The switch from my OEIC portfolio to my ETF one - one year on

Linton

Why should one be worried about exchange rates? Provided one has a highly globally diversified portfolio both geographically and in currency terms with ongoing re-balancing there may be individual winners and losers but unless the £ soars above everything else currency variation shouldnt be a major problem.

If the £ soaring is seen as a real risk you will need hedging at the portfolio level - many £ investments may actually follow global $ trends as we saw in the post BREXIT vote price gains.

aberlyfid_2000

exactly! if the goal is to have a diversified currency exposure, hedged products would run contrary to this and cancel out the diversification.

ivormonee

jamesd wrote: »

On average passive US funds investing in the US beat the average of actives. Same for global, which is around 55% US. For all other equities active on average beat passive on average, often substantially.

So if you, as a UK investor, follow the evidence applicable to UK investors you'll end up with the sort of thing I have: trackers for US large-cap and global large-cap equities, active for other equities.

On the other hand, if you become a US resident investor, pay careful attention to Mr. Bogle, because you're then investing from and probably largely within the area where 100% of trackers is the best choice.

So what you are saying is that, if you are USA resident, you will be better off constructing your entire portfolio from a mix of index trackers and that if you are a UK resident you should only use index trackers for the US large-cap and global large-cap equity components of your portfolio and go active for everything else.

So let's take two separate investors putting together their portfolios; one lives in America and the other in the UK. They both wish to have an exposure to, say European equities. According to your summation, the investor living in the US should use a tracker for this exposure but the investor in the UK should use an actively managed fund for the same exposure.

The inference from this is that UK managers of actively managed funds have adequate skill to be able to beat their respective index in European equities whereas their counterparts in the US do not. In other words, UK fund managers are better than US fund managers. I don't know if this is true but it feels that it would be very unlikely.

I have not come across any such findings previously and wonder what evidence you have come across to give you this perspective.

firestone

ivormonee wrote: »

So what you are saying is that, if you are USA resident, you will be better off constructing your entire portfolio from a mix of index trackers and that if you are a UK resident you should only use index trackers for the US large-cap and global large-cap equity components of your portfolio and go active for everything else.

So let's take two separate investors putting together their portfolios; one lives in America and the other in the UK. They both wish to have an exposure to, say European equities. According to your summation, the investor living in the US should use a tracker for this exposure but the investor in the UK should use an actively managed fund for the same exposure.

The inference from this is that UK managers of actively managed funds have adequate skill to be able to beat their respective index in European equities whereas their counterparts in the US do not. In other words, UK fund managers are better than US fund managers. I don't know if this is true but it feels that it would be very unlikely.

I have not come across any such findings previously and wonder what evidence you have come across to give you this perspective.

normally the financial papers/websites etc suggest that a tracker works best for the most efficient markets of which America is used as the best example as its said opportunities are harder to find so that over the years active managers find it hard to beat the index.While say an EM or India etc may have more potential for the active manager & not be forced into buying the whole market.There are features on Trustnet and others over the years as to this thinking but don't think it means the investor in America need only buy trackers

Linton

One reason (or example) for the US being different may be the high valuations of the major tech companies which have risen rapidly from very small beginings to become the largest members of the S&P 500. US indexes and trackers hence contain a comparatively large % of innovative companies.

The UK is very different. Once a dynamic startup gets to a reasonable size it is bought out by a larger company. The effect is that the FTSE100 appears to be populated to a great extent by large companies that have survived because no-one wants to buy them and so it has been about the worst performing of the world's major indexes for the past 10 years or more. It is easy for a fund to beat the FTSE100 (or FTSE All Share), - just invest more in smaller companies. The nature of Small Companies makes it generally unsuitable for trackers. Market Cap weighting doesnt make much sense and it pays to ignore those companies that the basic fundamentals tell you arent going anywhere.

Looking at the data there seems to be a similar effect in Japan and to a lesser extent in Europe. Whether this is due to the same cause I dont know.

A related observation - the average Small Company fund beats the Small Companies indexes in the UK, Europe, and Japan. It underperforms the SC index in the US.

bowlhead99

aberlyfid_2000 wrote: »

I admit it, i am confused by them

Ok, so don't use them, but you don't need to tell us all that they are bad products because you are personally confused by them or find them inaccurate or you are self defeated by them. Others are using them happily.

You mentioned that many funds or sub funds use them and I pointed out that it's relatively few. You said it was more common than I think, but it isn't. I'm familiar with the various products on offer and it's relatively easy to avoid them if you don't want them or seek them out if you do. When you are doing your due diligence to select your fund(s) of choice you will presumably read the factsheet, kiid and prospectus and you will see how they plan to operate the fund. You can then decide to buy a hedge fund or a non hedged one.

If i am concerned about FX risks, i will hedge it, myself, on a portfolio level. Mixing and matching hedged and non hedged products only confuses the situation.

I would agree it may confuse things if you are building a bespoke portfolio and implementing your own portfolio level hedging, which a majority of retail investors do not do. If they do do, presumably they will read the prospectus to see what is already being hedged, and if something is hedged that they don't want to be hedged, they will either apply some extra jiggery-pokery at portfolio level to reverse out the estimated effect of the hedge, or - more sensibly- not use the product in the first place.

you obtained the "desired" results by being lucky this year - what happened the year before when GBP fell?

