Some Active beats Indexing

[ERD50]

...
I think in general the average population does not truly understand what risk is as they believe by being in “indexes” that risk over the long term is eliminated. ... .

Is that really what they think? That's not my impression. I think the average population sees the stock market as 'risky' and maybe even a Wall Street con-game.

But it matters little to this group of investors what the average person thinks. For example, many of us use credit cards, pay off the balance on time and in full each month, and earn the rewards. It has no bearing on us that maybe the average person carries that debt and pays high interest and fees each month.

I certainly don't think indexes eliminate risk. They merely reduce stock specific risk through easy diversification, and eliminate the risk that I picked a hot or cold active manager.

I feel you are building straw men to knock down. And like Gone4Good, I'm not sure what your alternative is, or what your benchmark would be?

-ERD50

 

[Gone4Good]

For example, many of us use credit cards, pay off the balance on time and in full each month, and earn the rewards. It has no bearing on us that maybe the average person carries that debt and pays high interest and fees each month.

That's a good analogy.

And I'd extend it this way: It's because so many people carry balances at 20% interest that the card companies can afford the eight first class tickets we'll buy with points this year to fly around the world.

In the same sense, it is the hordes of people who believe they can beat the market, or pick managers who can, who pay the cost of keeping markets efficient.

Someone's got to pay for this stuff. It might as well be someone else.

 

[marko]

In the same sense, it is the hordes of people who believe they can beat the market, or pick managers who can, who pay the cost of keeping markets efficient.

OTOH, back in 1998 my idiot brother who has no idea about anything put an inheritance in Fidelity's Growth Discovery fund. He's outperformed the Dow and S&P nicely over that period.

How did he pick that fund? He liked the name! The proverbial monkey at the typewriter!
He doesn't even know the money is there anymore! (I manage this stuff for him)

Last year, I did a measly 2% and he clocked in at 7%!

Better to be lucky than good I guess.

 

[Running_Man]

What I am trying to say is index funds are constantly changing what an “index” fund is and claim it is the far superior method of investing, when there is no real investment history for a basis of comparison only theoretical beliefs. On top of that there are so many subsegments of “indexes” that index funds are now in reality replacing stocks with “tracking error” and timing of returns of various subsegments replacing the old lack of diversity risk.

For instance take the CRSP indexes now, they are replacing the old method of indexing because traders, you know those people who cannot possibly beat indexing, would front run the indexes and buy the stocks that were being added to the index and benefit from the jump a stock would have if added to an index or the fall when it was dropped from a major index. Now I saw where Swedroe said this was causing for instance the Russell 2000 to lose about 1 percent per year versus the CRSP method and the new indexing method will be far superior by adding random additions and partial withdrawals from the funds. Now this wasn’t available until 2012 but it is shown as outperforming, even though one could never invest in that matter, other small cap “managed” funds by an additional one percent and it is used for comparison purposes to prove it’s superiority. So a managed fund that was actually able to be invested in is being compared against an index fund whose investing style didn’t even begin until 2012, and the ingenuity of traders to sniff out and front run index investors is assumed to be solved going forward when there is literally billions at stake to be made. In an era when a CFO can hide billions of repurchase agreements at an investment firm such as Lehman in Great Britain for 7 days every quarter and never report the losses from that fund by that method and when found out still no action is taken against any of the principals who did so by the SEC, the ability of powerful investors to front run this index style will most likely continue.

And if the indexes were efficient before who was paying the old 1 percent before, or is this just another “tracking error"

 

[Gone4Good]

For instance take the CRSP indexes now, they are replacing the old method of indexing because traders, you know those people who cannot possibly beat indexing, would front run the indexes and buy the stocks that were being added to the index and benefit from the jump a stock would have if added to an index or the fall when it was dropped from a major index. Now I saw where Swedroe said this was causing for instance the Russell 2000 to lose about 1 percent per year versus the CRSP method and the new indexing method will be far superior by adding random additions and partial withdrawals from the funds. Now this wasn’t available until 2012 but it is shown as outperforming, even though one could never invest in that matter, other small cap “managed” funds by an additional one percent and it is used for comparison purposes to prove it’s superiority. So a managed fund that was actually able to be invested in is being compared against an index fund whose investing style didn’t even begin until 2012, and the ingenuity of traders to sniff out and front run index investors is assumed to be solved going forward when there is literally billions at stake to be made. In an era when a CFO can hide billions of repurchase agreements at an investment firm such as Lehman in Great Britain for 7 days every quarter and never report the losses from that fund by that method and when found out still no action is taken against any of the principals who did so by the SEC, the ability of powerful investors to front run this index style will most likely continue.

