Active vs Index Funds

[Which Roger]

This thread was started yesterday with the underlying assumption that the market will be going down, but it's up 5% so far today. Who knows what will happen going forward, but this does show the futility of trying to predict its direction.

 

[audreyh1]

I boldly predict that in the near future, the market will continue to swing wildly up and down each time there is a tiny whiff of changing pandemic news.

 

[REWahoo]

I boldly predict that in the near future, the market will continue to swing wildly up and down each time there is a tiny whiff of changing pandemic news.

That is definitely a bold prediction.

Think I'll bookmark your post so I can follow up to see if we need to assign you "Market Guru" status.

 

[sakowitzm]

I disagree with the original thesis 100%. If one believes that certain fund managers are "smarter" (whatever that means), the basis for their outlying smarts must lie in things like better algorithms; the ability to discern future trends; the ability to read the same numbers that everyone else reads but come to different conclusions, etc.

And so even if you accept that possibility that certain folks have those advantages, I think you have to throw all of those out the window right now. Who can predict what any firms profitability will be in Q2, Q3? Even if things instantly returned to 100% normal on any given date (say... July 1), when will their revenue begin to pick up? Will it immediately return to the previous level, or will there be a slow re-start? Will they instantly re-hire everyone they had before? Will those people even be available?

There's just too many variables to solve for and not one single historical analogy. Not the 1918 flu epidemic - the financial world looks nothing like it did 100 years ago. Not the more recent, more (relatively) minor epidemics such as SARS - SARS infected and killed less than 1% as many people.

No, whatever possible advantage an actively managed fund might have is best when working on "normal" circumstances. Not this.

 

[ncbill]

Well, as a frequent advocate for passive investing (some would say "tiresome"), here is my take (limited to equity funds; I am not a bond fund guy.):

Truly passive investing is doing what Eugene Fama has repeatedly said: "We have to hold the market portfolio." Everything. The only fund I know of that actually does this is VT/VTWAX though there are probably others. While technically the "total market" funds like VTSMX and VGTSX are picking stocks only in one defined market, they typically get a pass on this and are considered "passive."

At the other end are the unabashed stock pickers. These funds are deliberately non-diversified, concentrating instead on trying to pick a few winners. Less than 50 stocks maybe? I don't know what the exact number might be. They are characterized by higher fees, which are justified as being necessary to pay all their "experts." They are also characterized by high trading costs because their turnovers often exceed 100% per year. And, of course, in aggregate they fail to deliver.

Between these two there is IMO a confusing spectrum.

"Near passive" funds include the S&P 500 funds, which pick/hold only about 15% of the US market issues, but that 15% represents 80% of the US market cap. So they are kinda, sorta, total market funds. Another class of near passive funds are the closet indexers. These funds hold a large number of stocks, diversified to the point that they effectively track a total market index. This is a cushy ride for managers because they can talk big and collect big fees, but they are taking little or no risk.

The spectrum between the closet indexers and the true stock pickers is broad and deep. Your small cap index fund fits here as do many of the bigger sector funds. This is essentially stock picking/trying to pick winners, but with more diversification, hence less volatility than a true stock picking fund would give you.

There are also many funds with "index" in their names, created by hucksters who want to trap the naive investor who has been told to "buy index funds." You like the "Sabrient Multi-Cap Insider/Analyst Quant-Weighted Index" ?? Somewhere, some huckster is selling an "index" fund based on this. How about "FTSE Asia Pacific Qual / Vol / Yield Factor 5% Capped Index?" The index creators are happy to create any goofy and narrow index that they have buyers for. It is not their job to protect the public from the hucksters.

Brief question, complicated answer. Sorry.

Don't forget not only do those have higher fees but also higher risk.

I've noticed a tendency here to focus on returns...e.g. "my high-yield dividend stock portfolio beats the market" without a realization that comes with substantially more risk than the market portfolio.

 

[OldShooter]

Don't forget not only do those have higher fees but also higher risk. ...

You are right, of course. Thank you.

William Bernstein's comment pertains:

“Do you think that by choosing a portfolio of only a few stocks that you hope will score big, you are maximizing your chances of becoming wealthy? Indeed you are, but you are also maximizing the chances of a retirement of cat food cuisine”
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