Active vs passive equity investing

[MichaelB]

If the past decade was one of too much credit and the upcoming one will be continued tightening, that should have a ongoing negative effect on companies with impaired balance sheets – and give competitive advantage to companies with strong balance sheets.

Doesn’t this point to a disadvantage for broad equity indexes vs active fund management? In other words, is this a moment to shift from passive to actively managed funds?

 

[REWahoo]

In other words, is this a moment to shift from passive to actively managed funds?

Only if you time it juuuust right...

 

[yakers]

Only if you are a great investor like Warren Buffett.

Oh, wait, I'm down 33% on BRK since I bought it.

 

[FIREd]

How do you select the manager who will make the right decision time and time again?

 

[ERD50]

And get in before every other active fund manager does and drives the price up on those equities therefore negating any advantage.

-ERD50

 

[unclemick]

My crystal ball is cute - but it has never been terribly accurate. However I have this trusty dohicky called a REAR VIEW MIRROR.

Every year since I started investing in 1966 - it has always picked out the stock/mutual fund that beat the heck out of whatever I owned in any given year.

It used to tick me off.

Nowadays - me and the Norwegian make sure my SEC yield defense is up to snuff and I have 'enough' which I understand is the title of Bogle's latest book.

heh heh heh - I do have a few good stocks to keep the hormones happy. . Once again I predict a good season for the Saint's - way in advance.

 

[ats5g]

If the past decade was one of too much credit and the upcoming one will be continued tightening, that should have a ongoing negative effect on companies with impaired balance sheets – and give competitive advantage to companies with strong balance sheets.

Doesn’t this point to a disadvantage for broad equity indexes vs active fund management? In other words, is this a moment to shift from passive to actively managed funds?

If you've already had these thoughts, it's a good bet that a whole lot of other people have had these thoughts and probably acted on them, which has moved the prices of stocks. Remember, it doesn't matter what you know, it only matters what you know that others don't know.

 

[Midpack]

In other words, is this a moment to shift from passive to actively managed funds?

I would switch everything to active if I were you, but certainly not if I was me.

 

[Gone4Good]

If the past decade was one of too much credit and the upcoming one will be continued tightening, that should have a ongoing negative effect on companies with impaired balance sheets – and give competitive advantage to companies with strong balance sheets.

Doesn’t this point to a disadvantage for broad equity indexes vs active fund management? In other words, is this a moment to shift from passive to actively managed funds?

I don't understand why this changes anything with respect to active management vs. indexing. Those over leveraged companies have already seen their stock prices decline and their share of the index along with it. When I buy the index today, I'm buying a lot less Citigroup than I did last year.

And the argument against active management hasn't changed. When taken as a whole, investors can do no better than the market, less transaction costs. So, by definition, the majority of active managers will do worse than the index. And as far as I can tell there still is no art or science that in any way helps you select the minority of managers who will outperform in future periods.

 

[MichaelB]

Finding the right active manager – that’s a problem. Career risk pushes fund managers toward shorter term momentum and away from longer term appreciation.

Efficient market –this past decade leads me to doubt this efficiency. Assuming all this is already priced equally into each security - I am much less convinced about this than any time since I began investing.

Maybe what I’m looking for is more of a passive filter that eliminates equities that meet a condition – say, the lowest debt to equity ratios, or only the top 25% of debt to equity, or something like that. It just seems to me that excess leverage had so much to do with the appreciation of asset prices that it's gradual removal has to produce an opposite effect, not immediately but over a sustained period of time. It's just not clear how to invest in this.

 

[FinanceGeek]

MichaelB - I also doubt efficiency, it just doesn't seem possible that the amount of volatility in the market can be justified by anticipated changes in future cash flows.

Even though the market efficiency thing doesn't hold in the real world, that doesn't mean that its easy to outguess the market. So I happily stick to indexing.

 

[ats5g]

Personally, I think the market is micro efficient, not necessarily macro efficient. I'm going with Samuelson on micro efficiency vs. macro efficiency. From his 1994 paper in the Journal of Portfolio Management, The Long Term Case for Equities: And how it can be oversold.

I have considerable belief in microefficiency of liquid organized markets. I am doubtful about any great macroefficiency. General Motors' stock gets priced before and after dividend payments to preclude easy pickings. GM convertibles sell about right in ratio to GM common and GM preferred. (For a small firm, followed by few investors, I'd have to modify this plug for microefficiency.)

Why the shouldn't I believe that the level of the whole equity index gets priced right in good times and bad? The difference is that when Franco Modigliani sees a mispricing of GM common and preferred, he and others can make profits doing what corrects that discrepancy. And that's why the microefficiency gets wiped out as soon as it becomes significant enough to become recognizable.

How does the story run when, in the late 1970's Professor Modigliani opined that the Dow was below 1,000 "irrationally," in the sense that be believed it would be at least 1,400 if investors and speculator understood how not to double count the bad effects on corporations of then-current inflation? All he could do was write about it. Arguing with the tape by selling the general index short could be costly, and in any case ineffective, while animal spirits were what they were and analysts' shortcomings were what they were.

That is why I stand with Shiller (1986) as a doubter of market macroefficiency.

Caveat: I suspect that macro-mispricings will, as Japan during the period 1987-1992, create some tension toward correction. Therefore, I would expect a kind of bounded degree of macro-efficiency to prevail most of the time in the long run. Although I personally am cautious in trying to "time," when Tobin's Q wanders too far from its historic haunts, I find myself making modest changes in degree of equity exposure. Who's being human now?

Though, even in an inefficient market, indexing may be the better option:

The Inefficient Market Argument for Passive Investing

 

[redduck]

If you've already had these thoughts, it's a good bet that a whole lot of other people have had these thoughts and probably acted on them, which has moved the prices of stocks. Remember, it doesn't matter what you know, it only matters what you know that others don't know.

I'm not so sure about the last line (which I put in bold). It seems ALMOST EVERYONE was aware of the housing bubble. The wise ones figured out what to do about it. So, I'm thinking it's what you do with the information that's important. Now we have the government printing lots and lots of money and ALMOST EVERYONE knows about it. I wonder how the wise ones are going to play it (or, if it needs to be played at all).

 

[dixonge]

or you could just do index credit spreads...in which you profit when the market doesn't do much of anything quickly.

But the key is money management. No matter what your investment tool of choice, no matter what your selection process, money management (risk determination, position size, exit strategy) will make the difference between a wild ride and/or steady progress.