Question to passive investors - does it really return?

talexuser

DrSyn wrote: »

You mentioned Invesco Perpetual High Income. I remember when this funds investment style was out of fashion and it lagged the FTSE in the 1990's, during the tech bubble.

A bad example if wanting to promote passive, HI soared after the tech bubble burst. I first put 6k in 1995 in a Acc Pep and it is the only fund I have never swapped out of since then. Much better return then any equivalently close tracker.

Malthusian

le_loup wrote: »

Don't ya just love comments like that?
Particularly when they go on to talk about empirical evidence!

I think you may have misunderstood what "efficient" means in the context of the economic term "efficient markets". An "efficient market" is one that instantly takes all available information into account in setting the price of the good. It has nothing to do with whether the price being paid for the good is objectively sensible or not, or whether prices are stable or not.

For illustration, consider two markets in which bushels of wheat are being sold at $5 each, one of which is in a financial centre with high-speed broadband, thousands of commodities traders and 24-hour news feeds, and the other of which is in a remote mountain kingdom where the Internet is banned and news can only come the old fashioned way, from travellers on horseback. One day there is a massive crop failure which makes wheat twice as scarce as it was before. In the city market the price of wheat will react instantly to the news - by the time anyone's read the news of the crop failure, the price of wheat will have already doubled to $10. In the remote mountain market, however, no-one's heard of the failure yet so they're still trading wheat at $5 even though the true value of the wheat is $10. The first traveller to come in from the outside may tell them the news, or he might keep it to himself and make a killing by buying all the wheat he can at $5. Eventually the news will filter through and the mountain kingdom merchants will also sell at $10, but it takes longer for the price of their wheat to adjust itself to the true value. The city centre market is very efficient whereas the remote mountain market is inefficient.

Mainstream stock markets are extremely efficient because shares are being traded thousands of times a day and the price instantly adjusts to news, sentiment or anything else that may affect it. The important thing for this discussion is that it is nonsense to say things like "I've sold off my UK holdings because I believe prices are vulnerable to the impact of Brexit" as fund managers do constantly. This doesn't make any sense. Everyone already knows that the UK may exit Europe and everyone has an opinion on what this will mean for the value of UK companies. And all their beliefs are already factored into current share prices.

To justify buying or selling UK holdings because of Brexit, the only reason that would make sense is "I've sold off my UK holdings because I know more than everyone else about the probability of Brexit and/or I know more than everyone else about what effect this will have on UK share prices - oh but by the way this special insight into the UK electorate and/or economy does not consist of anything I would be obliged to declare to the market under insider trading rules."

It's nonsense. This special insight claimed by active fund managers does not exist.

le_loup

Efficient markets theory is somewhat shot by "last fool standing", "internet bubbles", "hi-frequency trading", "insider dealing" and a myriad of activities which have nothing to do with "the market knows best".

Malthusian

You've misunderstood what efficient markets theory is. It does not claim that "the market knows best". It simply means that the market price reflects all information available to it. If that information includes, for example, "there are a million idiots who want to buy these shares for double what they're objectively worth" then an efficient market will factor that idiocy into the market price instantaneously.

bowlhead99

Malthusian wrote: »

The important thing for this discussion is that it is nonsense to say things like "I've sold off my UK holdings because I believe prices are vulnerable to the impact of Brexit" as fund managers do constantly. This doesn't make any sense. Everyone already knows that the UK may exit Europe and everyone has an opinion on what this will mean for the value of UK companies. And all their beliefs are already factored into current share prices.

To justify buying or selling UK holdings because of Brexit, the only reason that would make sense is "I've sold off my UK holdings because I know more than everyone else about the probability of Brexit and/or I know more than everyone else about what effect this will have on UK share prices - oh but by the way this special insight into the UK electorate and/or economy does not consist of anything I would be obliged to declare to the market under insider trading rules."

It's nonsense. This special insight claimed by active fund managers does not exist.

So with Brexit, everyone knows there's a referendum. The bookies have the odds as something like 2/3rds likelihood of staying in, but a real and non-zero chance of us voting to leave.

If we vote to stay in, it is pretty much business as usual and probably a small recovery from the uncertainty and reduction of economic activity that's been observed recently. If we vote out we tumble into a pit of uncertainty where everything is up in the air and unknown and markets will not like that one bit (as acknowledged by IMF, OECD and BoE etc).

As everyone knows there is a referendum with some predicted odds of it happening, people have already taken their positions, and the market has moved ahead of the event. However, it is reflecting an expectation of probably staying in (i.e. the undecideds voting for the status quo, rather than the undecideds who decide to remain not actually bothering to vote because they've heard the country will probably vote remain, which they're happy with...).

As the market is reflecting perceptions that Remain is more likely than not, the market has moved BUT has relatively smaller upside than downside. So if you keep holding the assets you might have a 2/3rd chance of gaining (say) 15% and a 1/3rd chance of losing (say) 30%. The problem is that although that means the price is probably OK where it is, according to the sum of market perceptions, the market will not stay at this price.

It is a binary decision - as, all things being equal, the outcome would either be to go back up a little to where there was no uncertainty and no potential brexit on the horizon, or it will fall by a potentially large amount.

