Passive + active investment? Or just passive?

Thrugelmir

Linton said:

Thrugelmir said:

Linton said:

csgohan4 said:

Active funds are generally more expensive, whether they do better than passive is debatable and there will be defenders for both side, however passive will be seen as the more defensive option generally.

An extreme case of where it can go wrong is courtesy of Woodford Equity fund for the active side sadly. 

This is why it is important to do your own research. For a starter investor I would focus on passives first and certainly avoid individual stocks, the volatility alone will give you nightmares. Only do so if you money to burn and don't mind the stress

Active funds have their own place, as long as they fit your investment strategy and risk profile. The key is choosing the right one and not randomly choosing one because they top the MOrning star list

Passive funds can also go disastrously wrong. Look at IUKD over the period of the 2008 crash. 

If the mantra is don't buy UK stocks then it goes without saying they will languish.  Herd investing summed up in a nutshell. 

Sorry if it was not clear.  The lesson to be learnt is nothing to do with UK stocks. I am very much in favour of investing in UK medium/small companies.

Rather IUKD demonstrates that in some sectors blindly following an ill-conceived index can lead to as much if not more heart-ache as choosing a poor active fund. In particular going simply for highest yield without sector balancing is extremely dangerous.  Pre 2008 the highest dividend payers were frequently the banks.  The fund fell by 60% in a few months and did not recover for many years, it has barely recovered now over 10 years later.  Sadly I cant give you the figures as trustnet/charting is playing up again.

Such a fund should only be used to provide diversification to a portfolio. If dividends had been reinvested then the Total Return would apppear very differently. Only rebalancing the fund twice a year hasn't helped recently. 

JohnWinder

Thanks to all for the helpful comments.

Chickereeeee said:

Surely its easy to outperform 'the market',...The leverage ... and we all hope for a rising market otherwise we would not invest in a global tracker anyway. 

That seems a valid strategy to me, but one could execute it and cut out the middle-man IT by just buying the global tracker using some leverage. One for the youngsters with plenty of personal capital left.

Thrugelmir said:

JohnWinder said:

Can I ask what market and what sector we might want to invest in that is not covered by a decent index fund?

Why be constrained by individual indexes? Better to have a flexible investing approach.   Plenty of companies that I don't wish to invest in.  Likewise sectors at any given point of time. 

Indeed those are features of index investing: 'inflexible' with undesirable holdings. But it's like saying eating vegetables is problematic because of residual pesticides. The problems are just part of the package. We know, or think we do, that vegetables are good foods, just as the research strongly indicates that few people can, over a longer period, successfully pick the stocks and sectors they shouldn't invest in for the best risk adjusted returns. Of course, if we would choose not to invest for moral or religious reasons, that's different.

Thrugelmir said:

csgohan4 said:

Active funds are generally more expensive, 

Research costs money. Proper research is a time consuming exercise. Retail investors often prefer quick and easy. In the belief that somebody else will do the leg work for them. 

True enough, and guilty as charged. Unfortunately, most of that expensive research leads to underperformance in the long run for the large majority of professional researchers the fund managers use, the SPIVA evidence seems clear on that. Passive investors might be taking the benefit of that price discovery research, but a lot of it is surely wasted and the cost borne by other retail investors in fund fees.

NottinghamKnight said:

NottinghamKnight said:

There are sectors and geographies that will allow active management to outperform,...Smaller companies in lower value markets are an example....Trying to outperform a tracker in large us stocks will be a difficult task, small companies in emerging markets far less so. 

Less difficult probably, but achievable over a period of ....how long is our investment time frame....several decades, and we can pick in advance which manager will do it? And to be practical, how much of one's equity investments does one want in small companies in emerging markets? Doesn't seem to be a very popular sector in the financial press.

Sorry I don't understand your response.
Long term out performance using active management is more difficult than short term, many funds will out perform over a year or three years, far fewer over decades. 
If you are risk tolerant and have a very long investment horizon then large sums in small companies in emerging markets are likely to give you a far better return than an average passive world tracker.
I take little notice of the financial press and would urge others to do the same, often a very poor level of understanding and frequently influenced by advertising and sponsorship.

Sorry to have been unclear. So, we're talking about emerging market small cap stocks.

I agreed with you that it is probably easier to find the bargains in the small emerging bin than in the USA big cap space, allowing active managers to outperform a comparable index. But 'easier' to do that, or 'far less difficult' as you said, wouldn't be enough necessarily, so I looked to see if anyone had evaluated the performance of small cap emerging market active fund managers. Couldn't find any. All I found was the SPIVA report indicating that the last 15 year period in the emerging market space 94% of active funds underperformed their benchmark, and 73% of international small cap active funds did. So the jury is out on small cap emerging markets for me, but it doesn't sound promising, and I agree with you that investing there is likely to bring good returns because of the greater risk compared to global index, with the right fund (cheap-ish, etc).

You take little notice of the financial press? Smartest thing written in this thread, I'd say.

Thrugelmir said:

csgohan4 said:

 in small companies in emerging markets....will be far more volatile and riskier compared to global index trackers.

Why are global index trackers less risky?  Small companies are tomorrow's large ones. Twelve years ago Exxon was the largest market cap company in the world. Where does it stand now? 

I think we're talking about risk in terms of price volatility, standard deviation of returns or some such measure of variability.

Global trackers would be less risky I think because they are more diversified, by region, country, company size, sector probably.

13 years ago we didn't foresee the outcome Exxon had ahead of it, just as today we can't see the outcome investing in every small company in Nigeria will bring. So I don't think we can view 'riskiness' with a post hoc example like Exxon. But happy to hear some clear thinking on this.

Linton said:

Sorry if it was not clear. 
Rather IUKD demonstrates that in some sectors blindly following an ill-conceived index can lead to as much if not more heart-ache as choosing a poor active fund. In particular going simply for highest yield without sector balancing is extremely dangerous.

How very true. We pay too little attention to discussion of choosing a sensible index in all out talk of choosing a passive fund over an active one. With the popularity of index investing in recent decades have come the carpet baggers with ever more funds and new indices to capture some market share, and provide a point of difference.

The market capitalisation weighted index is a useful starting point to compare other indices with, because the theory goes: that's where and how the wisdom of the market has invested its money, so I'd be suggesting I'm smarter than the market to do otherwise. But, investing principally to get high dividends has a popular following, so you'd expect an index to pop up, allowing funds to be created to follow it - money for the index maker who licenses its use, and money for the fund managers in fees. But ill-conceived? Certainly not beyond criticism.

Alexland

JohnWinder said:
That seems a valid strategy to me, but one could execute it and cut out the middle-man IT by just buying the global tracker using some leverage. One for the youngsters with plenty of personal capital left.

When you dig into the high interest rates that ITs get lumbered with under long term borrowing arrangements there are often periods in which the leverage is making no contribution to performance. Even on new borrowing they are paying around 3% which is more than established homeowners pay. We run a modest mortgage (under 10% of assets) to provide some long term leverage to our investments - after a while the dividends on accessible accounts can provide enough cover for the debt repayments so no need to rely solely on personal capital. But then our main S&S ISAs are currently invested in an IT so we are leveraged to buy a leveraged investment that could be used to pay back the leverage...