Passive v active

N1AK

Surreyboy wrote: »

I think it's true that many or most active managers do fail to outperform the market over long periods, but there is a small band of managers/funds who seem to be able to outperform their respective indexes over the long term

Replace active managers with lottery players and outperform index with win the jackpot and that sentence still makes sense

My point? There are lots, and lots, of fund managers so some of them will invariably beat the market for extended periods of time. Some pretty extensive research has been done by various sources and the general view is that it would take decades of information to judge a fund managers performance (rather than his luck).

If 1,000 people played roulette starting with £100, betting it all and just picked a colour at random then after 4 spins ~60 of them would have £1,600 and after 10 spins 1 of them would have ~£100,000. Is the guy who lost everything on the first spin a worse gambler than the guy who walked away with £100k?

N1AK

princeofpounds wrote: »

Don't kid yourself, the real value of passive investment instruments is the low fees - where they do really have an advantage - and nothing else.

On the contrary: The low cost is a nice bonus, but for many passive investors the biggest benefit is related to risk. Active funds have to do 'something' to justify the higher fees, that something is invariably to make judgement calls. As a passive investor I get to decide on a few specific points (which market, method etc) and can avoid having to try and pick a fund manager who won't make poor/unlucky judgement calls.

dunstonh

As a passive investor I get to decide on a few specific points (which market, method etc) and can avoid having to try and pick a fund manager who won't make poor/unlucky judgement calls.

That is one side of it but the counter side is that a manager may choose to avoid a stock it feels is in decline and possibly failure whereas the tracker has to hold it until it is outside of the benchmark requirements.

There are too many positives and negatives with each.

bowlhead99

princeof_pounds wrote: »

The second piece of nonsense is that the benchmark is always the 'average' choice in some way. A benchmark is always an entirely artificial, man-made arbitrary construct; it is only representative of 'the market' if you happen to define 'the market' the way the index provider did (and there are many different and valid ways to do so). Actually by selecting a benchmark you are making almost as a big a choice as which stock to buy.

This is true. FTSE all-share for example decided to tell you the overall return of all the share capital you could get your hands on, in the London market (apart from the companies that don't make it onto the small cap list). In reality you are not trying to deploy hundreds of billions of pounds into scarce UK opportunities, so you don't need to stick 3000x as much into the largest company as you do into the smallest, to use up your money by putting a lot of it in oil and financials and big pharmaceuticals.

When you look at a world scale with the developed and developing markets indexes they are again capitalization weighted which is necessary if you want to know how much "the total market" grew but might give you a somewhat funny level of exposure to different types of companies if you thought about it too hard. You are not trying to find a home for $50 trillion so you don't need to put a whole percent of it ($567 billion) into Apple, right?

To follow your point and Dunstonh's that asset allocation is a form of active management. This is true even though it might not feel like it.

According to Moneysavingdude, it is difficult to better VLS. Well, if cheap market cap weighting makes sense for the "best" return, why is it overweight UK? Answer, because it is marketing to customers based there who like home bias. An important conscious decision to make, for better or worse.

Ok, why is it overweight Korea? Well that's because they track FTSE indexes for their developed market exposure (which define Korea as developed market), and they use MSCI indexes for emerging market exposure (which define Korea as emerging). So, you'll get a double dose of Samsung in your portfolio. Given Samsung as an international $100bn+ electronics firm strikes me as just as valid an investment opportunity as Apple, it may not be a bad thing that you put a bit more in Samsung to lower the gulf in your exposure between the two.

But it is worth knowing where your money is going, and making sure you are happy with how Vanguard Lifestrategy, or Blackrock Consensus, or any generic FTSE or MSCI all world fund, allocates your capital.

princeofpounds

On the contrary: The low cost is a nice bonus, but for many passive investors the biggest benefit is related to risk. Active funds have to do 'something' to justify the higher fees, that something is invariably to make judgement calls. As a passive investor I get to decide on a few specific points (which market, method etc) and can avoid having to try and pick a fund manager who won't make poor/unlucky judgement calls.