And if the indexes were efficient before who was paying the old 1 percent before, or is this just another “tracking error"

Is there good research to support that 1% number or did someone just pull it out of thin air?

But even if that's true, it doesn't support your case. Because old research circa 2012 and before still showed managers trailing an index they presumably were gaining an annual 1% advantage exploiting. If anything it proves active management is worse than we thought because somehow they managed to lose that 1% and more some other way.

Now if they were beating the old index, and are now trailing a new index, that might support your argument. But that's not what's happened.

Active managers have trailed indexes since the first researcher tried to measure performance. And they've continued to trail indexes in most of the research that's been done since.

 

[ERD50]

What I am trying to say is index funds are constantly changing what an “index” fund is and claim it is the far superior method of investing, when there is no real investment history for a basis of comparison only theoretical beliefs. On top of that there are so many subsegments of “indexes” that index funds are now in reality replacing stocks with “tracking error” and timing of returns of various subsegments replacing the old lack of diversity risk. ...

In addition to Gone4Good's Q's, I must restate that this just seems like a straw man.

So what if there are many subsets of indexes? I don't give a darn. I stick to the large broad indexes like SPY (or equiv) - when did THAT change (other than a few minor player stocks sliding in/out of that index, based on fairly mechanical decisions). As far as I can tell, that tracks the theoretical S&P500 index so closely I can barely tell there are two lines on any graph.

If I want to invest/trade in a bunch of sectors, that's a lot like market timing, and I just don't care to play. And if you do want to play sectors, I'd still think an index is a reasonable way to do it. You could pick your own stocks, or an actively managed sector fund, and they might do better, might not, and you won't know until after the fact.

So what is the point here?

-ERD50

 

[Gone4Good]

What I am trying to say is index funds are constantly changing what an “index” fund is and claim it is the far superior method of investing, when there is no real investment history for a basis of comparison only theoretical beliefs.

But we do have real investment histories to use for comparison. We have actual index funds with real money invested and real performance histories against which we can judge returns relative to other funds.

Here's Morningstar's analysis of Vanguard's Total Stock Market Index (image attached). It shows VTSMX returns ranking in the top two quartiles of performance in every period (1yr, 3yr, 5yr, 10yr, and 15yr). Tellingly, the longer the term, the higher VTSMX ranks going from 60th percentile performance (i.e. beating 60% of all comparison funds) in one year, to 71st after 5 years, 81st after 10 and 86th after 15 years.

Edit to add: I just checked the same info for Vanguard's 500 Index and also Small Cap index. Here are the 1yr, 3yr, 10yr, and 15yr performance percentiles for each fund;

500 Index: 86th, 89th, 91st, 83rd, 74th
Small Cap: 58th, 75th, 78th, 87th, 71st

 

[dand76]

I didn't want to create a login account either but searching found this. Click the View/Print button at this link for the American Funds "Active Scorecard" info.

"Results shown do not include sales charge. If a sales charge (maximum 5.75%) had been deducted, results would have been lower."

https://www.americanfunds.com/advisor/literature/detail.htm?lit=355051

 

[MRG]

Thought Sequoia was one of the active is better than index fund. The recent events didn't feel better to me.

 

[ERD50]

I didn't want to create a login account either but searching found this. Click the View/Print button at this link for the American Funds "Active Scorecard" info.

"Results shown do not include sales charge. If a sales charge (maximum 5.75%) had been deducted, results would have been lower."

https://www.americanfunds.com/advisor/literature/detail.htm?lit=355051

Thanks - On the last page (6), it shows "average annual total returns", and those do include the effect of sales charges. Now, IIRC, "average annual total returns" is a lousy measure, as a 25% drop requires a 33.3% rise to get back to even. So an average of zero could mean flat, or it could mean a string of -25% and +25% years, ending in a loss.

At any rate, They list "American Mutual Fund" as 6.27% for 10 years. However, even by this measure, VTSMX did 6.93%. A total return chart at Morningstar shows they are similar in total return -

Vanguard Total Stock Market Index Fund Investor Shares (VTSMX) Fund Performance and Returns (you need to expand the chart, and add AMRMX for compare).

Why bother? Especially risking a 5.x% load (and it wasn't clear if the effect of FE load was included)?

-ERD50

 

[youbet]

Why bother?