So, if you are an active fund manager it can be quite rational to say, in respect of the most brexit-sensitive stocks, "I've sold off my UK holdings because I believe prices are vulnerable to the impact of Brexit."

The rationale - if you were willing to listen to them - might be along the lines of, "My investors can stomach the uncertainty and volatility they have experienced so far when we lost a bit - due to a *chance* of Brexit becoming baked into prices - because that's within the range of acceptable returns that all my investors signed up to... But clearly the market does not reflect post-Brexit pricing, merely the chance of post-Brexit pricing. I am not willing to hold something that would lose 30%+ in a Brexit. I will instead hold something that would be relatively less affected by a Brexit and have a small relative downside in respect of Remain but miss the large downside potential inherent in current market prices of these particular UK stocks".

Of course you would write them off as crackpots because they don't have a crystal ball so how can they know what will happen next. They don't know what will happen, just what could happen. As such they may follow their convictions that we will stay in, or they may relocate assets to avoid downside. The tracker fund will not have a choice, but it doesn't need to, as its investors already gave it a mandate to drop another 30% if the market does that, or make gains if the market does that instead.

Thrugelmir

Malthusian wrote: »

You've misunderstood what efficient markets theory is. It does not claim that "the market knows best". It simply means that the market price reflects all information available to it. If that information includes, for example, "there are a million idiots who want to buy these shares for double what they're objectively worth" then an efficient market will factor that idiocy into the market price instantaneously.

Then along comes Centrica who place 7% of the value of the Company with institutional investors. Those unfortunate enough not to be able to participate suffer an immediate dilution of their own shareholding. May be many more Companies who take this cost effective route to shore up their balance sheets. Replacing debt with equity. Rather than the more expensive option of a rights issue.

Not the last one suspects

TheTracker

le_loup wrote: »

Efficient markets theory is somewhat shot by "last fool standing", "internet bubbles", "hi-frequency trading", "insider dealing" and a myriad of activities which have nothing to do with "the market knows best".

You also must take care to understand that the mathematical certainty of passive beating active does not rely on an efficient market. It is true of a highly inefficient market, too. You can see it well explained at http://www.etf.com/sections/index-investor-corner/swedroe-8?nopaging=1

BananaRepublic

bowlhead99 wrote: »

As a criticism, this sounds like nonsense to me.
[snip]
The real question is do you want 40-50% of your fund to be concentrated in just 10-15 of the 100 companies and generally focused in oil, banks and pharmaceuticals.

I was going to say that you need to think a bit about what I said, but oddly enough you later partially explain why I said what I said. Thus if for example the banking and financial sector has started to, or is about to tank, the argument goes that an active fund can bail out, avoiding or minimising losses, whereas a tracker suffers the entire fall until the tankers exit the market. That of course is the 'spin', and whether or not in practice the active manager can preempt the market is debatable, and I doubt most can. I do recall reading an interview with one very successful manager who bailed out of a sector, and underperformed for many months, or more, to the amusement of many, until the sector tanked, and he was vindicated.

An issue with buying into companies as they enter the index is that it takes no account of why they enter and you are in a sense buying after past success. Thus a surge in financials might mean buying into some new entrants at a high price, then selling a year on when they exit at a lower price.

As you indicate, a problem with for example a FTSE 100 tracker is that you end up overweight in a small number of companies.

TheTracker

bowlhead99 wrote: »

The rationale - if you were willing to listen to them - might be along the lines of, "My investors can stomach the uncertainty and volatility they have experienced so far when we lost a bit - due to a *chance* of Brexit becoming baked into prices - because that's within the range of acceptable returns that all my investors signed up to... But clearly the market does not reflect post-Brexit pricing, merely the chance of post-Brexit pricing. I am not willing to hold something that would lose 30%+ in a Brexit. I will instead hold something that would be relatively less affected by a Brexit and have a small relative downside in respect of Remain but miss the large downside potential inherent in current market prices of these particular UK stocks".

Of course you would write them off as crackpots because they don't have a crystal ball so how can they know what will happen next. They don't know what will happen, just what could happen. As such they may follow their convictions that we will stay in, or they may relocate assets to avoid downside. The tracker fund will not have a choice, but it doesn't need to, as its investors already gave it a mandate to drop another 30% if the market does that, or make gains if the market does that instead.

The problem with this hypothesis is that you must test the reverse.

If the said fund manager is so confident that the upside and downside risk do not match the current price that he will exit a position, as essentially you are hypothesising, then he must also have the confidence that, given an efficient vehicle to do so, his real opportunity is to short the stock. The march from short to long is a continuum, and there is only a small friction at the zero point. Thus the market sets prices based on real expectations. I recall you talking about bookies odds previously in a similar manner.

Thrugelmir

BananaRepublic wrote: »

Thus if for example the banking and financial sector has started to, or is about to tank, the argument goes that an active fund can bail out, avoiding or minimising losses, whereas a tracker suffers the entire fall until the tankers exit the market.

Off loading large shareholdings is very difficult. As requires matching buyers. Placing large lines of stock is often conducted at deep discounts to quoted prices.