Timing the market

BritishInvestor

Linton said:

BritishInvestor said:

Linton said:

BritishInvestor said:

MarkCarnage said:

Deleted_User said:

JohnWinder said:

There has been various work showing that in practice owning a relatively small number of stocks (up to 30 or at most 50) will provide c90% of diversification benefit....however that is only against that particular universe benchmark within equities.

I'd be interested to see that research, firstly to learn how one quantifies the benefit of diversification but also to see how it stacks up against Bernstein's assertion that 50 stocks just doesn't cut it (unquantified). http://www.efficientfrontier.com/ef/900/15st.htm

It all comes down to stock pickers figuring out the optimum portfolio size and a lot of assumptions.  Managing a 50 stock portfolio is tough. The whole thing is mute now with ETFs giving you the whole world for the price of a few basis points. 

But even if its just 30 stocks, modern stock pickers would try to cover key sectors. 

Managing a 50 stock portfolio is tough, but probably less tough than managing a 200 stock portfolio if you know your holdings well. Most successful active managers run fairly concentrated portfolios, have low turnover and relatively long holding periods, and accept that there will be times when their performance is very different from the market. If you want passive, I agree that you can get that very cheaply now even on a global basis. I think it's moot not mute you mean though.....:) 
Not all stock pickers will attempt to cover 'key' sectors. If they fundamentally don't like them they won't hold them is my experience of several successful managers. 

"Most successful active managers"

I wasn't aware that there were many - Peter Lynch was definitely one. Have there been any since?

Define "successful".  Basing it on alpha is not very meaningful when a fund is not competing with an index.  Woodford was an extremely successful fund manager in his Invesco days as he stuck to his remit despite the attractions of the market.

I would define a successful fund manager as one whose fund meets its stated objectives.  How it performs aganst an index is irrelevent unless that is included in the objectives.

If you can , why would you pay the additional expense (and potential style drift risk) of an active fund manager?

And if you cant replicate a fund manager's style using cheaply available factor funds? How on earth do you encapsulate a style into relative proprtions of Momentum, Value, Size etc?  Does it make best sense to buy one active fund that meets your objectives or 6 passive funds whose relative proportions requires calibration? The latter surely is active management, and an extremely inefficient way of doing it.


However "style" is not the main issue, but rather meeting requirements.  The range of passive index funds available to UK investors is too limited to do anything much more complicated than a long term global investment with a 20 year time frame.  There are many things that one may wish to do for which the basic tools are not available.

It would be useful to see an example of a requirement that isn't met by passive funds. I'm not saying there aren't any, just thinking what in particular you had in mind. 

Regarding the split of styles, it comes back to the reply I just made and understanding why you'd want to potentially incorporate those styles in the first place. 

Prism

BritishInvestor said:

Prism said:

BritishInvestor said:

Linton said:

BritishInvestor said:

MarkCarnage said:

Deleted_User said:

JohnWinder said:

There has been various work showing that in practice owning a relatively small number of stocks (up to 30 or at most 50) will provide c90% of diversification benefit....however that is only against that particular universe benchmark within equities.

I'd be interested to see that research, firstly to learn how one quantifies the benefit of diversification but also to see how it stacks up against Bernstein's assertion that 50 stocks just doesn't cut it (unquantified). http://www.efficientfrontier.com/ef/900/15st.htm

It all comes down to stock pickers figuring out the optimum portfolio size and a lot of assumptions.  Managing a 50 stock portfolio is tough. The whole thing is mute now with ETFs giving you the whole world for the price of a few basis points. 

But even if its just 30 stocks, modern stock pickers would try to cover key sectors. 

Managing a 50 stock portfolio is tough, but probably less tough than managing a 200 stock portfolio if you know your holdings well. Most successful active managers run fairly concentrated portfolios, have low turnover and relatively long holding periods, and accept that there will be times when their performance is very different from the market. If you want passive, I agree that you can get that very cheaply now even on a global basis. I think it's moot not mute you mean though.....:) 
Not all stock pickers will attempt to cover 'key' sectors. If they fundamentally don't like them they won't hold them is my experience of several successful managers. 