-ERD50

Great question! It does make me wonder why folks pay ER premiums to be in Wellesley or Wellington (or similar from Vanguard) when they could just grab a few low cost index funds off the list and over time beat those actively managed funds easily.

 

[REWahoo]

It does make me wonder why folks pay ER premiums to be in Wellesley or Wellington (or similar from Vanguard) when they could just grab a few low cost index funds off the list and over time beat those actively managed funds easily.

Ah, but then we'd have to forego chickenheartedness and find the courage to rebalance when the fit hits the shan like it did in 08/09.

Well worth it to me, but I definitely understand YMMV.

 

[youbet]

Ah, but then we'd have to forego chickenheartedness and find the courage to rebalance when the fit hits the shan like it did in 08/09.

Well worth it to me, but I definitely understand YMMV.

Just trying to go along with the spirit of the thread........ You know, all actively managed funds suck. All index funds are purrfect. And there's never a problem picking which index funds, and in what quantities/proportions, to include in your portfolio. That's always totally clear when you're gazing at a list of dozens and dozens of them........

I love it when folks start painting with the broad brush!

Edit: I have my son's IRAs and 401k in actively managed balanced funds (including some Wellesley) for the same reasons you're in Wellesley: he'd never get around to rebalancing or switching indexes with market conditions.

 

[ERD50]

Great question! It does make me wonder why folks pay ER premiums to be in Wellesley or Wellington (or similar from Vanguard) when they could just grab a few low cost index funds off the list and over time beat those actively managed funds easily.

Yeah, those two are pretty amazing aren't they? They do sure seem to do well 'despite' their managers!

But they certainly are a minority, aren't they? I keep telling myself I should go that route, but I also can't help feeling like if I did, that's just when they'd start lagging the indexes. So rather than move to the exceptions, I decide to stick with my benchmark. History says that's not a good choice, but who knows?

Are all your holdings that would fit that AA in either of those?

edit/add: I see you partially answered that with regard to your son's account. I also have to wonder - I don't think the W's do a strict rebalancing - they seem to have some magic something. I don't think their performance can be duplicated with merely rebalancing a few index funds.

-ERD50

 

[youbet]

Yeah, those two are pretty amazing aren't they? They do sure seem to do well 'despite' their managers!

They seem to do OK, but, as you say, index funds are better!

But they certainly are a minority, aren't they?

Dunno. Minority of what? What are the numbers?

I keep telling myself I should go that route, but I also can't help feeling like if I did, that's just when they'd start lagging the indexes.

What indexes would they lag? That always seems confusing. And as the Wellesley managers make changes, such as tweaks to the duration of the bond portion, do you change the indexes you'd compare to at the same time? How do you do that?

So rather than move to the exceptions, I decide to stick with my benchmark. History says that's not a good choice, but who knows?

The overwhelming majority of my equity investments are in broad based, common indexes such as TSM or S&P 500 or MSCI Developed, etc. But I'm never quite sure if I've optimized the percentages or even picked exactly the right ones. For example, do you prefer the market completion index to the mid-cap index? Or the Schwab 1000 index to the S&P 500 index? That's why I have my son's $$$ in actively managed balanced funds which target a typical AA for his age and personal situation. I don't want to make the choices for him and be responsible for timing rebalancing.

 

[NW-Bound]

... I don't think the W's do a strict rebalancing - they seem to have some magic something. I don't think their performance can be duplicated with merely rebalancing a few index funds...

These are truly active funds. Their managers have been on video interviews posted at Vanguard stressing that they are stock pickers, not indexers. More than having only 40% in stocks, Wellesley definitely has a conservative stance in regard to P/E; most if not all of its holdings therefore are dividend-paying stocks. I would be surprised to see any of the high P/E growth stocks in Wellesley. Even so, Wellesley surely churns its holdings. Its annual portfolio turnover is 60%. It does not get that high by mere rebalancing.

Wellington's stock picking style is more aggressive. Hence, its daily price fluctuations are often a lot more than those of Wellesley, relative to the 1.5x higher equity AA (60% stock).

PS. Neither of these two funds beat the market every year, or even a 60/40 (Wellington) or 40/60 (Wellesley) index strategy. However, in the long run, long meaning decades, they match the S&P long-term growth, but without the volatility. What they trail in go-go years, they make it up by crashing less in recessions.

