Help me rebalance my failing S&S ISAs Portfolio - Sept 2011

Linton

darkpool wrote: »

I got the below from the same document. It says only 1.9% of funds produce alpha after fees. 20% of funds have a negative alpha. Hardly a great endorsement of the fund industry.

"We

first show that the impact of luck on performance is substantial. Specifically, we find that our estimators of the number of mutual funds with positive or negative performance is much lower than those obtained with the standard approach (only based on significant funds). These differences are informative , since they lead to a completely different assessment of mutual fund performance. For instance, while the standard approach concludes that 7.7% of the growth and income funds generate positive alphas (at γ = 0.2), we find that all of them are purely lucky. Finding 7.7% instead of 0% is clearly a false discovery!"

"Third, we

find that the percentage of funds with negative alphas in the population is approximately equal to 20% across all categories, while the proportion of funds with positive performance is much lower (it amounts to 1.9% of all funds in the population) after accounting for luck. It implies that the performance of the industry as a whole is
not so bad because about 80% of the funds generate a performance sufficiently high to cover their expenses. The negative average performance documented in past studies is not due to the majority of funds but is caused by 20% of the funds."

Isnt this confirming what I have said?

The authors of the report are saying that 20% of funds produce statistically worse performance and 1.9% produce better performance AFTER FEES and after removing the luck factor.

So 78% of funds on average perform much the same as trackers after allowing for an appropriate amount of luck either way.

Bearing in mind there are other possible differences between trackers and managed funds - eg volatility - chosing a fund on the basis of whether it is a tracker or not is focusing on a minor point and ignoring what is important.

Linton

Having identified the Far East as a sector where a passive fund may not be a sensible investment, I have come across another ...

Many investors aim for dividend income from UK shares. If they dont want the hassle of owning individual shares they could chose an equity income managed fund or a passive ETF. There is one designed for the purpose, I-Share IUKD, which tracks the FTSE Dividend+ Index.

Clearly the low fee ETF must provide the best return..

Well no:
5 year returns...
IUKD : -24.5%
IMA UK Equity Income (average of funds in the sector): -1.8%

A fund with the performance of IUKD would be in the bottom 5% of those in the UK Equity Income sector.

Why does this happen? Presumably because shares can have high % yield if they are good solid companies focussing on returning money to shareholders or
because the companies are in dire straits and the share price has collapsed but this has not yet been reflected in the dividends. A passive fund cannot tell the difference whereas this would be a simple task for a fund manager.

gadgetmind

Linton wrote: »

Why does this happen? Presumably because shares can have high % yield if they are good solid companies focussing on returning money to shareholders or
because the companies are in dire straits and the share price has collapsed but this has not yet been reflected in the dividends. A passive fund cannot tell the difference whereas this would be a simple task for a fund manager.

Agreed, IUKD is too mechanical and focuses too much on yield with no sector spread, no filtering by dividend cover, no balancing of cyclical versus non-cyclical, and doesn't even exclude those evil companies who cut dividends.

MrMalkin

Linton wrote: »

You can believe that if you want to. My far east managed funds which I have held for around 10 years are showing an average return of about 10% annually (and that's after the recent falls). How's your FTSE tracker performing??

This is a meaningless comparison though, nobody invests in a FTSE tracker when they want the performance of Far East markets. You're comparing apples with pineapples. Index tracking doesn't just mean the FTSE, it means tracking an index of assets in the areas you wish to invest.

DavidLaGuardia

Linton wrote: »

Precisely. That is why the over-enthusiastic proponents of trackers are talking dangerous nonsense in claiming that a tracker is automatically better than a managed fund.

I agree there are people who do this, but they have not managed to grasp properly planned and diverse passive investment. Their postion is then unfortunately used as a strawman agument of this being what a sensible passive strategy looks like.

Linton wrote: »

What is important and what a novice investor should focus on is the sector. Having decided that then you should decide which fund. Whether the fund is a tracker or managed is only one of many factors you could consider.

If you really want to invest in shares that happen to be in the FTSE100 (and I have some difficulty understanding why you would want to do that as a strategy) and are prepared to take the risk level of the FTSE100 index then by all means go for a FTSE100 tracker.

Again selecting FTSE 100 trackers is flawed and not representative of the passive investment strategies I am referring to.

Linton wrote: »

However if you want to invest in the Far East surely the last thing you want to do is to match what appears to be the only available Index, that provided by MSCI.

Look at the Trustnet graphs. To be fair lets compare the MSCI Asia Pacific Index with the IMA Asia Pacific (including Japan) figure, the latter being an average of all funds in the sector. Over 5 years the MSCI Index is down 23%, the IMA average is up nearly 30%.

