active vs passive?

edinburgher

Low cost index investing is a simple and powerful concept that will deliver healthy returns for most people most of the time, with next to no faffing about. There are always risks with equity investing (i.e. total market collapse), all investors should be aware of these.

What becomes very wearing is when unsophisticated investors (no offence meant, including myself in this group) come to the board and ask a few questions about index investing, only to face a barrage of technical language, pet theories and unsubstantiated opinions. This sort of guff doesn't help, as very few investors have the skills to pick winning shares or funds over the long term. The topic of persistence in fund performance is well researched and most people can't do it/find it.

Most of us won't be a Buffett, suggesting that we can be is overly optimistic at best, downright dangerous at worst.

Anyway, that's what the block button is for

Jaguar_Skills

Ediburgher that's an excellent post and hits the nail on the head for me really.

I am keen to make some money and invest wisely but I don't really have the time to delve into the great realms of it. I have no idea how linton, Bowl head and Ryan et al know so much but I am assuming it is partly due to the nature of their job?

Really for me I just want:

Something simple where I can invest my £££'s per month (without having to give up my job to understand it!)
Doesn't take a lot of management ie can just drip feed and leave.

SomeOne mentioned index investing as this fitted these goals. Now I'm confused again

TheTracker

Jaguar_Skills wrote: »

SomeOne mentioned index investing as this fitted these goals. Now I'm confused again

Active and Passive Investing: What You Need To Know is a summary from the leading index investment provider. Naturally there are summaries from the other side of the fence. It ends with a suggestion that you talk to an IFA (I would say several IFAs) if you still can't make head or tails. No pun intended.

Ryan_Futuristics

TheTracker wrote: »

That's entertaining. Vanguard's whole concept is based on provable mathematics, implementing a strategy almost wholly based on findings by Nobel laureates. It's not worth debating further, we're venturing into troll territory.

I can explain it in more detail if you want

I think I've written a long post to you before that you didn't read, so just a few points (or in case anyone else is interested):


1 - Vanguard published a rehash of Malkiel's 1973 work which seemed able to show market behaviour was entirely random

Warren Buffett rebutted this in the 80s (in the Super Investors of Graham and Doddsville) when he dissected Malkiel's data - rather than lumping every investor together, he categorised them by investment style

Suddenly, instead of an amorphous blob of investors, you could quite clearly identify consistent over or under-performance by investment strategy ... Which meant results were no longer 'random' ... Malkiel has never responded


2 - It's deceptive to reduce fund performance simply to returns ... The average fund investor is looking for a combination of returns and stability

We know FTSE 250 returns over long periods have far exceeded the All Share index, yet not many investors would be happy to have the FTSE 250 as their main holding ... (You'd have to endure long periods of underperformance and poor income)

Risk and return tend to be very well correlated ... If there are as many conservatively run funds out there as there are aggressive, the average return should look somewhat like an index (it's rather a leap to say this means performance is random, yet this is the only data supporting that position)


3 - In the UK, Vanguard sell trackers; in the US, they sell active funds too ... This is reflected in the information they pass to customers

For example in the US they'll mention how their active funds consistently beat the index and offer lower volatility - and these are very actively run funds with large teams of managers

I expect they will launch some actives over here at some point (as their trackers are still relatively new), and their tone to UK clients may change (after all there are just as many papers out there they could cite or recreate which support active management principles, not least their own track record)

Linton

Jaguar_Skills wrote: »

.....

Something simple where I can invest my £££'s per month (without having to give up my job to understand it!)
Doesn't take a lot of management ie can just drip feed and leave.

SomeOne mentioned index investing as this fitted these goals. Now I'm confused again

If you want a very broadly invested single fund that you can simply drip feed:

Look at https://www.trustnet.com. Select Unit Trusts&OEICs. Select one of the "IMA Mixed Investment" sectors. The higher the % the better the long term return but the greater the volatility. "Search" for the list of funds.

If you want you can sort by performance over different numbers of years by clicking the column header. Choose a fund - best to avoid the worst performers. Look for words like Balanced, Managed and Multi. You will also see the Vanguard LS series and the L&G multi index funds there if you want index funds.

You can get more details on individual funds by clicking on the fund name. Avoid funds which dont subscribe to Trustnet - they are probably small and obscure.

You should find something there which is reasonably safe and will provide a reasonable long term return. Perhaps more importantly it is very unlikely to be a disaster.

dunstonh

What's the rreason a multi asseasset fund is more beneficial? I'm thinking of dripping £600 a month into a SIPP AND £400 into SandS Isa.