 

[rdy2go]

Just to see how well American Funds are doing vs the S&P 500 over the last ten years, I went to Yahoo Finance and did a comparison chart of three large American Funds to GSPC (S&P500). Personally, I am letting Wellesley and Wellington handle my retirement money and Wellesley is kicking Wellington's butt so far this year.

GSPC- (S&P 500) +63.2%
AMRMX - (American Mut Fund) +28.75%
AGTHX - (Growth Fund of America) +27.46%
AIVSX - (Inv. Co. of America) +4.77%

 

[Gone4Good]

Ah, but then we'd have to forego chickenheartedness and find the courage to rebalance when the fit hits the shan like it did in 08/09.

It is funny how everyone is a stouthearted hero when the market is roaring but once we experience a little downturn like earlier this year and all of a sudden you start seeing threads pop up about going to cash and how the market looks like 1932.

heh-heh-heh as some are known to say.

 

[ERD50]

Too tedious to embed all the quotes, but I think anyone can follow along by looking back a few posts:

They seem to do OK, but, as you say, index funds are better! ...

Did I say that?

Studies show that few actively managed funds beat their indexes, and the ones mentioned by the OP appear to have failed as well. That's why I said 'why bother' with that fund.

Dunno. Minority of what? What are the numbers? What indexes would they lag? That always seems confusing. And as the Wellesley managers make changes, such as tweaks to the duration of the bond portion, do you change the indexes you'd compare to at the same time? How do you do that?

I'm sure you are familiar with the many studies that show only a minority of actively managed funds beat the indexes, and fewer still do it over longer time frames. I google it from time to time, to see if it still holds, and it always seems to.

As far as which index to compare, I look at that in a pragmatic way, rather then the technical way you are describing. I may chose to invest in X or Y. But that doesn't mean my choice Y has to attempt to duplicate every move and allocation that X does. It's just a choice, and we will see how it plays out over time.

The overwhelming majority of my equity investments are in broad based, common indexes such as TSM or S&P 500 or MSCI Developed, etc. But I'm never quite sure if I've optimized the percentages or even picked exactly the right ones. For example, do you prefer the market completion index to the mid-cap index? Or the Schwab 1000 index to the S&P 500 index? That's why I have my son's $$$ in actively managed balanced funds which target a typical AA for his age and personal situation. I don't want to make the choices for him and be responsible for timing rebalancing.

I'm never sure if I've optimized anything either, and don't worry about knowing the un-knowable. One segment (mid-cap, small-cap, etc) will do better here and there, but who knows going forward? Over time, things seem to even out. I'm happy (maybe even dumb and happy?) with a loose AA based mostly on SPY and a Total Bond Index fund.

I don't follow your 'broad brush' comments in other posts. If we are talking about active versus passive funds in general, well that is a broad brush view, no bones about it. Then there was the specific American Fund - not broad brush, a comparison to SPY, as an example.

Vanguard's Wellesley and Wellington specifically have done amazingly well over the long run. I'm puzzled by that - if it was knowledge based, why isn't it repeated by more active funds? Do they really have the 'secret sauce'? Can it be taught to the next managers (seems so, they've been on a long run)?


PerfCharts - StockCharts.com - Free Charts

Slide the bar to the full 15 years, and Wellesley is impressive.

-ERD50

 

[rdy2go]

Looking at that chart makes me want to dump Wellington! Wellesley has done a great job, hasn't it!

 

[dallas27]

It's all very simple. Do you want to try to be the hot superstar and take the risks of not being the "one", or do you want a guarantee at being the benchmark itself which is the measuring stick by which hotness is even measured.


Sent from my iPhone using Early Retirement Forum

 

[youbet]

It's all very simple. Do you want to try to be the hot superstar and take the risks of not being the "one", or do you want a guarantee at being the benchmark itself which is the measuring stick by which hotness is even measured.


Sent from my iPhone using Early Retirement Forum

Which single benchmark do you have 100% of your investments in? Are you in, say, 100% S&P 500 so that you can be "guaranteed" at being the benchmark itself?

 

[youbet]

Slide the bar to the full 15 years, and Wellesley is impressive.

Yep, sure is. That's why you won't see me on the "all actively managed funds suck" bandwagon. Some do seem to do OK.

I insist on no-load and relatively low ER funds whether they are actively managed or passively indexed. I don't insist on an "index only" approach. (Although my portfolio is dominated by index funds.)

I like Wellesley. I like the balanced funds available in my 401k. Those are simply a mix of S&P 500, Int Developed and Total bond indexes in various AA's which they actively rebalance for you. ER's are very competitive vs single category index funds too.