"Most successful active managers"

I wasn't aware that there were many - Peter Lynch was definitely one. Have there been any since?

Define "successful".  Basing it on alpha is not very meaningful when a fund is not competing with an index.  Woodford was an extremely successful fund manager in his Invesco days as he stuck to his remit despite the attractions of the market.

I would define a successful fund manager as one whose fund meets its stated objectives.  How it performs aganst an index is irrelevent unless that is included in the objectives.

If you can replicate a fund manager's style using cheaply available factor funds, why would you pay the additional expense (and potential style drift risk) of an active fund manager?

I have certainly thought about that and decided in most cases its too difficult and the results wouldn't be accurate. For example to replicate Fundsmith you could split between

Healthcare medical devices - no pharma or insurance
Technology software - no hardware or telecoms
Consumer staples
Consumer disc - luxury brands only

Or for a macro based multi asset like Capital Gearing Trust, which does use passive funds, you would need to be agile and know when to move in and out of various markets, gold, property and bond types.

For smaller companies you would need to do significant research at the company level - besides, passive index funds are not available for small companies.

I think the first question is "why would I want to replicate a fund manager's style?" History has shown us that small-cap value has outperformed (outperform obviously means different things to different people), so you'd think a rational investor (on the assumption that factor timing isn't possible) would tilt to these factors over the long term assuming he didn't want to take "boring" broad market exposure.

Fundsmith is not a small-cap value investor, so using the above reasoning, I'm not sure why his style would be appealing over the long term.


"For smaller companies you would need to do significant research at the company level - besides, passive index funds are not available for small companies."

Depends how small, but there are funds that follow MSCI World Small Cap Index. But again I would question what a small cap tilt alone would bring (in the absence of a tilt to value/quality etc). 

Small caps certainly do seem to outperform over the long term but not always over the shorter term. The same with value investing which can work until it doesn't. Investing in both seems like a reasonable compromise. However small caps and value investing are both more volatile which I rate up there with pure performance. If someone really doesn't care about volatility then they should go fully for micro caps and private equity - but of course most people do care about such things.

Something like Fundsmith is not just for the long term. Its about crash protection, at least in theory.

MCSI World cap is a bit difficult to place. It includes companies which are over $50bn in size which is a bit of a stretch for anyone I imagine to think of as small. Small cap to me is less than £1bn, especially value which by its nature should be underpriced and even cheaper. I have never seen a passive index fund at that size. The closest seems to be Dimensional but I'm not sure that is really passive, although its pretty low cost.

Thrugelmir

Prism said:

BritishInvestor said:

Prism said:

BritishInvestor said:

Linton said:

BritishInvestor said:

MarkCarnage said:

Deleted_User said:

JohnWinder said:

There has been various work showing that in practice owning a relatively small number of stocks (up to 30 or at most 50) will provide c90% of diversification benefit....however that is only against that particular universe benchmark within equities.

I'd be interested to see that research, firstly to learn how one quantifies the benefit of diversification but also to see how it stacks up against Bernstein's assertion that 50 stocks just doesn't cut it (unquantified). http://www.efficientfrontier.com/ef/900/15st.htm

It all comes down to stock pickers figuring out the optimum portfolio size and a lot of assumptions.  Managing a 50 stock portfolio is tough. The whole thing is mute now with ETFs giving you the whole world for the price of a few basis points. 

But even if its just 30 stocks, modern stock pickers would try to cover key sectors. 

