Managed versus Indexed

[danearnold]

My 401k consists of managed MFs (OAKBX, FLPSX, FCNTX, FDIVX, OAKLX, FEXPX, LMNVX, FDCAX, FFTYX, NBGEX).

Lately I have been reading/thinking more about the benefits of indexed funds. But I am having a little trouble deciding what, if anything, is so wrong with what I have. For example, an index fund available to my 401k is VINIX – it has an expense ratio of .05 compared to an average of .90 for my funds, and a turnover rate of 5% compared to an average of 57% for my funds. I know both of these are benefits of the index fund.

But VINIX has three, five, and ten year trailing returns of 17.08, 0.34, and 9.13; compared to averages for my funds of 22.32, 9.68, and 13.82. I am not an expert on interpreting the numbers I see in M*, but much of what I see (not counting expense ratio and turnover) looks (to me) like my mix is better - Bear Market Decile Rank of 3.7 average versus 7 for VINIX for example.

Do trailing returns take into account the expense ratio and the turnover? If not, how do I make the translation?

What am I missing?

Thanks

 

[JPatrick]

<<<<Do trailing returns take into account the expense ratio and the turnover? If not, how do I make the translation?
>>>>>

I think you are asking if you can trust the published trailing returns.
Published returns are generally based on net asset values(NAV).
The NAV on a given day is the value of the share and what you get if you sell, assuming no backloads are paid.  The expenses you reference work their way into the NAV as do the prices of the stocks the fund may hold.  So if the NAV of your fund doubled  --your money doubled, again assuming we are dealing with no loads.
The thing about managed vs index is that you are paying management to beat a given index.  If they fail, shame on them.  The success ratio depends a great deal on market conditions.  Over the last two years it has been much easier to beat index funds.  Rewind to the late 90's and 76% of the managed funds were getting whipped by the index.
So yes, you can believe trailing returns based on NAV's.  However, it's an ever changing game so check often.  One example--I think your FDCAX has fallen out of favor a bit if you compare it to say a 500 index or total stock market.

 

[cute fuzzy bunny]

The short answer is that there is no translation. Market movements in periods of under ten years are often cyclical and controlled by investor psychology. Fund returns in actively managed funds look better in some of these shorter periods.

There are only a handful of guys who beat the "market", ie a standardized index of s&p500 or total stock market. Aside from Buffett, I dont think anyones done it for a long time. Miller is over a decade but I have a funny feeling he's in for a bad stretch. Peter Lynch had a good run but if you look at his results he started losing it towards the end of his moderate length run and had to thrash trade just to stay ahead...bet his investors were thrilled with their 1099's at the end of that year. Couple of other guys have had or are having nice short term results.

If you take the number of active funds that solidly beat the market vs funds available, you'll see that monkeys with a dartboard would hit more bullseyes on average. In other words, their odds arent even as good as simple chance. In other words, active management over long periods of time is usually worse than no management at all. Frequent trading, emotional decisions, over analysis, trying to apply sensibility to an irrational group psychological force? Who knows. Maybe all of the above.

Over ~20+ year periods, something called the "gordon equation" kicks in and brings buckets of stocks like the s&p 500 back to their real fundamental value and returns (real oversimplification there, but google it and read on). Bottom line is that in long holding periods, such as one accumulating wealth or spending it, index funds have HISTORICALLY exceeded the returns of managed funds.

 

[justin]

five2fire,

It's important to note something about the managed funds you mentioned you own. It looks like about half are value-tilted, mid or small cap tilted, or international, or own bonds. The rest look like large cap blend or growth funds, what VINIX is, for the most part.

Your 401k provider has looked at past returns, and picked the best performing funds. This decision was premised on the assumption that past winners will continue their good performance.

Look back ten years. What would have made you pick the ten or so funds you currently own back in 1996 as the winners that they ended up being. How confident are you that these same winners will continue to win for the next 10 years?

In the end, expenses matter.

 

[danearnold]

Yep, thanks, I understand the arguments for indexed funds. Just to make sure though ... I dont have to manually deduct expenses from the trailing numbers on M* to get a true comparison of what these funds have done. My mix has indeed done well compared to that one indexed fund, but I cannot expect that on a longer term. Right?

You folks have made other good points too, I'm not ignoring them, just wanted to clarify that one point. Thanks.

 

[JPatrick]

Yep, thanks, I understand the arguments for indexed funds. Just to make sure though ... I dont have to manually deduct expenses from the trailing numbers on M* to get a true comparison of what these funds have done. My mix has indeed done well compared to that one indexed fund, but I cannot expect that on a longer term. Right?