Could I just track an index from different nations for simplicity ie FTSE etc?

You can just select a FTSE index fund but that would be poor quality investing. Ignoring the higher risk nature of that (100% equity), it is a single market. If you went FTSE100 then its not a very diversified market either. Do you think Amercians or Germans would wake up in the morning and think that they should invest 100% of their money in the FTSE?

When using single sector funds, you aim to use a spread of them to build a portfolio to give you the diversification of the different markets and different asset classes. However, if you are doing that on £600pm you face the problem that its going to be many years before it becomes sensible. For example, if you allocated 3.7% to Japan then on £600 that is £22.20. Not a big amount. You can do it but is it worth it?

Plus, do you intend to be a lazy investor or active investor? if you are going down the lazy route then you shouldnt build a bespoke portfolio as you will need to adjust it to suit the economic cycle and rebalance it.

Multi-asset funds control the asset allocation within the fund. They can give you the diversification without you choosing the amounts to allocate to each sector. Then, when the portfolio gets bigger and if you still feel you want to do more with it then you can change to a bespoke portfolio.

TheTracker

Who's the mathematician here?

Ryan_Futuristics wrote: »

3 - In the US they'll mention how their active funds consistently beat the index and offer lower volatility

I am not aware they say both about any one fund they offer, can you reference? They offer a "Global Minimum Volatility Fund" which naturally offers lower volatility, and the returns from their active funds have historically consistently beaten the index/market.

There are two reasons why their active funds may have beaten the indexes that do not contradict their passive ideology.

First, Manager Risk is introduced. A population of investable assets is chosen (the index). A group of actors (fund managers) chooses samples of the population based on some principle, which may or may not be random. Some of those managers will beat the index and others not. Over time slightly lower numbers of managers will not beat the index than do, because the index is the aggregate of managers minus costs. It may well be that the increased return the Vanguard Active's have is attributable to MR.

Second, and more fundamentally, Vanguard believes in the efficient market hypothesis which says that risk is rewarded with return. When comparing relative returns across funds once must take into account the relative risk. Showing that the return on the Vanguard Health Fund was higher than the return of the S&P 500 says nothing if you don't account for the relative risks. It is therefore likely that some portion of the higher returns of the Vanguard Actives is attributable to higher risks. I could construct my own "actively managed" portfolio against the S&P-500. I could weight the allocations by ordinal position rather than market cap, or I could exclude the top 100. Both of these increase the risk and should be expected to bear a larger return over time.

Vanguard's literature on why they sell Active Funds makes the play that the market isn't always truly efficient, but rather only reasonably efficient. I don't believe many people think that it always is, or we wouldn't have up's and downs week by week let alone stock bubbles and crashes. The rationale of their Active Funds is to identify and exploit such inefficiencies. That's not too different from the strategies you follow. My guess is that this is as much a sales strategy as a financial strategy to subdue the passive vs active debate, and to further eat away at the market active fund managers have through cheaper fees. It also allows investors who are otherwise passive investors to tilt their portfolios against non-trackered sectors.

Ryan_Futuristics wrote: »

Vanguard published a rehash of Malkiel's 1973 work which seemed able to show market behaviour was entirely random

Warren Buffett rebutted this in the 80s (in the Super Investors of Graham and Doddsville) when he dissected Malkiel's data - rather than lumping every investor together, he categorised them by investment style

Suddenly, instead of an amorphous blob of investors, you could quite clearly identify consistent over or under-performance by investment strategy ... Which meant results were no longer 'random' ... Malkiel has never responded

I imagine the lack of response reflected Malkiel's lack of respect for Buffett's reasoning. Only one, after all, is an academic.

The market is either random or not random. Buffett believes that he can show the market is not random through the following argument. If a substantial number of long-term market-beaters share a common investment strategy, and they do not work with one another, then the investment strategy must be successful going forward, and the market must not be random.

To demonstrate this argument he selected nine successful funds. He selected funds that followed a particular strategy (value) run by people that were known to him before they became successful. If that sentence doesn't tell you all you need to know about the significance of his findings and his scientific approach than I do not know what would. Imagine a gambler who plays the lottery each week and believes he can pick the numbers through strategy. He has been successful for quite some time. To prove this is due to strategy, he notices that nine other previous winners, independently of each other, also used a similar strategy. The only other relationship they have is they know each other through a gambling website where they discuss strategy but not individual numbers and he knew them before they won the lottery. Therefore the market is not random.