I think you miss the point. Picking any kind of passive fund is a judgment call in itself.

In fact it's probably a bigger judgment call in risk terms than what most active fund managers do vs. their benchmark, given it involves large volumes of asset allocation.

This sort of demonstrates my point actually, that there is this perception that picking a passive product is essentially risk-neutral.

It's only risk neutral if you measure your risk relative to the very same benchmark, which is something of a tautology.

dunstonh

According to Moneysavingdude, it is difficult to better VLS. Well, if cheap market cap weighting makes sense for the "best" return, why is it overweight UK? Answer, because it is marketing to customers based there who like home bias. An important conscious decision to make, for better or worse.

Better is an interesting word to use.

For example, there is one investment strategy that is risk rated in the same level to the VLS and across all VLS versions, the VLS does better in growth periods but has greater volatility. In periods of loss the other does better. Now you may think that they should be in different risk profiles but they have very similar asset classes. its just that the other has a focus to have lower volatility and to many inexperienced investors, low volatility is better than higher long term returns.

Management is not just about coming in best. If you take the all the risk profiles of funds in the same sector you will have a large risk variance. Some of those funds never aim for that top spot in short term discrete performance. Some of the funds will, by nature be extremely volatile and jump from quartile 1 to 4 frequently in discrete performance. They are not aimed at the long hold investor.

bowlhead99

princeofpounds wrote: »

This sort of demonstrates my point actually, that there is this perception that picking a passive product is essentially risk-neutral.

It's only risk neutral if you measure your risk relative to the very same benchmark, which is something of a tautology.

In theory the passive product has a very low risk of outperforming or underperforming "the market", if you consider the return of the market to be equal to the return of the index on which the passive product has been based.

However, a)the return of the market is not always desirable and b) the return of the market might be expressed in multiple ways only one of which is the one shown at the top of the page of a newspaper, internet or TV story.

Totton

Active for me, it's not difficult to select managers regularly beating a passive, likewise it's easy to find managers who can't/don't manage that :-)

If you wish to get better than average returns you need to explore individual companies and understand what the shares you are buying represent.

I would't agree with that, you can do this with the correct IT's or funds although in all cases you need to do some work.

jamesd

bowlhead99 wrote: »

Ok, why is it overweight Korea? Well that's because they track FTSE indexes for their developed market exposure (which define Korea as developed market), and they use MSCI indexes for emerging market exposure (which define Korea as emerging).

And of course FTSE recently made that decision while MSCI didn't, so suddenly a holder of this tracker fund got to go from no Korea to lots of Korea, based on the FTSE group's opinion. But not of its investment potential, based on things like market liquidity and trading hours.

Of course it wasn't only FTSE making an asset allocation decision. Vanguard used to use MSCI then recently switched to FTSE so they also made an asset allocation decision via their choice of index. Which according to the press might have been because FTSE was willing to offer them a cheaper price than MSCI.

So why Korea? Because the low bid index tracking firm thought that it was a nice liquid market with long trading hours and a variety of other things having not a lot to do with potential investment returns.

atypical

Whether 'passive' is 'passive', or actually 'less active' or something else seems a distraction. Vanguard's paper on this here is great (with normal bias caveats): https://www.vanguard.co.uk/documents/inst/literature/case-for-index-fund-investing-uk.pdf

"We demonstrate that, after costs, (1) the average actively managed fund underperformed its benchmark while exhibiting greater volatility, (2) reported performance statistics can deteriorate markedly once you account for survivorship bias, and (3) that the persistence of performance among past winners is no more predictable than a flip of a coin. To the extent that a few active managers do outperform, ex ante identification is not a simple matter of examining recent performance; low cost appears to be the only quantifiable factor that is associated with higher average returns, but it is also necessary to make sure that the manager has an appropriately disciplined long-term investment philosophy."