Managing a 50 stock portfolio is tough, but probably less tough than managing a 200 stock portfolio if you know your holdings well. Most successful active managers run fairly concentrated portfolios, have low turnover and relatively long holding periods, and accept that there will be times when their performance is very different from the market. If you want passive, I agree that you can get that very cheaply now even on a global basis. I think it's moot not mute you mean though.....:) 
Not all stock pickers will attempt to cover 'key' sectors. If they fundamentally don't like them they won't hold them is my experience of several successful managers. 

"Most successful active managers"

I wasn't aware that there were many - Peter Lynch was definitely one. Have there been any since?

Define "successful".  Basing it on alpha is not very meaningful when a fund is not competing with an index.  Woodford was an extremely successful fund manager in his Invesco days as he stuck to his remit despite the attractions of the market.

I would define a successful fund manager as one whose fund meets its stated objectives.  How it performs aganst an index is irrelevent unless that is included in the objectives.

If you can replicate a fund manager's style using cheaply available factor funds, why would you pay the additional expense (and potential style drift risk) of an active fund manager?

I have certainly thought about that and decided in most cases its too difficult and the results wouldn't be accurate. For example to replicate Fundsmith you could split between

Healthcare medical devices - no pharma or insurance
Technology software - no hardware or telecoms
Consumer staples
Consumer disc - luxury brands only

Or for a macro based multi asset like Capital Gearing Trust, which does use passive funds, you would need to be agile and know when to move in and out of various markets, gold, property and bond types.

For smaller companies you would need to do significant research at the company level - besides, passive index funds are not available for small companies.

I think the first question is "why would I want to replicate a fund manager's style?" History has shown us that small-cap value has outperformed (outperform obviously means different things to different people), so you'd think a rational investor (on the assumption that factor timing isn't possible) would tilt to these factors over the long term assuming he didn't want to take "boring" broad market exposure.

Fundsmith is not a small-cap value investor, so using the above reasoning, I'm not sure why his style would be appealing over the long term.


"For smaller companies you would need to do significant research at the company level - besides, passive index funds are not available for small companies."

Depends how small, but there are funds that follow MSCI World Small Cap Index. But again I would question what a small cap tilt alone would bring (in the absence of a tilt to value/quality etc). 

Small caps certainly do seem to outperform over the long term but not always over the shorter term. The same with value investing which can work until it doesn't. Investing in both seems like a reasonable compromise. However small caps and value investing are both more volatile which I rate up there with pure performance. If someone really doesn't care about volatility then they should go fully for micro caps and private equity - but of course most people do care about such things.

Something like Fundsmith is not just for the long term. Its about crash protection, at least in theory.

MCSI World cap is a bit difficult to place. It includes companies which are over $50bn in size which is a bit of a stretch for anyone I imagine to think of as small. Small cap to me is less than £1bn, especially value which by its nature should be underpriced and even cheaper. I have never seen a passive index fund at that size. The closest seems to be Dimensional but I'm not sure that is really passive, although its pretty low cost.

My smallest individual holding is in a company worth just over £15m. I've always found sub £50m a fertile fishing ground. As companies grow and hit the higher £50m incremental levels then an increasing number of institutional investors step in. 

Linton

BritishInvestor said:

Prism said:

BritishInvestor said:

Linton said:

BritishInvestor said:

MarkCarnage said:

Deleted_User said:

JohnWinder said:

There has been various work showing that in practice owning a relatively small number of stocks (up to 30 or at most 50) will provide c90% of diversification benefit....however that is only against that particular universe benchmark within equities.

I'd be interested to see that research, firstly to learn how one quantifies the benefit of diversification but also to see how it stacks up against Bernstein's assertion that 50 stocks just doesn't cut it (unquantified). http://www.efficientfrontier.com/ef/900/15st.htm

It all comes down to stock pickers figuring out the optimum portfolio size and a lot of assumptions.  Managing a 50 stock portfolio is tough. The whole thing is mute now with ETFs giving you the whole world for the price of a few basis points. 

But even if its just 30 stocks, modern stock pickers would try to cover key sectors. 