I can't answer the Morning* part of your question because I don't use their info, but no doubt the key is to insure your are comparing NAV's.  It is also worthwhile to note that different funds produce different tax situations (when held outside of a 401K etc)
Regarding what you can expect longer term--Who knows??  The products, the markets, and the world for that matter are constantly changing.  I do believe the set it and forget it people are better off in a series of index funds.  For those that have the time and inclination to take care of business on a regular  basis---managed beats them all the time and probably always will.  It ain't easy though.

 

[cute fuzzy bunny]

I couldnt find where morningstar specifically said how they calculate their returns with regards to fees.

I did find this on yahoos site
"Unless marked as load-adjusted total returns, Morningstar does not adjust total return for sales charges or for redemption fees."

Morningstar did say that they presume reinvested dividends and that they may use different reinvestment periods or investment period start and stop dates than the fund companies themselves use.

So it sounds like fees are not incorporated into morningstars reported results, but reinvested dividends are. Vanguard appears to incorporate fees but not reinvested dividends.

As far as "expect that on a longer term", if you buy the index fund argument and if your managed funds have done well for a period of time, they'll almost certainly have to do quite poorly for a while such that the overall result is that they dont "beat the market" over a period of decades. If they do then they'll become some of the first funds to do so. Which is plausible...past history is no predictor of future results....

 

[danearnold]

It's important to note something about the managed funds you mentioned you own.    It looks like about half are value-tilted, mid or small cap tilted, or international, or own bonds.  The rest look like large cap blend or growth funds, what VINIX is, for the most part. 

My mix is
Large Cap Value  26.83%
Large Cap Growth  37%
Mid/Small Value  17.42%
Mid/Small Growth  18.75%
---
Cash 6.7%
US Stocks 63.43%
Foreign Stocks 22.51%
Bonds 6.82%
Other 0.54%

I know if i was to buy VINIX, for example, I'd have to decide which fund(s) to trade, keeping in mind (and reconsidering) whether my current asset allocation mix was reasonable.

 

[justin]

It's sort of funny that your available funds are very similar to the funds available in my 401k and my wife's 401k. Because they are the current outperforming hot funds. As soon as they have a couple years of crappy underperformance, they'll get booted. I keep seeing it with my 401k.

 

[danearnold]

Taking one example OAKBX, Fidelity, my 401k Manager, shows:

Quarter-End Average Annual Total Returns (%) as of 12/31/2005 
3 Year   13.87   
5 Year   11.27   
10 Year   13.72   

Average Annual Total Returns (%) as of 12/31/2005 
3 Year   13.87
5 Year   11.27
10 Year   13.72

And notes that:

“Average annual total returns include changes in share price and reinvestment of dividends and capital gains. Quarter-end returns include the effect of any applicable recurring and non-recurring fees (including short-term trading fees or redemption fees).”

M* uses data ending 1/30 for its 3 and 5 year numbers, but its 10 year number is as of 12/31 and is the same as the Fidelity number, so it looks like they are using the same formula.

Vanguard (http://flagship.vanguard.com/VGApp/hnw/FundsSnapshot?FundId=0820&FundIntExt=EXT) also has the following:

Average Annual Returns—Updated Quarterly as of 12/31/2005 (fee-adjusted)*
3 Year 13.87%
5 Year 11.27%
10 Year 13.72%
*Returns are adjusted for fees and loads if applicable.

Checking these other sources makes me think the M* numbers are fee adjusted.

 

[Howard]

I am an Index Fund Junkie, I like the convenience of being able to Buy and Sell like a stock, and I look on it as my Portfolio on Cruise Control.

You buy a fund you buy the Manager, the Managers change, you are back to square 1.?

There are so many ETF's available it is pretty easy to set up and follow your portfolio.

I do not buy Bond ETF's, I prefer to own the Bonds directly.

 

[yakers]

There may not be anything wrong with the funds you have chosen. ( I have to watch it, I may get my diehards membership revolked ) For a good time post your question on the Vanguard diehards website http://www.diehards.org/ I am recommending that my wife transfer her 403b to a Vanguard Target Retirement fund when she retires in June,one of her funds is theFidelity Contrafund and it has done pretty well for her. We have our Roth in the Vanguard Asset Allocation fund (VAAPX). It is not indexed but I like their allocation choices. My 401k type account is all in index funds. But if you like your fund selection and if any loads have already been paid then stay with what you like. I have an account for my son in a American Fund (AGTHX) which I expect will stay there until he uses it for college in the next couple years. I am a big fan of Vanguard and indexes but they are not the only way to go. Costs are a big thing, an asset allocation you like and a good tax appropriate selection.