A question came in a few days ago from a reader who said he was not comfortable knowing which foreign countries to own or how to access any countries he might think he wants to own. He reasonably asked why not just buy a couple of actively managed OEFs and let experts do the work for you.
It should be obvious that any choice you make will have pros and cons. I would think weighing the pros and cons of whatever you choose would be a priority so you know the drawbacks. This is not to say you shouldn't buy an active fund just because I don't but to realize no choice is perfect.
The reader mentioned owning, I believe, three actively managed foreign funds. There are several drawbacks. The first one to mention is sector makeup. What if all three had overweighted the financials going into the dip during the summer? The funds would have been hit harder than an index fund or maybe a mix of common stocks (depending on the mix). Further, what if in addition to overweighting financials, all three had Northern Rock at an 8% weighting.
I concede the chances of the above are remote but not impossible and more generally problems with overlap in accounts with a bunch of actively managed OEFs happens all the time.
If you use an indexed product you know how much exposure you have to a given sector at all times and you know what the exposure will be, approximately, six months from now.
That brings up another issue which is that a fund manager is just like anyone else. He will get some right and get some others wrong. Chances are he is where he is because he is right more often then not but a manager being wrong at exactly the worst time possible doesn't seem like a stretch to me.
From the top down I want to control the sector weightings, country weightings, the yield, volatility, cap size and style very precisely as I imagine most top down managers would want to. The more actively managed products you use the tougher that becomes.
You need to weigh out for yourself the right way to access all the market segments you want to own drilling down as narrow as you are comfortable with. Obviously I go narrow but that may not be right for you for a whole bunch of different reasons.
One last note on this is that I would not describe the above mentioned use of indexed products as passive. In smaller accounts where I have fewer holdings and use sector ETFs I actively manage, as best as I can without having 45 holdings, to work in all of things mentioned above. This is something anyone can do if they have/want to spend the time to allocate an account this way. I think of passive as what the DFA guys do.
That picture is Dustin Pedroia hitting an important 7th inning home run helping the Red Sox overcome a 3 game to 1 deficit and make it in to the world series. As a fan I never gave up when they were down but having such a big hole to dig out of made it tough.
14 comments:
Alternative Benchmark to SP 500
Consulting firm proposes judging portfolio performance against a basket of stocks chosen by a computer. This proposal takes The Wall Street Journal's dartboard contest of throwing darts to pick stocks to the next level.
It is easy for professional financial advisers and money managers to beat SP 500. They have a whole lot of "tools" to evaluate stocks, can sell stocks that are going down in price or hit peak and to take profit and buy stocks that are starting to increase in price or expected to incease. They can talk to the top officals of companies. They can buy value or growth or blend stocks and mutual funds. They can buy a variety of mutual funds, exchanged traded funds, and concentate in countries and industries and sectors. They know which are performing the best and the worse. They know if insiders and instituations are buying or selling.
The SP 500 has stocks which are decreasing in price and analysts say sell or avoid (don't buy). They have decreased with no sign of increasing in price for long time. Stocks no one would own. Fundamentals and techicals are bad. Stocks no analyst advices to buy but sell. Stocks that insiders and institutions are selling. These stocks drag down the SP 500.
The Chairman of American Association of Individual Investors. (his agenda is different than financial advisers as he wants people to join AARP). He basically said any money manager worth his grain of salt will beat SP 500.
He added, if you throw darts at stock table and invest equal amounts on each hit, the odds are you will have lower risk and better performing portfolio than an index fund and SP 500.
Morning Star ----"Bold Proposition"
Use a computer generated portfolio instead SP 500 to compare your portfolio.
Consulting firm Hewitt Bacon & Woodrow has a bold proposition:
Dump the indexes and instead compare fund and portfolio performance against a basket of stocks chosen by a computer. The Financial Times said ---adopt an "unconstrained" benchmark consisting of portfolios built by a software program.
The proposal takes The Wall Street Journal's dartboard contest to the next level. For years WSJ ran a regular feature in which money managers tried to pick companies that would outperform a handful of stocks chosen by throwing a dart at the newspaper's stock listings. The managers were judged on whether their picks had beaten the dart's portfolio not an index.
A Joke or an Improvement?
Should U.S. mutual funds and finanical money managers consider making this change? That suggestion might sound fanciful but addresses some real problems.
Actively managed funds and financial money managers would have to be more creative to earn the fees they charge. One can argue that software-selected portfolios would be more appropriate benchmarks.