Presumably that year he either:

- wasn't hedged because he was happy with GBP's strength vs yen, dollar etc (which was a different relative strength than at the start of this year); or

- was hedged but happy to take the result of hedging even if it was worse than the raw return because that was what he "desired" having considered the options in the market and the potential risks.

You can see from Jamesd's post history that he has plenty of experience of forming a view on what he wants, researching it to understand options available, and buying it.

ivormonee wrote: »

So what you are saying is that, if you are USA resident, you will be better off constructing your entire portfolio from a mix of index trackers...

If you are US-based, then, assuming you want a bit of domestic bias overlaid onto available global investment opportunities (which are inherently US-centric anyhow, US being the largest accessible public and private equity and debt markets in the world), a few things will be the case:

a) a large proportion of your investments (compared to those of more internationalised investors) will be into US markets

b) those markets are diversified and highly developed /efficient meaning you can access to a nice broad portfolio through an index which individual market participants find hard to consistently or significantly beat, after fees.

c) the tax legislation where you live will favour - for both your domestic and international investing - the use of cap-weighted index funds because such funds have relatively few disposals and acquisitions of underlying investments, with only a few holdings changing around the periphery at the time of quarterly index promotions/demotions. By contrast, the more active funds will make disposals triggering short term or long term capital gains for tax purposes which are taxable on you the investor in the year they are crystallised within the fund, even if you have not bought or sold any units in the fund during the period. Short term gains are taxed at your highest marginal income tax rate. That's a big negative for using a fund which takes opportunistic positions and trades holdings to try to eke out higher returns.

By contrast...

...and that if you are a UK resident you should only use index trackers for the US large-cap and global large-cap equity components of your portfolio and go active for everything else.

For the UK investor, again presuming a bit of 'home bias' is rational, you will have a less US-centric portfolio. Then when you look at how to build the components in it:

1) it can still make sense to use index trackers for US large cap and global large cap equities, for the same reason as b) above.

2) but using an index tracker for your home country exposure (ie UK FTSE all-share, principally composed of FTSE100) gives a very unbalanced set of industries, eg high oil, big pharma, banks etc, but very little tech, car manufacturers etc, which is poor investing. UK and European markets have observed relatively better performance by active funds, smaller companies etc.

3) the advantage of index funds for US-based investors granted by IRS, in terms of reduced gains tax through lack of churn in underlying investment portfolio, does not exist here. The UK investor pays tax when they eventually cash out of the fund and HMRC doesn't seek to tax you when your "mutual fund" makes a gain on flipping out Tesco to buy more Sainsbury.

So let's take two separate investors putting together their portfolios; one lives in America and the other in the UK. They both wish to have an exposure to, say European equities. According to your summation, the investor living in the US should use a tracker for this exposure but the investor in the UK should use an actively managed fund for the same exposure.

Say the tracker fund manager guy buys and holds the index each year and gets 4.8% return after fees. The active fund manager guy flips the whole portfolio once every single year and charges more fees but still gets 5.0% after fees.

In the US, the investor in the active fund pays his 20% tax on the 5% in-year capital gains and is left with 4% return. After that 4% return compounds up for a decade, he has 1.04^10 =1.48, or 48% return.

Meanwhile the US investor in the passive fund which doesn't realise a gain from year to year will not have any in year taxes to pay and will get the 1.048^10 which is 1.60. Then pays his 20% tax on the 60 and is left with 48% return.

So for that US investor he ends up in the same place whichever fund he uses and given the passive fund had lower fees, might as well just use that in the hope that it's consistent even though the headline return of 4.8% a year is worse than the headline rate of what the active fund offered.

In the UK it's different. We can buy the higher performing 5% fund, pay no tax from year to year, and turn the pot into 1.05^10 = 1.63, then pay our 20% tax on selling out of the fund, and be left with 1.50. So we get 1.50 instead of 1.48 by going active instead of passive. We get to keep our high gains from going active, but the US investor would not.

That example has a fake tax rate. Really in the US, the short term capital gains tax rate is higher than that, and they don't have the same high £20k allowance for ISA (Roth IRA) or £40k allowance for pension (401-k) so they do more unwrapped investing.

The inference from this is that UK managers of actively managed funds have adequate skill to be able to beat their respective index in European equities whereas their counterparts in the US do not. In other words, UK fund managers are better than US fund managers. I don't know if this is true but it feels that it would be very unlikely.

We might like to think 'our' UK active fund managers are better at investing into Europe than the US active fund managers because Brits are physically closer to Europe and understand foreigners and overseas equities...while the Mericans are further away and more inward looking as a society. That's probably just xenophobia and in reality, US managers have had many years of practice of making international equity investments.

