There was an interesting article in the Washington Post (via IndexUniverse) on the active/passive debate which included some model portfolios from Burton Malkiel and Larry Swedroe. Malkiel allows for a little active management in certain instances but Swedroe says no dice.
Swedroe had a great quote in there that I agree with wholeheartedly; "Investing is really very simple -- it's just not easy because emotions get in the way." The discussion of active versus passive is always a good debate. Each one has flaws and each has its attributes.
With active management the biggest potential flaw, IMO, is that the person making the decisions gets some things wrong or goes on a cold streak. Every active manager will get some wrong of course or otherwise have a cold streak, the timing of the cold streak matters as does the consequence of the cold streak.
One thing I have talked about many times before is not letting the extent to which you get something wrong be ruinous to the portfolio. Actions that could be ruinous would include 30% in emerging markets or a large weighting to anything that is so volatile that an implosion in that area creates intolerable volatility for the overall portfolio. One example from a couple of years ago was when Canada announced changes to the tax laws for the royalty trusts and they all got crushed. This example is a good one because it the rest of the market is doing ok and this one little group blew up for a little while. Another example from a reader a couple of years ago who practically wiped out for owning too much of one biotech that did not get the FDA ruling it needed.
I've been taking another run at Fooled By Randomness and this is a point that Taleb made, it seems like common sense but many people put themselves at risk of being undone in this fashion.
With passive management the biggest potential flaw, IMO, is that if you really are passive then the equity portion of your portfolio will feel every bump on the road to down a lot. At some point I'm passive, I'm passive, I'm passive might lead to giving in to emotion and selling in desperation at precisely the wrong time.
It is going to be a good March. Six overtimes in MSG last night! Did you stay up? Syracuse had to give a lot of run to a walk on, that's how depleted they were. Crazy.
Proud Member Of
Random Roger
© 2009 | Gadget Theme Blogger Template
Original WPtheme By Blogger Template | Converted By Gadget Lover
| Distributed by eFree Blogger Help
Original WPtheme By Blogger Template | Converted By Gadget Lover
| Distributed by eFree Blogger Help
21 comments:
Probably the most important thing I've learned from you, Roger, is small position size. Ironically, it allows me to indulge my penchant for semi-active trading since I've so many more positions to manage. Thank you for harping on that.
Personally, I'm not a big fan of the tournaments since one loss can undo a whole season's worth of accomplishments. It's like leading for 499 miles at Indy and losing to a wreck on the last lap. The Big 12 is a mess now, for instance.
On balance, all participants in the market get average returns, this is necessary by definition. Active managers over time lag the market average by their expenses. Therefore, by just eliminating active managers one can boost their long term returns by the average expense of active funds. Seems like a no brainer. Adios.
Don't know how many times I have been told by readers of this blog that indexing doesn't work. Indexing is a passive strategy that can include both equities and bonds. By following a passive index strategy, my portfolio value down, but nowhere near the decline of the major averages. Cash is being reinvested in the underperforming class right now, which is equities. Indexing can also be a way to gain exposure to a certain segment of the market without the worries of some buffoon doing something stupid.
The hard part of investing is getting the mix of equities and bonds correct and then sticking to it. I'm sure this will no go over well here.
Stupid blogspot.
Anyway. I'll be darned - Swedroe committed to a specific portfolio! Interesting that he went all value.
Thanks for the link.
Active management = Bernie Madoff
Stephen Drone,
What's with your comment? It is well known that Swedroe favors value. He posts model portfolios all the time. His own personal portfolio which he has posted on the Bogleheads site is something like 30% equities composed of mostly small value and emerging market. The rest is high quality municpal bonds. He has repeatly said, even before the market decline, that he has no need to take risk, so he doesn't. He does feel that the effects of taxes on a portfolio are very important, something that is routinely dismissed here. How's that for something fresh, a manager who practices what he preaches.
Here's a Madoff quote from the WSJ,
"To the best of my recollection, my fraud began in the early 1990s. At that time, the country was in a recession and this posed a problem for investments in the securities markets. Nevertheless, I had received investment commitments from certain institutional clients and understood that those clients, like all professional investors, expected to see their investments out-perform the market. While I never promised a specific rate of return to any client, I felt compelled to satisfy my clients' expectations, at any cost. I therefore claimed that I employed an investment strategy I had developed, called a "split strike conversion strategy," to falsely give the appearance to clients that I had achieved the results I believed they expected."
This shows why education and the ability to manage your own finances are important.
Just for the record, the piece in the Washington Post was done by Kiplinger (and properly attributed to them); Kiplinger published a version on its website in late January.
There always will be true believers in active management and in passive management. Live and let live. Whatever works for you. Etc. etc. Perhaps the debate needs to be framed differently. That is, between buy-and-hold and, well, not buy-and-hold. Folks who held a passive S&P 500 index fund and sold in a timely fashion (200 DMA?) protected themselves reasonably well, as did holders of active funds. Those who 'bought-and-held' are having a tough time. Passive/active? The decision-making needs to be at a deeper level. In the market or not in the market? And in the future, when to return, or not to return?
