Some Active beats Indexing

[Lsbcal]

The main reason that the typical investor under performs the market isn't that they have bad timing when the markets go down, it is that they fail to get back in in time when the markets go back up. They typically lose out on the major upswings.

This sounds generally correct to me.

Well any decent market timing system would have a sell AND buy strategy. Their are probably few good market timing strategies out there and any good ones are probably unpublished (my guess).

There is a very good discussion of some moving average type of market timing with provisions for skipping some sell signals at this site:
1) Trend Following In Financial Markets: A Comprehensive Backtest | PHILOSOPHICAL ECONOMICS

2) Growth and Trend: A Simple, Powerful Technique for Timing the Stock Market | PHILOSOPHICAL ECONOMICS

3) In Search of the Perfect Recession Indicator | PHILOSOPHICAL ECONOMICS

WARNING: These articles are very long and involved.

 

[OrcasIslandBound]

I have, myself, done what might be construed as a bit of market timing upon 3 occasions in the last 10 years. All were relatively small compared to the bulk of my investments, perhaps 5% or less. When I rebalanced by moving into bonds the prior year, in around 2010, and again in 2011, the market had a sizable pull back. I moved around $40k back into stocks after 10-15% drop. I figured that I sold high and bought back low, so taking advantage of the moment.

Recently, I employed a similar strategy buying an oil ETF for $11k in December after this sector was beaten down so hard. Another $11k when it was further beaten in January. All these "timings" were successful. But in general, I avoid market timing.

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[harley]

Their are probably few good market timing strategies out there and any good ones are probably unpublished (my guess).

I've been thinking about publishing my strategy, which has worked out well for me. Basically, it involves making a lucky move, then becoming paralyzed with fear and indecision and not making any additional stupid moves. Overall I've come out pretty well.

 

[Lsbcal]

I've been thinking about publishing my strategy, which has worked out well for me. Basically, it involves making a lucky move, then becoming paralyzed with fear and indecision and not making any additional stupid moves. Overall I've come out pretty well.

Sounds like an excellent strategy and all one needs is the lucky move.

I did that once. Played once in the California lottery and won!!! Got a whole $9 back. Have never played again. I bet few can claim they are net winners of the lottery.

 

[meierlde]

Actually if you look at broad index funds you can do the s&P 500, a total us stock market index which is still about about 80% made up of the S&P 500. If you want to go index then the widest index would be the way to go. One way might be a total world stock market fund. Or possibly if you want to spend time look at country based index funds but then you have to decide how to allocate your funds.

 

[Totoro]

Only way to have rallies is when more people than usual are buying. Same for crashes. So the majority will be buying high and selling low. Otherwise no such variance. Pretty much by definition.

So who is causing the swings then and getting stuck with the bad results?

I believe individuals who invest via mutual funds, i.e. indirectly, are the ones indeed losing out the most. And I think they do it because many don't understand what they are buying. If they did, they would have probably done it themselves.

I have a few friends where I saw that scenario play out (for small amounts of money luckily). None of them stayed in the market after the first crash hit them.

 

[haha]

I posted this on another thread, but active fund managers are handicapped by the very people who invest in them. I see it all the time at work. When the market goes down, people panic and shift out of stocks. When the market skyrockets, they go all in. They're basically forcing the managers to sell low and buy high.

How would open end index fund managers be immune to this? Similar with an ETF, if it is open ended it would be subject to untimely redemption runs.


Ha

 

[harley]

How would open end index fund managers be immune to this? Similar with an ETF, if it is open ended it would be subject to untimely redemption runs.

Because index fund investors are made of sterner stuff, being fully comfortable with their asset allocations and able to ride out the vagaries of the market. Not!

You're right, this would happen in an index fund as well as an actively managed fund. I do think that those who invest in index funds are a little less likely to bolt. And since index funds pretty much never lead the market, they don't get the fast money moving in either. So there might be a lesser effect, but certainly not none.

 

[DrRoy]

I do think that those who invest in index funds are a little less likely to bolt. And since index funds pretty much never lead the market, they don't get the fast money moving in either. So there might be a lesser effect, but certainly not none.

The effect in a broad index fund/ETF should be very muted. To some degree, index investors (ex: Bogleheads) are more likely to be buy and hold, rather than timers or emotional players. Also, since a broad index mirrors the full market, you are only going to see what the entire market is doing.

 

[ERD50]

... I do think that those who invest in index funds are a little less likely to bolt. And since index funds pretty much never lead the market, they don't get the fast money moving in either. So there might be a lesser effect, but certainly not none.