You really would have to be a True Believer to go down the tracker route.

The MSCI includes many illiquid and risky stocks in this that would not be considered by most funds, even passive ones so this is a skewed observation. I think also you are confusing passive investment with using index-tracker funds. The latter is included in the former but they are not interchangable terms.

Linton

MrMalkin wrote: »

This is a meaningless comparison though, nobody invests in a FTSE tracker when they want the performance of Far East markets. You're comparing apples with pineapples. Index tracking doesn't just mean the FTSE, it means tracking an index of assets in the areas you wish to invest.

Agreed, though from some years looking at this site I believe many novice investors think a tracker means a FTSE tracker, as do some tracker enthusiasts.

My point remains: it's the sector that really matters, not the passivity of the fund. And a passive fund may or may not be appropriate for the chosen sector.

Even where it is appropriate, the return is not significantly different from the average managed fund after the deduction of fees. So why should any rational investor be particularly concerned when there are other more important factors to be considered?

Linton

DavidLaGuardia wrote: »

The MSCI includes many illiquid and risky stocks in this that would not be considered by most funds, even passive ones so this is a skewed observation. I think also you are confusing passive investment with using index-tracker funds. The latter is included in the former but they are not interchangable terms.

If you dont base your passive fund on an external index what do you base it on? Perhaps a private one or one generated automatically by some algorithm. Once you get a person using their skill and judgement to decide a stock is too illiquid or risky you are on your way to being a managed fund.

Perhaps you could suggest a Far East (excluding Japan) passive fund as an example. Or a UK equity income passive fund.

MrMalkin

Linton wrote: »

Even where it is appropriate, the return is not significantly different from the average managed fund after the deduction of fees. So why should any rational investor be particularly concerned when there are other more important factors to be considered?

I don't understand, if active funds generally return the same as passive funds then surely the default position should be to go with the cheaper passives - otherwise you're just giving money to the fund managers for no particular reason.

It's a pretty big premium to pay for a small chance of outperformance, a larger chance of underperformance, and a belief that fund managers can time the market in order to beat the bear markets - which I doubt they can do, and even if they can they largely do it by having a big cash position, which I can do myself for nothing.

I think overall asset allocation is far more important than choosing individual funds in terms of meeting investment goals, and when paired up with a range of index funds the strategy works very well.

darkpool

Linton wrote: »

Isnt this confirming what I have said?

The authors of the report are saying that 20% of funds produce statistically worse performance and 1.9% produce better performance AFTER FEES and after removing the luck factor.

So 78% of funds on average perform much the same as trackers after allowing for an appropriate amount of luck either way.

i just don't understand how someone can look at these figures and decide managed funds are better than trackers.

with managed funds there is a 20% chance the fund will underperform a tracker, 78% chance it will match a tracker, less than a 2% chance it will beat a tracker. why not just go for a tracker?

with the growth and income funds there was no evidence of added alpha due to skill. so investors are paying good money for fund managers and getting nothing in return.

DavidLaGuardia

Linton wrote: »

If you dont base your passive fund on an external index what do you base it on? Perhaps a private one or one generated automatically by some algorithm. Once you get a person using their skill and judgement to decide a stock is too illiquid or risky you are on your way to being a managed fund.

Perhaps you could suggest a Far East (excluding Japan) passive fund as an example. Or a UK equity income passive fund.

Yes its fair to say that such passive strategies involve an element of decision making but they are on their way to being active managed funds in the same way that flying to Dublin from London is "on your way to New York". The major divide (ignoring TER) is the avoding the drag caused by frequent trades where there is stamp duty and spreads. A reason not to base everything on trackerts is that like active managers they lose out by buying low and selling high whtether thats changing a stock to fix the index or slavishly rebalancing.

In answer to your two questions, I don't want to extent the controvesy and this is personal and irrelevant to the passive vs active, but here goes:

1. I would not be interested in a far east fund per se. The first divide to me is between the developed world and emerging markets otherwise there is a strong correlation and I would say is it UK or the rest of the developed wotrld.. I would obviusly have a bais towards the UK to avoid dispraportionate risk through currency movements.

2. More contraversial perhaps but, while I would work within sectors of the UK (smaller etc) I don't see the income sector as being a relevant indicator. To me dividend returns have little long term to do with overall return. It may vary in individual holdings, but essentially if a company makes 10p per share, what it doesn't pay in dividends gets added to its book value -yes I appreciate it is more complicated than that but I don't see the income sector to be as relevant as it's made out to be as it "all comes out in the wash" If you need income and don't have the yield it comes out of selling capital and capital gains has a larger allowance and a lower rate of tax.