100% Equity vs Equity/Bond

jdw2000

jamesd wrote: »

Nice try at dodging. You asserted that "Actives also incur trading charges" as if passives don't. I asserted that passives do pay trading charges. Do you agree that passives do also pay trading charges?

Perhaps you'd think that a passive fund holding 500 shares will inherently have lower trading costs than an active fund with 25, even though there are twenty times as may deals to do for the passive one just to get the money invested?

Cost of holding a fund (not just the OCF) depends on the particular fund and distribution channel. It's entirely possible to have an active fund with a lower total holding cost than a passive fund. Say compare the Virgin FTSE tracker at 1% including platform cost with a balanced managed fund for say 0.4% in a biggish workplace pension. Or hold a tracker with 0.1% OCF at a place with a 0.45% platform charge, like HL.

I can't speak for other investors, but I won't be trading as I have VLS. So good luck getting lower trading charges than me.

jamesd

jdw2000 wrote: »

I can't speak for other investors, but I won't be trading as I have VLS. So good luck getting lower trading charges than me.

Was that supposed to be a joke or were you serious?

jdw2000

jamesd wrote: »

Was that supposed to be a joke or were you serious?

I was serious.

bowlhead99

jdw2000 wrote: »

I was serious.

So, you do your one trade to buy your VLS fund with your £100. VLS pools your £100 with thousands of other net cash inflows on that day. It doesn't want to keep the £100k in cash because that's a drag on performance and will lead to tracking error which will stop people using it as their passive fund of choice.

So it has to deploy that £100k into investee company shares and bonds and government bonds. Via VLS's investee funds, the £100k has to get split 5000 ways. That's £20 per investment, except Apple wants £30 and some of the others only want fractions of a penny.

Is that more efficient than what happens in an active fund running with a cash buffer doing its trades a couple of times a month? Yet the passive investing fans will tell you that active funds incur more broker commissions through "churn" because they sell 50% of the portfolio each year. Yet 50% of 50 companies is still only selling 25 companies and buying 25 others, plus a few more trades to use up ad hoc new subscriptions.

StellaN

Linton wrote: »

Looks sensible overall to me.

A strategic Bond Fund will adjust the bonds in which it invests in line with its assessment of market conditions. So it could be argued that there isnt a lot of point in you changing its allocation by adding two specific bond funds. On the other hand the AXA fund seem to be relatively highly invested in Gilts which may not be the best investment at the moment.

Point taken Linton and thank you for your input. I take your view on the additional bonds however I just thought it might be best to spread the bonds over a few funds? I will look into the Gilts fund so thanks for that.

I am a little surprised not to have received any feedback from other posters in fact this thread has turned into more of a passive/active discussion. That's not a criticism trust me it's purely an observation and I must admit a little selfish on my part because I'm seeking a range of opinions?

Thank you all again.

grey_gym_sock

jamesd wrote: »

The Monevator case ignores the real world where what will be bought and sold by trackers can be predicted and front run by active investors.

and as i've explained, that's barely significant if you're using the most straightforward passive funds.

and i see that vanguard have recently launched a fund tracking the FTSE global all-cap index - see https://www.vanguard.co.uk/adviser/investments/product.html#/fundDetail/mf/portId=8617/assetCode=equity/?overview - that fund covers "large, mid-sized and small company stocks in developed and emerging markets"; it uses sampling, currently holding 4,307 shares, compared to 7,703 in the index. you could hold that as your entire exposure to equities, and then there would be absolutely no issue with front running.

grey_gym_sock

StellaN wrote: »

I am a little surprised not to have received any feedback from other posters in fact this thread has turned into more of a passive/active discussion. That's not a criticism trust me it's purely an observation and I must admit a little selfish on my part because I'm seeking a range of opinions?

there's nothing particularly wrong with your selection of bond funds, IMHO.

though one could argue that you should either trust the manager of a strategic bond fund to allocate across the different types of bonds, and so just use a strategic bond fund; or alternatively, not use a strategic bond fund at all, and hold a bond fund for each type of bonds - which might mean: 1 for gilts, 1 for (investment grade) corporate bonds, 1 for high-yield bonds. (you could also add global bonds, though it's debatable how worthwhile that is.)

grey_gym_sock

bowlhead99 wrote: »

So, you do your one trade to buy your VLS fund with your £100. VLS pools your £100 with thousands of other net cash inflows on that day. It doesn't want to keep the £100k in cash because that's a drag on performance and will lead to tracking error which will stop people using it as their passive fund of choice.