Managing a 50 stock portfolio is tough, but probably less tough than managing a 200 stock portfolio if you know your holdings well. Most successful active managers run fairly concentrated portfolios, have low turnover and relatively long holding periods, and accept that there will be times when their performance is very different from the market. If you want passive, I agree that you can get that very cheaply now even on a global basis. I think it's moot not mute you mean though.....:) 
Not all stock pickers will attempt to cover 'key' sectors. If they fundamentally don't like them they won't hold them is my experience of several successful managers. 

"Most successful active managers"

I wasn't aware that there were many - Peter Lynch was definitely one. Have there been any since?

Define "successful".  Basing it on alpha is not very meaningful when a fund is not competing with an index.  Woodford was an extremely successful fund manager in his Invesco days as he stuck to his remit despite the attractions of the market.

I would define a successful fund manager as one whose fund meets its stated objectives.  How it performs aganst an index is irrelevent unless that is included in the objectives.

If you can replicate a fund manager's style using cheaply available factor funds, why would you pay the additional expense (and potential style drift risk) of an active fund manager?

I have certainly thought about that and decided in most cases its too difficult and the results wouldn't be accurate. For example to replicate Fundsmith you could split between

Healthcare medical devices - no pharma or insurance
Technology software - no hardware or telecoms
Consumer staples
Consumer disc - luxury brands only

Or for a macro based multi asset like Capital Gearing Trust, which does use passive funds, you would need to be agile and know when to move in and out of various markets, gold, property and bond types.

For smaller companies you would need to do significant research at the company level - besides, passive index funds are not available for small companies.

I think the first question is "why would I want to replicate a fund manager's style?" History has shown us that small-cap value has outperformed (outperform obviously means different things to different people), so you'd think a rational investor (on the assumption that factor timing isn't possible) would tilt to these factors over the long term assuming he didn't want to take "boring" broad market exposure.

Fundsmith is not a small-cap value investor, so using the above reasoning, I'm not sure why his style would be appealing over the long term.


"For smaller companies you would need to do significant research at the company level - besides, passive index funds are not available for small companies."

Depends how small, but there are funds that follow MSCI World Small Cap Index. But again I would question what a small cap tilt alone would bring (in the absence of a tilt to value/quality etc). 

1) It was you who raised the topic of a manager's style and claimed it could be copied with a tweak of factors.   Personally I am not interested in a manager's style, just in what the fund says it will do and what it actually does.

2) True, a tilt to small companies coupled with a tilt to value/quality would be very helpful as some companies were big  and deserve to be small.  You would generally get this tilt with an active fund as the managers carry out due diligence.  How do you do it if you are restricted to passive funds?  Similar considerations also apply to income funds where some companies have a high yield because their price has fallen..  Look at the history of IUKD over the 2008 crash when up to that point it invested dangerously heavily in the banks.

On small companies I have looked at one of the few UK small company ETFs - the iShares MSCI one.  Over the past 5 years if the ETF had been an OEIC/UT its performance would have been 44th out of 45 funds.  

Diplodicus

British Investor - Thank you for the link. I have found the missing bit of the cfasociety paper now:

https://www.cfasociety.org/calgary/Documents/Professionals_2. The Power of Compounded Returns.pdf

I think I see what they have done here, starting with the assertion, "Volatility amputates final wealth" justified through measuring compounded wealth (geometric mean) against a yearly average (arithmetic mean). But I read from the annuity digest link that The geometric mean will always be equal to or less than the arithmetic mean. And furthermore, for the investor, the yardstick is somewhat irrelevant. From the paper:  the average periodic return does not determine final wealth (..) What determines final wealth is the average compounded return.

Didn't Linton answer this upthread with a traffic jam analogy?

MK62 - Yes, I understand the palliative worth of diversification and rebalancing but what the readers of this paper are given to understand is that they will have a wealthier outcome than those who do not practice diversification. I don't think that claim stands up. I'd like to see the cfasociety publish their updated results since '14 for Russell1000/ US 10yr treasury and a 60/40 portfolio of the two.

