Professional Finance people no better than amateurs

darkpool

jem16 wrote: »

That seems to be reserved for you as you have shown time and time again.

you must be a blonde? anyway stick with the UTs, and don't let evidence get in the way of what some IFA told you to think.

HelpWhereIcan

darkpool wrote: »

"Third, we find that after accounting for luck, 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). 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."

Soooo 20% of funds have negative alpha and 1.9% have positive alpha, circa 78% will match a tracker.

At last, a mention of some real issues to discuss.

There has been a lot of talk about Alpha and fees etc in this thread.

Little experiment to put all of this discussion into 'real world' context.

Let's assume we have 2 funds, one a FTSE All Share Tracker and the other an Active Managed Fund.

Both have the IMA UK All Companies as their benchmark.

Over 3 years the benchmark (IMA UK All Companies) has returned 76.2 on a cummulative basis.

We obtain the following Statistical Ratios for the funds:

FTSE All Share Tracker
Alpha: -1.19
Beta: 1.05
R2: 0.94
Sharpe: 0.69
Volatility:17.38%

Active Managed Fund
Alpha: 3.67
Beta: 1.63
R2: 0.93
Sharpe: 0.92
Volatility: 28.19%

Would anyone care to speculate as to what the cummulative performance of the two funds (FTSE All Share Tracker & Active Managed) might be?

A 'guesstimate' will do, as will 'in the region of' or 'a difference of'.

What difference in fees (if any) would be acceptable?

Any other observations worthwhile making?

Over to you darkpool.

darkpool

Helpwhereican certainly lived up to his name with that document, here are some more quotes from it. It seems to back up what some of us here have been saying about active fund management for a long time.

"From an overall perspective, we observe more frequently funds with negative rather than positive performance."

"Expressed as a percentage of the fund population, the proportion of funds with positive alphas is extremely low."

darkpool

HelpWhereIcan wrote: »

FTSE All Share Tracker
Alpha: -1.19
Beta: 1.05
R2: 0.94
Sharpe: 0.69
Volatility:17.38%

Active Managed Fund
Alpha: 3.67
Beta: 1.63
R2: 0.93
Sharpe: 0.92
Volatility: 28.19%
making?

Over to you darkpool.

ahhh the old throw in some technical jargon routine. how often does that work in a real life meeting? whenever you get a customer asking difficult questions you just throw in a couple of "sharpes" and "R2s" to bamboozle him?

that paper you quoted from basically said active management was p1sh. do you not have any research that says active management is cost effective?

Lokolo

darkpool wrote: »

ahhh the old throw in some technical jargon routine. how often does that work in a real life meeting? whenever you get a customer asking difficult questions you just throw in a couple of "sharpes" and "R2s" to bamboozle him?

Do you not understand what these are?

If you don't, I cannot believe you can write derivatives, these are basics of investments. You seem to want to think you know it all, but in fact you know very little.

1) You say UTs are managed funds.
2) You say that managed funds are normally distributed.
3) You now ignore a valid discussion point from HelpWhereICan with the excuse "oh using technical jargon", all of which isn't technical, it is part of the basics.

HelpWhereIcan

darkpool wrote: »

ahhh the old throw in some technical jargon routine. how often does that work in a real life meeting? whenever you get a customer asking difficult questions you just throw in a couple of "sharpes" and "R2s" to bamboozle him?

No, the 'allow darkpool to show how much he knows' routine.

I was just going to give you the Alpha - the much oft debated and quoted figure - but then I thought

"darkpool will just claim there's not enough info to guess at the performance!"

so I gave you more to work with.

But, if you prefer, use the alphas quoted to give us your insight into the difference in performance of the two funds over 3 years.

We've used a study that quotes alphas, let's take the next step and put that into figures that mean something to those who know less than you do.

Go on.

gadgetmind

HelpWhereIcan wrote: »

Would anyone care to speculate as to what the cummulative performance of the two funds (FTSE All Share Tracker & Active Managed) might be?

Is the active managed 100% equities and all from the FTSE All Share? If not, then it's apples and oranges.

I use trackers, but it's a balanced portfolio of global trackers (with carefully chosen territory and cap exposure) with property, bonds, infrastructure and a few other themes alongside.

As my GPP is investment mostly in the Friends Life Balanced Index Enhanced Fund of Funds, I have chosen this as the benchmark that I aim to beat.

Ask me in ten years how it's gone.

What difference in fees (if any) would be acceptable?

I would pay perhaps 15bp more than the 0.4% TER I'm paying now, but would still watch the active fund like a hawk.

Any other observations worthwhile making?

Yes, a well-constructed and carefully balanced portfolio can be achieved for well under 0.5% TER per annum. If the fees are any higher, then serious under-performance is very likely.

darkpool

Lokolo wrote: »

Do you not understand what these are?

If you don't, I cannot believe you can write derivatives, these are basics of investments. You seem to want to think you know it all, but in fact you know very little.

LOL!! if i phoned up my derv broker and started going on about sharpes and R2s he would hang up. all he wants to know is sell/ buy, put/ call, strike and expiry.

do you even know what a derivative is?

HelpWhereIcan

gadgetmind wrote: »

Is the active managed 100% equities and all from the FTSE All Share?