In fact, all Buffett has done is shown that a particular strategy works retrospectively. He has given undue weight to the fact he and others chose this strategy before it was known to be successful. It's undue because whatever strategy had turned out to be successful would naturally have had proponents many years prior. I believe his article was mainly written to counter the "buffett is one in a million winner" argument by showing there are many other winners. But he didn't prove or try to prove the statistical significance to the fact others also did well.

Can you point me to where Buffett "dissected Malkiel's data"? He didn't do this in the article.

Now while Malkiel never directly responded, in 2012 he gave a carrot to value investing. At the time he said "Emerging market equities are particularly attractive. The price-earnings multiples for emerging markets have traditionally been about 20% higher than for U.S. stocks. Today they are 20% lower." That sounds more Buffett than Malkiel. Whether or not this was a change of heart, or a random selected sentence that has been read into too much, is another matter.


I think the saddest aspect of all this debate is that our civilisation is being leached of the greatest and brightest minds by midas's gravitational pull to the financial industry. It's terribly sad to think that thousands of the smartest mathematical minds head to wall street and canary wharf rather than to the industries that canary wharf and wall street invest in.

atush

Personally, I would not go 100% active or passive.

Passive is great for a core holding, as long as you diversify your markets and asset classes as D suggests. Holding just UK equity trackers is very high risk.

But some markets and asset classes dont have a lot/any passive funds to choose from and I personally like to hold contrarian investments as part of my overall portfolio.

TheTracker

Yes, 100% UK Equity is high risk. Many people would expose themselves to a higher risk than UK Equity through additional Small Cap exposure, but diversify other asset class holdings to reduce risk much further. Holding equities within a tracker doesn't increase that risk.

And one may still be contrarian with trackers. What's interesting about algorithmic investors who buy actively managed funds that generally follow their favoured algorithm is they'd be best to follow a passive tracker if they existed. It costs money to set up a fund, but in theory there is nothing stopping the inception of a passive tracker that uses Ryan's CAPE strategy and only that strategy. We see more and more of these smart trackers arise. Less Ferraris for the managers, better choice for the consumer.

Ryan_Futuristics

TheTracker wrote: »

... A population of investable assets is chosen (the index). A group of actors (fund managers) chooses samples of the population based on some principle, which may or may not be random. Some of those managers will beat the index and others not. Over time slightly lower numbers of managers will not beat the index than do, because the index is the aggregate of managers minus costs. It may well be that the increased return the Vanguard Active's have is attributable to MR.

It is therefore likely that some portion of the higher returns of the Vanguard Actives is attributable to higher risks. I could construct my own "actively managed" portfolio against the S&P-500. I could weight the allocations by ordinal position rather than market cap, or I could exclude the top 100. Both of these increase the risk and should be expected to bear a larger return over time.

First bit - we're all guilty of this, but you've created a hypothetical there and shaped it to fit your belief

While your reasoning sounds fine to me, I don't know anything about what percentage of Vanguard's fund managers do or don't beat the index (and this would be the critical piece of information)

And the second bit: absolutely ... Risk and return are very well correlated - another way of looking at it is return vs time-scale ... This could perfectly well describe Neil Woodford's long-term track record

Also agreeing with you: as has been said in other studies, if you weight an index on how many board members wear bow-ties, you will usually beat the index ... Random (or 'clown') portfolios do exceptionally well on average (however, the bad ones do exceptionally poorly ... hence why you wouldn't invest in one)

To demonstrate this argument he selected nine successful funds. He selected funds that followed a particular strategy (value) run by people that were known to him before they became successful. If that sentence doesn't tell you all you need to know about the significance of his findings and his scientific approach than I do not know what would. Imagine a gambler who plays the lottery each week and believes he can pick the numbers through strategy. He has been successful for quite some time. To prove this is due to strategy, he notices that nine other previous winners, independently of each other, also used a similar strategy. The only other relationship they have is they know each other through a gambling website where they discuss strategy but not individual numbers and he knew them before they won the lottery. Therefore the market is not random.

AKA 'confirmation bias'

Absolutely, but what I mean by respecting the maths is that the principle you describe is fine - it probably explains some or all of Buffett's position (and to some extent may explain every conclusion based on every use of statistics in history)

But I've no idea how much it explains it ... It may be that Graham investors just scored 20 heads in a row on a coin toss, but we'd need to scrutinise the data to work out how likely that is

However the onus is on Malkiel of course, because for his conclusion to be reasserted, his model needs to be able to answer this particular criticism

What we can't do is use Malkiel's conclusion as the default and assume doubt on anything else (the thinking of a creationist, where the 7-million-year-old dinosaur bone is clearly planted to test man's faith)


(and apologies if I've not responded to all - on a mobile so a bit awkward re: links)