{{Sandi reminded me monkeys had beat the market. Then I remember seeing an article years ago. Monkeys threw darts at newspaper stock listings and beat the market. Monkeys threw names of stocks on pieces of paper down stairs and the ones that went further became the portfolio and reportedly beat the market.
Grade school stock picking contests.
grade school kids have 4 member teams. Some teams beat SP 500.
drwater@fuse.net
I've often thought that the S&P 500 was too narrow a benchmark for a balanced portfolio and increasingly, for an equity portfolio. Do investors in Germany, to pick one country, benchmark the S&P or the DAX? Isn't "the market" more global today, implying that investors should have a correspondingly global benchmark?
Roger,
I agree that the importance of using passive etf's is the ability to know a portfolio's exposure to industries, sectors and yields stc. I imagine you use software that "looks inside etfs" such that you don't have to calculate the exposure of etf portfolio across these dimensions. What is it and how much does it cost? Or is there a reasonably priced product that would make sense for managing a small number of accounts. Thanks, Any guidance appreciated.
ftm--
If you're not already familiar with etfconnect.com, take a look. Roger may have some proprietary software ideas for you, but this is free and a good place to start.
re software, I use very few ETFs and the ones I do use are very narrow so the issue is not that relevant for me. ETFconnect is a great tool, Morningstar sometimes is good depending on the funds used (it does not know every ETF).
re that first comment, I can't defend the SPX being less than ideal to benchmark to but that it is easy to beat seems flat out wrong to me based on how few OEF beat it consistently.
Anon 10:58.
I can't tell if you're saying that it's easy for active managers to beat the market because of their "tools" to evaluate stocks (which you clearly stated). Or if you are saying that they sometimes beat the market through luck much like the dart throwing monkeys you mentioned.
The real truth concerning most actively managed portfolios such as mutual funds is that, "Though you would think that mutual funds provide benefits to shareholders by hiring alleged "expert" stock pickers, the sad truth of the matter is that the vast majority of mutual funds underperform the average return of the stock market. Over time, because of their costs, approximately 80% of mutual funds will underperform the stock market's returns."
http://www.fool.com/school/basics/basics04.htm
http://tinyurl.com/2umzgp
Do any research on this matter and you will come to this sad conclusion. And few active managers have more of the resources or "tools" that mutual fund managers have.
The reason active managers have no better luck that the dart throwers is because man does not have the ability to predict the future. It's a simple as that.
So then the only free lunch is diversification and dividends. And keep your fees and taxes as low as possible. That we can control.
And on the further subject of diversification and not loading up on hot sectors, this is an interesting article on the possible near future of emerging markets:
http://tinyurl.com/2qwrga
Re: the first comment, I don't know where you got your information, amigo, but i believe that about
20% of professional advisors beat the S%P consistently over 5-10 year periods. This would include their charges for managing your account.
This is why relatively passive managers like Brinker
routinely beat the market, because they use low
expense funds, mainly indexed. In his case, the
FA advisor fee is negligible since he does not actively manage the funds, rather sells his advice.
If you can find someone like Roger, who can
consistently provide a higher beta, and an alpha
close to 1, then that is the type of advisor who
is worthy of their fees, in my opinion. Unfortunately, most advisors do not publish their track records minus expenses, unlike mutual fund managers. Enjoy the last days in Hilo, Rog. Scoot
Regarding mutual fund performance: Isn't one of the "knocks" to mutual funds their (1) remaining fully (or close to it) invested and (2) inability to short?
Leisa, there are several mutual funds who keep as much as 25% cash, in order to take advantage of
good buys (FAIRX is a 5star example), and others
like CGMFX (up about 70% ytd) actually buy shorts in their funds, as I understand. Shorting homeowners
gave that last fund a boost this year, I believe.
I think that diversification strategies should include not only sectors and indexes, but investment tools as well (individual stocks, bonds, cash, ETF's and Mutual Funds).
Good day for defense funds, another baaaad day
for energy. Oh well. Scoot
Leisa, that depends entirely on the individual mutual fund's fundamental policies: AFAIK there is no prescription in the investment company act of 1940 regarding fully invested status or shorting; in fact I don't believe there are any provisions in that act at all regarding supervision of a company's actual investment decisions provided those are made public in the fund's prospectus and/or statement of additional information.
IOW what is regulated, fairly strictly, is transparency and conflict of interest; otherwise the prospectus governs.
OK, I'll bite. What's an OEF? I've been reading about investing for a long time but this is a new one on me. And a web search found "Operation Enduring Freedom". You wouldn't buy that?
open end mutual fund aka traditional mutual fund
Thanks for the answer, Roger.
BTW, you're my favorite author on SeekingAlpha.com :-)
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