So it has to deploy that £100k into investee company shares and bonds and government bonds. Via VLS's investee funds, the £100k has to get split 5000 ways. That's £20 per investment, except Apple wants £30 and some of the others only want fractions of a penny.

is this meant as a challenge to jdw2000's knowledge of how passive funds work? rather than being based on how you actually think they work. it could easily be misleading to some people.

i've read that vanguard use futures contracts so that their funds can obtain the returns from odd bits of cash that haven't been invested yet (that they would have obtained if it had been fully invested).

although i haven't read this, i think it's pretty obvious that, when they do buy actual shares for cash, they will use sampling. so even if the fund holds 5000 different shares, they don't have to top up all of the 5000. they might buy all of the biggest few companies, and for the rest a selection, using a representative sample across countries, industry sectors and company sizes.

the record suggests that competent managers of passive funds (such as vanguard) can clearly do all this at minimal cost, and track an index to a very high degree of accuracy.

Is that more efficient than what happens in an active fund running with a cash buffer doing its trades a couple of times a month? Yet the passive investing fans will tell you that active funds incur more broker commissions through "churn" because they sell 50% of the portfolio each year. Yet 50% of 50 companies is still only selling 25 companies and buying 25 others, plus a few more trades to use up ad hoc new subscriptions.

compared to a sensibly run passive fund, an active fund has no obvious advantage when deploying new money. wanting to buy a smaller number of shares may make the dealing commissions fractionally lower. but they may lose more than that from the market impact of their purchases - i.e. if the manager wants to buy a lot of shares in a company, the price will go up as a result. so it's not obvious (at least to me) whether active or passive funds incur higher costs deploying new money.

where active funds have a huge cost disadvantage is with the costs of voluntary buying and selling (i.e. when the manager chooses to change the portfolio).

many funds seem to have a portfolio turnover of c. 100% per year.

funds are also allowed to pay inflated dealing commissions ("soft commissions") in return for kick-backs to the fund management company. so part of the dealing commissions are disguised management charges (not included in the OCF).

the market impact of large purchases and sales is also significant factor when changing the portfolio.

overall, passive funds have a major advantage over active funds in trading costs. but i suspect you knew that, and were just testing jdw?

grey_gym_sock

Linton wrote: »

Also, only about 11% of the UK market is owned by UK OEICs, UTs and ITs, and a much smaller % of the world market. So the truism that returns are split evenly either side of the average for the whole market doesn't preclude the the split being rather different if one just looks at retail funds. For example the % of the UK market held by private direct U.K. Investors is slightly higher than 11%, so It is possible that private direct investors generally underperform whereas the professionals overall don't.

yes, it's possible.

and in fact, it's true that active funds outperform ... before charges. but not after charges, which is what matters.

see this - https://henrytapper.com/2016/11/28/michael-johnson-80-of-fund-management-industry-is-redundant/ - discussion of the FCA's recent interim Asset Management Market Study.

it says: "active funds for sale in the UK, on average, outperformed benchmarks before charges were deducted, but underperformed benchmarks after charges on an annualised basis by around 60 basis points"

of course, not all - or even most - of the other 89% of the UK market is held by private investors. some is held by passive vehicles. some is held in active institutional products, which (according to the same report) did a bit better than active retail funds, outperforming benchmarks before charges, but about level with benchmarks after charges.

but that's just the average active manager. can't you pick the better one?

well, good luck. from the same source:

"In the third quarter of 2016, of 1,137 funds, only 28 consistently produced top quartile returns (i.e. 2.5%). Using blind luck, one would expect 18 funds to achieve this, which leaves only 10 fund managers, 0.9% of a universe of 1,137, who could legitimately claim that their success was down to skill."

bowlhead99

grey_gym_sock wrote: »

compared to a sensibly run passive fund, an active fund has no obvious advantage when deploying new money. wanting to buy a smaller number of shares may make the dealing commissions fractionally lower. but they may lose more than that from the market impact of their purchases - i.e. if the manager wants to buy a lot of shares in a company, the price will go up as a result. so it's not obvious (at least to me) whether active or passive funds incur higher costs deploying new money.

where active funds have a huge cost disadvantage is with the costs of voluntary buying and selling (i.e. when the manager chooses to change the portfolio)

An active fund does generally have an advantage when dealing with ongoing subscriptions and redemptions, on the basis that they will have particular shares that are on their watchlist to buy or add, or others that they are happy to reduce, so when there is cash which needs to be deployed or needs to be cashed out, they have that ability to deal in fewer stocks as they move their portfolio to where they want to get it. They are not trying to buy so many separate stocks and keep the absolute fixed ratios (give or take sampling error) that the passive funds do.