BritishInvestor

Prism said:

BritishInvestor said:

Prism said:

BritishInvestor said:

Linton said:

BritishInvestor said:

MarkCarnage said:

Deleted_User said:

JohnWinder said:

There has been various work showing that in practice owning a relatively small number of stocks (up to 30 or at most 50) will provide c90% of diversification benefit....however that is only against that particular universe benchmark within equities.

I'd be interested to see that research, firstly to learn how one quantifies the benefit of diversification but also to see how it stacks up against Bernstein's assertion that 50 stocks just doesn't cut it (unquantified). http://www.efficientfrontier.com/ef/900/15st.htm

It all comes down to stock pickers figuring out the optimum portfolio size and a lot of assumptions.  Managing a 50 stock portfolio is tough. The whole thing is mute now with ETFs giving you the whole world for the price of a few basis points. 

But even if its just 30 stocks, modern stock pickers would try to cover key sectors. 

Managing a 50 stock portfolio is tough, but probably less tough than managing a 200 stock portfolio if you know your holdings well. Most successful active managers run fairly concentrated portfolios, have low turnover and relatively long holding periods, and accept that there will be times when their performance is very different from the market. If you want passive, I agree that you can get that very cheaply now even on a global basis. I think it's moot not mute you mean though.....:) 
Not all stock pickers will attempt to cover 'key' sectors. If they fundamentally don't like them they won't hold them is my experience of several successful managers. 

"Most successful active managers"

I wasn't aware that there were many - Peter Lynch was definitely one. Have there been any since?

Define "successful".  Basing it on alpha is not very meaningful when a fund is not competing with an index.  Woodford was an extremely successful fund manager in his Invesco days as he stuck to his remit despite the attractions of the market.

I would define a successful fund manager as one whose fund meets its stated objectives.  How it performs aganst an index is irrelevent unless that is included in the objectives.

If you can replicate a fund manager's style using cheaply available factor funds, why would you pay the additional expense (and potential style drift risk) of an active fund manager?

I have certainly thought about that and decided in most cases its too difficult and the results wouldn't be accurate. For example to replicate Fundsmith you could split between

Healthcare medical devices - no pharma or insurance
Technology software - no hardware or telecoms
Consumer staples
Consumer disc - luxury brands only

Or for a macro based multi asset like Capital Gearing Trust, which does use passive funds, you would need to be agile and know when to move in and out of various markets, gold, property and bond types.

For smaller companies you would need to do significant research at the company level - besides, passive index funds are not available for small companies.

I think the first question is "why would I want to replicate a fund manager's style?" History has shown us that small-cap value has outperformed (outperform obviously means different things to different people), so you'd think a rational investor (on the assumption that factor timing isn't possible) would tilt to these factors over the long term assuming he didn't want to take "boring" broad market exposure.

Fundsmith is not a small-cap value investor, so using the above reasoning, I'm not sure why his style would be appealing over the long term.


"For smaller companies you would need to do significant research at the company level - besides, passive index funds are not available for small companies."

Depends how small, but there are funds that follow MSCI World Small Cap Index. But again I would question what a small cap tilt alone would bring (in the absence of a tilt to value/quality etc). 

Small caps certainly do seem to outperform over the long term but not always over the shorter term. The same with value investing which can work until it doesn't. Investing in both seems like a reasonable compromise. However small caps and value investing are both more volatile which I rate up there with pure performance. If someone really doesn't care about volatility then they should go fully for micro caps and private equity - but of course most people do care about such things.

Something like Fundsmith is not just for the long term. Its about crash protection, at least in theory.