I wonder if this could be seen to a higher degree in the 'target retirement funds'? Those tend to have lower in/out trading I think.

-ERD50

 

[petershk]

My own personal experience is that my level of activity is inversely proportional to my total return. whether that's picking individual stocks, ETFs, mutual funds or boxes of cereal . The winners of that are the people/organizations that collect from the level of activity.

So... for me personally the long term goal has been to reduce activity to as close to 0 as possible. That has been incredibly challenging because I think I'm really smart and I love tinkering. I have lots of evidence to prove I'm really dumb and should stop tinkering, but somehow I'm insanely stubborn about it.

 

[gcgang]

My own personal experience is that my level of activity is inversely proportional to my total return. whether that's picking individual stocks, ETFs, mutual funds or boxes of cereal . The winners of that are the people/organizations that collect from the level of activity.

So... for me personally the long term goal has been to reduce activity to as close to 0 as possible. That has been incredibly challenging because I think I'm really smart and I love tinkering. I have lots of evidence to prove I'm really dumb and should stop tinkering, but somehow I'm insanely stubborn about it.

+1

Incredibly well said.

 

[Fedup]

My own personal experience is that my level of activity is inversely proportional to my total return. whether that's picking individual stocks, ETFs, mutual funds or boxes of cereal . The winners of that are the people/organizations that collect from the level of activity.

So... for me personally the long term goal has been to reduce activity to as close to 0 as possible. That has been incredibly challenging because I think I'm really smart and I love tinkering. I have lots of evidence to prove I'm really dumb and should stop tinkering, but somehow I'm insanely stubborn about it.

Agree 100%. The dumb ones in my family do really well in the stock market.



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[fourinone]

Isn't indexing just buying stocks from some list, and then everybody just owns the same list of stocks? When the tech bubble happened the S&P 500 was 40% tech companies, and indexers were smiling paying low fees while they were getting wiped out. There are hundreds of indexes these days. I'd rather have someone at the wheel thinking. Individual stocks are great - and, even cheaper than index funds since there's no expense, and I know what I own at all times.

 

[DrRoy]

Isn't indexing just buying stocks from some list, and then everybody just owns the same list of stocks? When the tech bubble happened the S&P 500 was 40% tech companies, and indexers were smiling paying low fees while they were getting wiped out. There are hundreds of indexes these days. I'd rather have someone at the wheel thinking. Individual stocks are great - and, even cheaper than index funds since there's no expense, and I know what I own at all times.

Yes, it is owning stocks from a list, but the real point is that the list should be very broad and very steady to spread risk, and it would be an awful lot of stocks to own individually. In the 2000-2002 market the S&P 500 was affected by the tech weighting, but where tech as a group was down 80-90%, the 500 was down half as much and recovered faster also. To me, true indexing means the S&P 500 or the total market, not the many narrow slice indexes that are also available. You can get the broad indexes in an ETF with expenses of .1% or less, which is little to pay for the convenience of 500 to 5000 stocks. When you look at multi decade performance, it is virtually impossible to beat the return of the dividends reinvested broad indexes. Even active managers who do it for a while have following periods where they lose their touch and the higher fees also drag. If an active fee is 1% higher than a passive one, over 30 years that's 30% that the manager has to outperform just to keep even. Why go against the odds with active?

 

[Gone4Good]

Isn't indexing just buying stocks from some list

Yeah, but it's not just any list.

The idea behind indexing is to own the entire capitalization-weighted market, not just some random list of stocks. And the idea behind owning the entire market is that nobody has demonstrated a strategy for consistently earning above market returns.

The various specialized "indexes" you mention don't really follow the original rationale for indexing. They're nothing more than vehicles for making specific market bets; the very thing the original rationale for indexing described as counterproductive.

And, yes, the Tech Bubble was a good (and to my recollection only) clear example of a wide-spread market mispricing so obvious that stock-pickers should have had a field-day exploiting it. And yet when we do a postmortem on the returns of actively managed funds from that time period we find most still fared worse than the dumb old S&P 500. Many did so poorly that they no longer even exist.

So the theory still stands.

 

[ERD50]

Isn't indexing just buying stocks from some list, and then everybody just owns the same list of stocks? When the tech bubble happened the S&P 500 was 40% tech companies, and indexers were smiling paying low fees while they were getting wiped out. There are hundreds of indexes these days. I'd rather have someone at the wheel thinking. Individual stocks are great - and, even cheaper than index funds since there's no expense, and I know what I own at all times.

