compared to say VEA

 

[Jager]

The outperformance of actively managed mutual funds - of those that do - decline versus their index peers as the period of observation lengthens. By 20 years, it's a only a small percentage of funds that beat the indexes. Most end up being discontinued as their performance lags.

Understanding that high fund mortality and the difficulty in picking which funds will be the winners over time, sure, an actively managed fund would be fine in a tax-sheltered account; and maybe, depending upon your tax situation, even in a non-tax-sheltered account.

There's nothing intrinsically wrong with an actively managed account and its higher ER. Just the human fallibility of trying to beat the market. Something that's relatively easy to do in the short term. But a thing that becomes moderately difficult to do in the medium term. And exceedingly difficult to do in the long term.

Index Fund Returns Get Better With Age - Forbes

 

[haha]

So, I've been reading a lot about the lazy/couch potato portfolio strategy with the thought of simplifying my accounts across after tax, 401k, rollover IRA, and Roths.

And, I've been re-examining the approach of just using low expense ratio ETFs as well.

Now - when it comes to picking candidate funds I'm currently in, I've compared the returns and in some cases the managed funds have done exceedingly better using a 1, 3, and 5 yr comparison.

For example....

The lazy portfolio strategy is to use a total overseas market index ETF, such as Vanguard's VXUS.

I have been holding Fidelity's Worldwide Fund (FWWFX) for "international" equity exposure for several years (and prior to my serious contemplations of early retirement and deep diving into planning).

It has a high expense ratio, but when comparing it to the VXUS, it crushes.

To the crux of my question - is it ever 'worth it' to just hold your cards, not churn the portfolio and keep a high performing managed fund despite it having high ER?

Seems like you have already answered this question. Obviously it was worth it for these funds and this time period.

Will the same hold in the future. I don't know.

 

[eta2020]

It does not matter over 2 plus years of lifetime of VXUS. Compare FWWFX to SPY over last 20 years. FWWFX is a dog......

And once you have 20 years of VT (which closer to FWWFX) it will most likely outperform.....

 

[LOL!]

Beg to differ when compared to say VEA

A buy of VEA was also mentioned in the LOL! MT thread: http://www.early-retirement.org/forums/f44/lol-s-market-timing-newsletter-57042-10.html#post1431618 Could my timing be improved? Of course!

 

[pb4uski]

I think that you missed LOL's point. You need to be very careful in comparing the performance of different funds and make sure they are sufficiently similar.

 

[clifp]

Ok..fair enough...although one could argue semantics that "International" can include US equities...whatever...

To the crux of my question - high ER funds are poo poo'd - would tend to agree. But - if the track record is there, can/should they be considered at all, or summarily dismissed?

No we shouldn't

I mean we don't dismiss Wellesley and Wellington just because they managed.

I recently met a couple of local ER members for lunch. During the lunch one of the guys Kimo gave me a book called the 2014 Independent Guide to Vanguard Funds. Basically it consists of a single page evaluation of each Vanguard fund. About 2/3 of it consists of the same type of performance data you'd see at Morningstar. About 1/3 of it is the authors qualitative assessment of the funds. I haven't read all of the book, but did read much of it.

It appears that in solid majority of the funds, the author prefer the managed fund vs the index fund, based on the past track record.. This was especially true in the case of international funds.

For instance the the 10 year returns (to 2013) of Total international VGTSX is 101.5% If we look at the 10 year total returns of the 3 actively managed international Vanguard funds. We have Global Equity at 111.9%, International value at 112.6% International Growth at 129.5%, and International Explorer (small cap) at 156.2%. Now the managed funds are slightly more volatile than the index fund, but the difference isn't huge a Beta of VGTSX of 1.13 vs Explorer of 1.18.. The ER is certainly higher .4-6% vs .15% for the admiral international index fund.

It seems to me that international stock picking is one area where indexing may not be the way to go.

One other thing I learned in looking at Vanguard's website 102 out 111 Vanguard stocks funds beat their indexes over a ten year average. Now Vanguard has a lot of Index funds, but they also have a ton of active funds. The one characteristic of Vanguard funds is low expense, I wonder if that isn't a big factor in the 102 out of 111 funds more than indexing.

 

[Animorph]

Beg to differ when compared to say VEA

If your question is whether a fund is "good" or not, VEQ and VWO are totally different index funds and both good and both low ER. You should probably have both of them. They'll behave differently and smooth out your portfolio.

On the other hand if you want to say you screwed up by overweighting VWO instead of VEA, that's fine too.

But just because VWO didn't match the performance of VEA in the last one to five years doesn't make VWO a bad fund.

Be sure to compare your active funds against their nearest index fund benchmark. I don't think we've seen two similar funds mentioned in this thread yet.

 

[REWahoo]

One other thing I learned in looking at Vanguard's website 102 out 111 Vanguard stocks funds beat their indexes over a ten year average. Now Vanguard has a lot of Index funds, but they also have a ton of active funds. The one characteristic of Vanguard funds is low expense, I wonder if that isn't a big factor in the 102 out of 111 funds more than indexing.

+1

"Cost matters"...or so I've heard.

 

[MichaelB]

Morningstar recently published a series of articles on fund expenses, showing that total expense is the single best predictor of future performance relative to other funds in the same category. The website "The Mutual Find Observer" picked it up and did some additional data analysis. I'll see if I can find the links and post here. The evidence was solid.

One thing to keep in mind when it comes to extrapolating past performance is large fund companies often merge or close poor performers, this helps creates the appearance that over performance is sustainable.

 

[MooreBonds]

The only actively managed funds I have in my portfolio are for foreign markets.

It's impossible to find true broad exposure to the depth that want in Vanguard or other low-cost index funds - it's like wanting to own the US market, but only finding an index fund that has the top 20 US stocks by market cap, or going with a small-cap fund that only has 20-30 US small-cap stocks. I want to try and capture a lot more exposure to a lot of the smaller name in various markets, and sometimes the easiest way is by a few actively-managed funds, like a Matthews fund. It's a trade-off I'm willing to make, although I surely don't like it.

But the other thing is that many foreign actively-managed funds do have higher expenses just from the aspect of paying more for stock trades and other requirements of trading on foreign exchanges...so there's only so low you can go on a foreign ER (except for the billions in a fund like VWO).