100% UK equities

gadgetmind wrote: »

If not, then it's apples and oranges.

apples with apples by all accepted measures - but we are also looking at what alpha really means to an investor doing their research

gadgetmind wrote: »

I use trackers, but it's a balanced portfolio of global trackers (with carefully chosen territory and cap exposure) with property, bonds, infrastructure and a few other themes alongside.

So do I - that's why I keep talking about a Core/Satellite approach.

gadgetmind wrote: »

As my GPP is investment mostly in the Friends Life Balanced Index Enhanced Fund of Funds, I have chosen this as the benchmark that I aim to beat.

Ask me in ten years how it's gone.

Knowing the benchmark you will compare performance too is one of the most important things.

I genuinely wish you nothing but success.

gadgetmind wrote: »

I would pay perhaps 15bp more than the 0.4% TER I'm paying now, but would still watch the active fund like a hawk.

OK. Thank you for your contribution - at least you have made one.

gadgetmind wrote: »

Yes, a well-constructed and carefully balanced portfolio can be achieved for well under 0.5% TER per annum. If the fees are any higher, then serious under-performance is very likely.

Thank you

JamesU

HelpWhereIcan wrote: »

By the way, http://papers.ssrn.com/sol3/papers.cfm?abstract_id=869748, one of the other links I posted that darkpool cannot be bothered to read - or debate on the real issues.....

Now, correct me if I am wrong, but hasn't just about everyone said that part of an IFA's role is to help 'unsophisticated or inattentive investors' make their decisions?

That's correct, one would expect an IFA to inform, but providing a specialised paper (that may or may not be understandable to many) is not necessarily the best way for an IFA to go about helping 'unsophisticated or inattentive investors' make informed decisions with regards to the merit of costs associated with actively managed funds and/or the choice and justification for those funds by IFAs.

Having said the above, I guess us "unsophisticated investors" should at least try to make an effort to understand what you are saying, and establish if the data, reasoning and justifications you have put forward with this paper are important. So here we go anyway:

(1) Generally, the "working paper" seems pretty obscure and it is difficult to judge what importance and weighting a single paper submitted to the Journal of Finance should have on such a generic topic. Furthermore there is no way of knowing to what extent the establishment, Authors or anonymous Referees are experts in their field. By and large anybody with a modicum of expertise can write a paper about something specialised, but that does not make it a seminal piece of work that can be relied upon. A more robust review rather than a single specific paper would seem more appropriate.

(2) In the paper, the "skill" of the manager is defined as manager talent to select stocks sufficient to generate a positive alpha net of fund expenses and/or trading costs, with calculations based on approx 2,000 open ended equity funds in the US. However between the US and UK there are substantial variation and differences between these costs, and incompatible tax contributions to those costs. Hence I find it quite difficult to rationalise how the basic premis in the US study can be meaningful regarding investing in actively managed funds in the UK.

(3) Specifically, the gist of the paper is on the development of statistical analysis to differentiate between unskilled, zero-alpha and skilled funds and removing the elements of chance (luck) and false positives. The statistical analysis performed does seem to be able to differentiate between the three groupings which is of course useful to know. But what is most interesting are the real findings in this paper concerning the 2000 actively managed funds between 1975 and 2006:

(a) 75% of funds exhibit zero alpha (net of expenses) i.e managers have enough stock picking skill to cover their costs, but do not add any value to the fund
(b) 24% of funds are unskilled
(c) Only 0.6% of actively managed funds are found to be skilled, but statistically this finding cannot be distinguished from zero.
(d) The reduction in the percentage of skilled actively managed funds has been an ongoing trend, from 14.4% in 1990 to 0.6% in 2006.

Based on (a)-(d) above, which are the results of the study the paper describes, the conclusion is that there is no evidence to justify the use of actively managed funds.

HelpWhereIcan wrote: »

"Our paper focuses the long-standing puzzle of actively managed mutual fund underperformance on the minority of truly underperforming funds. Most actively managed funds provide either positive or zero net-of-expense alphas, putting them at least on par with passive funds. Still, it is puzzling why investors seem to increasingly tolerate the existence of a large minority of funds that produce negative alphas, when an increasing array of passively managed funds have become available (such as ETFs)."

I find this part of the discussion in the paper quite amusing myself, and I am quite surprised you have highlighted the bolded part inferring it has some form of positive meaning regarding the justification for using an IFA to choose actively managed funds. Your bolded part in the paper refers to the fact that actively managed funds net of costs (3a and 3c above) do not outperform passive funds. The only circumstance where this occurs is with the 0.6% of actively managed funds that have positive alpha (see (3c) above) but this finding is not considered statistically significant by the Authors as they state that this 0.6% is actually indistinguishable from zero.

This paper does not seem to provide any evidence that would justify the use of actively managed funds over passive alternatives, as already highlighted in 3a-3d above.

HelpWhereIcan wrote: »

Now, correct me if I am wrong, but hasn't just about everyone said that part of an IFA's role is to help 'unsophisticated or inattentive investors' make their decisions?

That is correct. But if the IFA is reliant on data from papers such as the one you have cited here, it is important for the IFA to interpret and disseminate that data accurately, correctly and in unambiguous manner to facilitate investors' informed decisions.

JamesU