Well, here's a chart of the Fund you praised in an earlier thread ( ACSTX - Invesco Comstock), compared to Vanguard Total Market during the 2008 crash and subsequent recovery:

PerfCharts - StockCharts.com - Free Charts

Your thinkers must have been asleep at the wheel! They dropped further, and they failed to recover as well as 'a list of some stocks'!

You really want to pay for under-performance?

-ERD50

 

[ziggy29]

And, yes, the Tech Bubble was a good (and to my recollection only) clear example of a wide-spread market mispricing so obvious that stock-pickers should have had a field-day exploiting it. And yet when we do a postmortem on the returns of actively managed funds from that time period we find most still fared worse than the dumb old S&P 500. Many did so poorly that they no longer even exist.

Stock pickers may have had good times, but very large funds have so much cash to deploy that they have to pretty much buy the whole market anyway.... and when the market is tanking, they pretty much have to sell the whole market.

That said, yeah, by early 2009 there were some really good companies "on sale" massively -- think bluest of the blue chips with 4-5% dividend yields -- and if an individual had a million bucks to deploy rather than a fund needing to invest $5 billion, they could have just bought the best companies at a deep discount. Massive funds can't be that selective in their buying and selling.

 

[ERD50]

...
That said, yeah, by early 2009 there were some really good companies "on sale" massively -- think bluest of the blue chips with 4-5% dividend yields -- and if an individual had a million bucks to deploy rather than a fund needing to invest $5 billion, they could have just bought the best companies at a deep discount. Massive funds can't be that selective in their buying and selling.

Is there any data to show that those "bluest of the blue chips with 4-5% dividend yields" recovered any sharper from early 2009 than the broad market?

Using DVY as a proxy, this chart says, yes, a little (run slider back to JAN2009). But enough to make a bet like that on? :

PerfCharts - StockCharts.com - Free Charts

-ERD50

 

[youbet]

The idea behind indexing is to own the entire capitalization-weighted market,........

The various specialized "indexes" you mention don't really follow the original rationale for indexing. They're nothing more than vehicles for making specific market bets; the very thing the original rationale for indexing described as counterproductive.


So the theory still stands.

The theory may still stand but with the passage of time and the development of dozens and dozens of new indexes and funds that track them, the terminology is now misleading and incorrect. When someone says "I'm an indexer" you can no longer assume that means they have purchased and are long term holding only one broad based domestic fund like, for example, VTSMX.

Some "indexers" prefer to own a handful of more focused index funds so they can tweak their AA. For example, instead of owning a TSM fund, you might own a S&P 500 plus a Completion Index (the rest of the domestic market) fund. Or, you might ration your resources out even a bit finer.

It's been a long time since "indexes" meant only TSM or S&P 500 and terminology needs to catch up.

 

[youbet]

That said, yeah, by early 2009 there were some really good companies "on sale" massively -- think bluest of the blue chips with 4-5% dividend yields -- and if an individual had a million bucks to deploy rather than a fund needing to invest $5 billion, they could have just bought the best companies at a deep discount. Massive funds can't be that selective in their buying and selling.

Zig, I know you would have been able to pick out the "best companies" without error. But many of the pros were making mistakes because some of the traditional metrics and sign posts didn't pan out during the 2008 - 09 time frame. Yes, flexibility can be a good thing and if you're either insightful or lucky you can do very well. Unless you don't.

As for myself, in retrospect I'm glad I was frozen in fear and did nothing. My domestic equity portfolio is dominated by a TSM index fund and I just stood pat with that since I found myself paralyzed and unwilling/unable to either sell it or buy more.

 

[Totoro]

Is there any data to show that those "bluest of the blue chips with 4-5% dividend yields" recovered any sharper from early 2009 than the broad market?

Using DVY as a proxy, this chart says, yes, a little (run slider back to JAN2009). But enough to make a bet like that on? :

PerfCharts - StockCharts.com - Free Charts

-ERD50

Try consumer defensives, like vanguard VDC
PerfCharts - StockCharts.com - Free Charts

Things is not the sharp recovery but more the fact they drop less.

 

[ERD50]

Try consumer defensives, like vanguard VDC
PerfCharts - StockCharts.com - Free Charts

Things is not the sharp recovery but more the fact they drop less.

Thanks for the chart, but I was responding to Ziggy's comment that " ... by early 2009 there were some really good companies "on sale" massively -- think bluest of the blue chips with 4-5% dividend yields -- ... an individual ... could have just bought the best companies at a deep discount. " That comment from him was about the recovery, not the 'dropping less'.