You are right that a Vanguard tracker might put their pending new money into a total return swap or similar derivatives to avoid cash drag - just as an active fund might - but at some point they will be net buying new stocks or net disposing of stocks across the board, because they have a broad portfolio to deal with. While, the active fund is buying - or selling - but doing it more selectively ; any of its deployment of new money in an active fund goes towards the objectives, reducing the 'huge' cost of voluntary buying and selling of which you speak. When you get to the quarter end and the manager says he added company x and reduced company y, quite a bit of this can come from the inflows and outflows process.

You are right that there are implicit costs of doing buys or sell and these can include market impact and spread in addition to the explicit stuff like broker and custodian fee for the transaction. Those implicit costs are of course seen when you look at the total performance for the year rather than seeing them in the OCF, but they are still a hurdle to meet when a manager decides he wants to buy an asset and later exit the asset. Nobody is doubting that these exist.

However when a 5 billion dollar 'passive' fund of funds takes in 1 billion dollars of new investor capital in a year, and services 1.1 billion dollars of redemptions a year later, their fund has incurred the 'cost' of spread and broker fees of investing a billion dollars and selling over a billion dollars, just like an active fund. It's 20% turnover.

If the active fund has 30% turnover (more than the 15-20% reported by groups like Woodford and Fundsmith) he does more trading than that 20% of the passive fund, and timing factors can stop it being efficient (it doesn't all come from subs and reds), so he may well be doing twice as much trading volume. But of course twice as much trading volume doesn't always make for twice as much cost, as the brokers and custodians will give cost break on larger volumes for larger quantities, and some of the costs which are 'cheekily' bundled into the brokerage costs (like research / market data) can have a relatively fixed cost base, which does not result in a linear fee model.

I'm not trying to deny that active funds incur costs, if they have a highly changeable portfolio. Of course they do, and anecdotally it might cost a quarter to a half percent a year. However: if I am an "Active" manager (not physically active buying and selling daily, just using the definition of anyone who is not holding the cap-weighted index), I can buy a non cap-weighted ratio of Apple to Samsung and hold that for years. The index chose a cap-weighted ratio. That does not necessarily make it cheaper for the index manager to buy in or sell out either end of the multi-year hold, or to deal with his subscriptions and redemptions along the way.

overall, passive funds have a major advantage over active funds in trading costs. but i suspect you knew that, and were just testing jdw?

It's nothing personal. New investors get better faster when they get a grilling

The point was really, that JDW was boasting that he is getting better trading costs than everybody else because he is in a passive fund and never trades. But that is perhaps just the fact that he does not trade himself and has that heard passive holdings have low costs (buy-and-hold the index except for when it changes) so has not scrutinised it. The VLS80 fund was £600m at its last year end in March. During the year to that point it had done £260m of purchases and £60m of sales of the underlying funds to take care of the £200m of new money coming in. That's plenty of buying and selling. As it gets bigger it gets more efficient. But if we go back a couple of years, in 2014 when they were smaller they claimed 0.25% transaction costs (source: long-form annual accounts). Woodford's equity income fund claimed 0.09% last year.

many funds seem to have a portfolio turnover of c. 100% per year.

Many don't though. Perhaps more like 50-70% as an average which has been dragged up by some of the wild funds that are several multiples of that. Just because an 'active' fund is focussing on holdings that exhibit certain characteristics not found in an index, doesn't mean he wants a high turnover. Some managers hold the same company for years.

funds are also allowed to pay inflated dealing commissions ("soft commissions") in return for kick-backs to the fund management company. so part of the dealing commissions are disguised management charges (not included in the OCF).

Things like including research costs in the service offered to the manager and then bundling into dealing commissions, certainly frustrates the drive for transparency. I would prefer to see those in the OCF. However, I don't buy by OCF alone. The net return after the transaction costs and the OCF is what they are getting judged on at the end of the day.