My "broad brush" comment was simply expressing my observation that it's common on this forum and on the Boglehead forum to think of "actively managed funds" as all having front end loads, high ER's, 12b-1 fees and dumb as a stump management. And that index funds are all based on broad indexes (TSM, Developed International, etc.). In fact, some actively managed funds, like Wellesley or some target funds or balanced funds, have no loads, no 12b-1 fees, reasonable ERs and apparently competent managers. And some index funds are based on very focused indexes tracking focused, non-diversified market segments that could lead investors far astray from overall market performance.

I noticed in the nice chart you presented that you compared Wellesley and Wellington to the S&P 500. When you evaluate the performance of your own portfolio, what single index do you use? Also the S&P 500?

Do you consider yourself as having a true passive index fund based portfolio (a few broad based index funds you hold passively for the long term only rebalancing periodically) or do you consider yourself as having an active portfolio based on index funds but where you tweak AA from time to time and even trade some individual stocks and focused index funds and that sort of thing?

Edit: I went and looked at one of the actively managed funds within my 401k to refresh myself on exactly what it's holding and the goal/strategy. It's called "Balanced Fund I."

48%S&P 500/12%MSCI EAFE ND/40%BC Agg TR --- ER = 0.044 --- No load

It basically holds three index funds (available separately if you wish) and actively rebalances for you. The prospectus says they might modify the AA incrementally but only with prior announcement.

I left this fund a number of years ago because I wanted to call the exact AA myself and include some small and mid cap exposure and a bit more international. So far, drats, my blend (all indexes) hasn't done as well as the actively managed fund I left mainly due to international and small cap lagging large cap. Soooooo....... Ya never know.

 

[ERD50]

... My "broad brush" comment was simply expressing my observation that it's common on this forum and on the Boglehead forum to think of "actively managed funds" as all having front end loads, high ER's, 12b-1 fees and dumb as a stump management. ...

I won't re-quote it all, I'm pretty much in agreement across the board, just a few points...

(Just kidding a bit here - in case that doesn't come across: ) I think maybe your 'broad brush' comment is a bit too 'broad brush' itself! Yes, you have a point, but then again, there are a lot of Wellesley and Wellington fans here (not sure about BogleHeads, I don't spend much time there, unless someone links from here - though I do like their 'wikis').

... I noticed in the nice chart you presented that you compared Wellesley and Wellington to the S&P 500. When you evaluate the performance of your own portfolio, what single index do you use? Also the S&P 500?

I've actually gotten pretty laid back about all this over the years, so let me explain that first. My first step in 'laid-backish-ness' was noting how portfolio survival rates were pretty similar over a broad range of AAs ( ~40/60 ~ 95/5). The range of ending portfolio values widens with increasing equity exposure, but survival is similar. So that led me to not worrying much about any specific AA - go for a walk instead!

Second step was the studies that showed that the highly revered (and seemingly helpful sell high-buy low approach) process of re-balancing really made no/little difference either, and sometimes hurts (selling into a long, slow bull)! So that led me to not worrying much about rebalancing - spend some time on a hobby instead!

All the other sector divisions seem to just rotate in/out - can I really help myself by picking some specific blend? Or will I hurt myself? Take a nap instead!

I've become pretty much an Alfred E. Neuman - "What, me worry?" type when it comes to all this.

So bottom line, there are other things that drive my choices. I'm pretty aggressive, 70/30 ~ 85/15 I guess (have not even checked in a while). I keep some fixed, am moving towards total bond index rather than some bond sectors I had before, but to me that's just details, no worries. For my equities, SPY is my default, and I don't worry much about looking at anything else. Though last year I did move much of my fixed and SPY to BRK in my taxable account to reduce divs, so that I could maximize my ROTH conversions before pension/SS come into play.

Throw in a few testosterone plays along the way for good measure. That's about it.

-ERD50

 

[ERD50]

RE:
http://stockcharts.com/freecharts/perf.php?VWIAX,VWENX,SPY

Slide the bar to the full 15 years, and Wellesley is impressive.

Looking at that chart makes me want to dump Wellington! Wellesley has done a great job, hasn't it!

Considering the targets for Wellesley is something like (going from memory here) 40/60, and Wellington is 60/40, the performance difference isn't all that great, and I would have expected Wellington to lead over the long run.

Wellesley certainly has done a great job. Again, it really makes me wonder why more active managed funds aren't doing this well. Did the managers sell their soul at the crossroads?

-ERD50