But if you slide the bar on that chart to the dip in early 2009 ( ~ March 04, 2009), you won't see any big recovery compared to SPY. Where was the "deep discount" that Ziggy spoke of?

And you may be 'cherry picking' a bit with VDC? The focus was on high-div payers, SPY pays ~ 2.1%, VDC ~ 2.9%, DVY (the most reasonable proxy for DIV payers, IMO, as that is it's stated purpose) ~ 3.21%. I'm sure we can search out funds after the fact, that performed well.

Bottom line, it appears to be an oversimplification (or even not true at all), that a simple approach of purchasing the big div payers in a downturn has any real advantage.

edit/add: I think this whole idea of DIV payers providing all this safety, or higher returns (adjusted for volatility) has been repeated so often that people accept it as true. I had accepted it as true, until I started looking at these charts. I just don't see any reliable, distinctive trend. That usually turns to a claim that those funds don't hold the 'right div payers'. Well, anyone can pay that game, and pick some winners to make their point. BRK, with ZERO divs, doesn't behave fundamentally different from SPY or DVY.

-ERD50

 

[Totoro]

Well, I thought we were discussing bluest of blue chips with strong dividends, not necessarily high dividend yielders per se. High dividend yielders are composed of both blue and not so blue (red?) companies. The ones that tend to collapse quite violently when they no longer can afford ever increasing dividends that they promised.

Hence VDC as my example: Proctor and Gamble, Coke, Pepsi, Costco, Walmart, Big Tobacco. And yes, they are now at 2.9% but would have been at 3%-4% in 2009.

Likewise Berkshire, as a holding company, has adopted that approach. The dynamic does seem to be that they underperform in upmarkets, and outperform in downmarkets.

High dividend yielders by themselves aren't a strong indication, e.g. vanguard https://personal.vanguard.com/us/funds/snapshot?FundIntExt=INT&FundId=0923#tab=1

Hence Buffets famous quote: "Only when the tide goes out you can see who has been swimming naked".

 

[Running_Man]

Thanks for the chart, but I was responding to Ziggy's comment that " ... by early 2009 there were some really good companies "on sale" massively -- think bluest of the blue chips with 4-5% dividend yields -- ... an individual ... could have just bought the best companies at a deep discount. " That comment from him was about the recovery, not the 'dropping less'.

But if you slide the bar on that chart to the dip in early 2009 ( ~ March 04, 2009), you won't see any big recovery compared to SPY. Where was the "deep discount" that Ziggy spoke of?

And you may be 'cherry picking' a bit with VDC? The focus was on high-div payers, SPY pays ~ 2.1%, VDC ~ 2.9%, DVY (the most reasonable proxy for DIV payers, IMO, as that is it's stated purpose) ~ 3.21%. I'm sure we can search out funds after the fact, that performed well.

Bottom line, it appears to be an oversimplification (or even not true at all), that a simple approach of purchasing the big div payers in a downturn has any real advantage.

edit/add: I think this whole idea of DIV payers providing all this safety, or higher returns (adjusted for volatility) has been repeated so often that people accept it as true. I had accepted it as true, until I started looking at these charts. I just don't see any reliable, distinctive trend. That usually turns to a claim that those funds don't hold the 'right div payers'. Well, anyone can pay that game, and pick some winners to make their point. BRK, with ZERO divs, doesn't behave fundamentally different from SPY or DVY.

-ERD50

Anyone could see that in March of 2009 O Realty with a yield of 7 percent, Coca Cola with a yield of 4 percent, Altria with a yield of 6.5 percent, VFC with a yield of 3.5 percent, Home Depot at 4 percent Johnson and Johnson at 4 percent, Fed Realty at 3.5 percent all were great picks and all mentioned here.

DVY is not a “proxy” for blue chip dividend stocks, it merely is a a so called index fund that really is a managed fund by a computer that gets totally over allocated into whatever sector happens to have the highest yield per the rules the “index” decides to invest in at the moment, in 2007 it was 45% into finance stocks then in 2010 it was 40% in energy stocks.

The blue chip dividend fund is SDOG which never gets over allocated in any sector as it takes even number of stocks from each sector. It has outperformed the S&P500 index since it was released as a ETF by 15% since October 2012, I have been pushing it since it came out and it has outperformed the S&P500 and I believe it will continue to do so by the amount of the extra dividends it is able to obtain from quality large companies over a wide swath of the economy.