However, it's true that they are hampered by the IRS tax treatment of mutual funds. And also, while there are lots of cheap brokers in the US for people wanting to self manage their portfolio, people appointing wealth managers /FAs in the US may pay high rates of commissions. Here, following our Retail Distribution Review and Platform Review, commission for both the platforms and the advisors are banned. If you are not already paying high commissions you will take a lot of notice of the mutual fund management fee. In the US you may not notice it as much or there can be people telling you it's worth paying as they get commission from it... and only the likes of rival passive providers and their (albeit very vocal) fans shouting that it isn't.

So in USA you might find a fund to invest in somewhere 'exotic' like Europe, using active techniques, might have a high management fee. Whereas over here Europe doesn't sound very far off and exotic and foreign so we might pay a lower OCF The difference is exacerbated by the fact that in the US there are some really really cheap OCFs on their index funds due to more economies of scale than is typical over here.

jamesd

aberlyfid_2000 wrote: »

you obtained the "desired" results by being lucky this year - what happened the year before when GBP fell?

I held unhedged trackers and made a profit. I wasn't purely lucky with hedging in one year, I took a carefully considered view about whether I wanted to be hedged or not and invested accordingly. Then I was fortunate that my protection delivered what I bought it for instead of being just a small extra cost. The hedge was cheap vs what it was protecting against.

I also have lots of unhedged currency exposure, though most of that isn't using trackers.

For tracker fans this should be illustrating that what you choose to track - a hedged or unhedged index - is itself an active management choice, even though the implementation used passives.

jamesd

ivormonee wrote: »

So what you are saying is that, if you are USA resident, you will be better off constructing your entire portfolio from a mix of index trackers and that if you are a UK resident you should only use index trackers for the US large-cap and global large-cap equity components of your portfolio and go active for everything else.

For UK investors today, yes. Subject to change in the future and with an important caveat:

You need to pay attention to changes of human manager. If you won't do that, even as a UK investor, use trackers. Too much of the performance is human manager dependent for it to be sensible to use actives without paying attention. So I tell those who don't want to pay attention to use passives.

To illustrate, many years ago here I looked at and posted the persistence of results of UK global growth sector top ten active funds. In every case the outperformance persisted unless the human manager changed. That produced a usually significant drop. Just about all academic studies ignore changes in human manager, meaning "management firm" not "humans" when they write about manager changes.

So don't gamble on a new manager, switch to another established team or passive until you see whether the change works well. The odds don't favor sticking and you don't need to take the risk.

ivormonee wrote: »

The inference from this is that UK managers of actively managed funds have adequate skill to be able to beat their respective index in European equities whereas their counterparts in the US do not. In other words, UK fund managers are better than US fund managers.

It's performance net of fees and tax effects also matter. US costs are different and the US has a higher capital gains tax on sales within a year on holdings inside a fund that we don't have. In the UK you don't even have to think about reporting trades within a fund in your tax return because you only have to do it when you sell the fund and for the fund as a whole. Also different regulation-related costs. UK humans aren't inherently better or worse, just a different environment.

Also remember the peril of averages. It's not had to find trackers costing 1% or 1.5%. Particularly in a workplace pension scheme that might be the least bad choice available. Any active managed funds available might also not be the best ones. That FCA study used averages and you don't have to pick the average cost and tracking error tracker any more than you have to pick an average active.

ivormonee wrote: »

I have not come across any such findings previously and wonder what evidence you have come across to give you this perspective.

As well as the recent FCA results there was a US study some years back that looked at performance for NY residents. The actives beat the passives before tax but lost after tax.

You probably didn't know it but tax is part of why ETFs grew in the US. They were designed with a structure that removed a lot of the US tax aggravations. Can still be useful here, but without that particular benefit.

aberlyfid_2000

jamesd wrote: »

I held unhedged trackers and made a profit. I wasn't purely lucky with hedging in one year, I took a carefully considered view about whether I wanted to be hedged or not and invested accordingly. Then I was fortunate that my protection delivered what I bought it for instead of being just a small extra cost. The hedge was cheap vs what it was protecting against.

I also have lots of unhedged currency exposure, though most of that isn't using trackers.

For tracker fans this should be illustrating that what you choose to track - a hedged or unhedged index - is itself an active management choice, even though the implementation used passives.

fully agreed, and well done on this!

Bowlhead - w.r.t the prevelance of hedged products : if you consult your experience, you may find that around 1 in 3 fixed income funds will hedge out GBP exposure. If not, take a closer at their KIIDs, factsheets and prospectii.

jamesd

aberlyfid_2000 wrote: »

fully agreed, and well done on this!

I'm far from perfect, though:

1. I had a high for me cash weighting around brexit vote time. Expensive, but it delivered the protection from extreme events, which didn't happen, that it was for. By far my most expensive recent choice.

2. I normally have close to 100% equities but now I have a steadily increasing P2P fixed interest positioning that I expect to be over 50% by summer 2018. Will equity markets rise enough that any fall, whenever it happens, does less well than the fixed interest? Time will tell. (shrug) I know why I made the choice and am happy with it but only hindsight will tell whether I could have done better.

3. For equities I tend to have very high small cap weightings and also have and have had lots of Europe including heavy small cap weight. Has worked well but small caps aren't where you want to be in a big drop or very late in an economic cycle. Will I adjust enough in time? We'll see.