As for basketball conference tournaments. Humph. They were invented after conferences saw the mongo bucks the NCAA tourney generates Their purpose is to generate revenue.
Madoff is a sociopath and (redundantly) a liar. How dare you quote him as though he is expressing objective truth.
I had to do it. I plugged my active funds and a selection of Vanguard index funds into a fund comparison tool at marketwatch.
I'll keep my active funds.
I'm tired of reading about these avocates of index investing. How many investors can hold an index fund while it's a loosing position for many years? I spend the time looking for great managers and researhing the funds they manage which I will give 2-3 years to perform and if they don't I switch to another. I can beat any index fund over a 10 year period so I avoid them.
It's interesting that Malkiel has his EM exposure at 30%. India at 10%? Then if you graph TDF vs. FXI, it is substantially underperforming. If you look at the premium/discount history, it has carried a substantial discount since inception - and has had only brief periods below a 10% discount, which seems to refute the argument in the article about buying a CEF at a discount. Also from the article: "Although Malkiel isn't sure that Mobius can beat the relevant index, he nonetheless considers him an excellent manager." Similar volatility, lower return, net loss = excellent manager?
I suppose I disagree with him on India, CEFs, and the definition of "excellent".
I do agree with Anon above that the passive/active stories should focus on or incorporate timing/not timing. Paying for someone to properly allocate, time your investments, and manage volatility is definitely worthwhile - while I believe (IMO) it's been disproven that an all-equity fund can continuously beat an appropriate benchmark.
Thanks for the story.
to the comments about timing versus not I would say that one of the key concepts to what i do and so by extension this blog is a timing vehicle (the 200 DMA). presumably the idea of some sort of timing vehicle is attractive to large portion of the readers of this blog because it gets written about so often here.
point being we may not be an unbiased crowd.
Roger,
Just a thought! Where do you see oil in the next 3 to 6 months. There was a time prior to oil breaking about $110 that an increase in the price helped the market. Do you think as oil goes up it will help the market, or should I say, they will help each other.
BWJR
I ran numbers for Swedroe's portfolio:
2008: -25.13%
2009 YTD: -12.4%
SCZ didn't exist before that, and I can't find any numbers on what its index might have done.
oil in 3-6 months? not really my wheelhouse. how can oil price remain at a level that is not profitable for the people taking it out of the ground for any meaningful length of time?
For those who love active management, here are two words: Bill Miller
Anonymous 5:57 AM
"On balance, all participants in the market get average returns, this is necessary by definition."
Disagree. Most of the time prices are a relatively small amount above average. For a smaller proportion of time time prices are considerable below average.
Assume an average of 1.0 For much of time - say 80% - prices might be at 1.1, for 20% of time they might be at 0.6. Overall average is 1.0, but most investors buy in at an above average price.
Whilst equally they might also sell at an above average price, paying a relatively higher price results in a lower dividend yield, and dividends make up a considerable proportion of overall total investment rewards.
A similar effect applies to stocks. Most stocks underperform the average, a few make large gains that counter (and more) the large marjority of under-performers.
anon 3:45
Where would you have rather been from 1997 for next 10 years?
http://tinyurl.com/c48tfe
Clive, not talking about prices. I'm talking about long term returns for equities. Emphasis on long term > 20 years.
There is no doubt that in the short term some active funds outperform the market. Can you tell me which ones will next year, for the next five years, or for the next twenty years?
There is a mountain of academic evidence that supports passive investing. Doesn't set well with this crowd though.
fboness, congratulations. I hope your luck holds out or you will share your skill in consistently selecting above average managers.
"not talking about prices. I'm talking about long term returns for equities. Emphasis on long term > 20 years."
It's the same.
If the average market yield is say 4.5%, and averages a 6.5% capital gain = 11% p.a. average total return.
Throw in some yearly volatility - perhaps 20% standard deviation - and the compound (annualised) is around 9.2%.
You'll only get that longer term (20+ years) rate however if you buy and sell at the average yield level. Many investors wont and will have paid a higher price (or sell out at a low price). Such that both the capital gain and dividend yield are lower, often significantly so.
The key to beating the longer term average is buying in at below average levels (Dow yield 4.5%+ or any other time independent measure you care to use) and sell out at a average or higher level.
For long periods of time however stocks sit at above average levels, so a large majority of investors are buying into below average longer term performance.
That includes commercial fund managers who have to cope with cash-flows. Usually with cash injections into the fund occurring when prices are high and cash withdrawals occurring when prices are low (worse possible times).
Accordingly drip feeding into an Index Tracker is a low cost no brainer. That will not beat a good fund manager over the longer term however. The problem is that good fund managers are in demand (polite way of saying that many FM's aren't any good) and are usually privately employed. (Groucho Marx's "I wouldn't want to belong to any club that would have me as a member" comes to mind).
In the absence of having a good FM working for you the next best thing is to learn and manage your own account. As Roger has repeatedly said - it's relatively simple.
Post a Comment