MCSI World cap is a bit difficult to place. It includes companies which are over $50bn in size which is a bit of a stretch for anyone I imagine to think of as small. Small cap to me is less than £1bn, especially value which by its nature should be underpriced and even cheaper. I have never seen a passive index fund at that size. The closest seems to be Dimensional but I'm not sure that is really passive, although its pretty low cost.

Size effect - I think you have to tilt to other factors to make it (potentially) work

https://www.aqr.com/Insights/Perspectives/There-is-No-Size-Effect-Daily-Edition

I would question whether Fundsmith would be defensive if the value factor came back into vogue. It might not be a crash, more a dreary decade of underperformance (relative to value etc).

Yep, below £1bn and some funds might struggle due to capacity constraints etc - even the Dimensional targeted values are above this.

BritishInvestor

Linton said:

BritishInvestor said:

Prism said:

BritishInvestor said:

Linton said:

BritishInvestor said:

MarkCarnage said:

Deleted_User said:

JohnWinder said:

There has been various work showing that in practice owning a relatively small number of stocks (up to 30 or at most 50) will provide c90% of diversification benefit....however that is only against that particular universe benchmark within equities.

I'd be interested to see that research, firstly to learn how one quantifies the benefit of diversification but also to see how it stacks up against Bernstein's assertion that 50 stocks just doesn't cut it (unquantified). http://www.efficientfrontier.com/ef/900/15st.htm

It all comes down to stock pickers figuring out the optimum portfolio size and a lot of assumptions.  Managing a 50 stock portfolio is tough. The whole thing is mute now with ETFs giving you the whole world for the price of a few basis points. 

But even if its just 30 stocks, modern stock pickers would try to cover key sectors. 

Managing a 50 stock portfolio is tough, but probably less tough than managing a 200 stock portfolio if you know your holdings well. Most successful active managers run fairly concentrated portfolios, have low turnover and relatively long holding periods, and accept that there will be times when their performance is very different from the market. If you want passive, I agree that you can get that very cheaply now even on a global basis. I think it's moot not mute you mean though.....:) 
Not all stock pickers will attempt to cover 'key' sectors. If they fundamentally don't like them they won't hold them is my experience of several successful managers. 

"Most successful active managers"

I wasn't aware that there were many - Peter Lynch was definitely one. Have there been any since?

Define "successful".  Basing it on alpha is not very meaningful when a fund is not competing with an index.  Woodford was an extremely successful fund manager in his Invesco days as he stuck to his remit despite the attractions of the market.

I would define a successful fund manager as one whose fund meets its stated objectives.  How it performs aganst an index is irrelevent unless that is included in the objectives.

If you can replicate a fund manager's style using cheaply available factor funds, why would you pay the additional expense (and potential style drift risk) of an active fund manager?

I have certainly thought about that and decided in most cases its too difficult and the results wouldn't be accurate. For example to replicate Fundsmith you could split between

Healthcare medical devices - no pharma or insurance
Technology software - no hardware or telecoms
Consumer staples
Consumer disc - luxury brands only

Or for a macro based multi asset like Capital Gearing Trust, which does use passive funds, you would need to be agile and know when to move in and out of various markets, gold, property and bond types.

For smaller companies you would need to do significant research at the company level - besides, passive index funds are not available for small companies.

I think the first question is "why would I want to replicate a fund manager's style?" History has shown us that small-cap value has outperformed (outperform obviously means different things to different people), so you'd think a rational investor (on the assumption that factor timing isn't possible) would tilt to these factors over the long term assuming he didn't want to take "boring" broad market exposure.

Fundsmith is not a small-cap value investor, so using the above reasoning, I'm not sure why his style would be appealing over the long term.


"For smaller companies you would need to do significant research at the company level - besides, passive index funds are not available for small companies."

Depends how small, but there are funds that follow MSCI World Small Cap Index. But again I would question what a small cap tilt alone would bring (in the absence of a tilt to value/quality etc). 

1) It was you who raised the topic of a manager's style and claimed it could be copied with a tweak of factors.   Personally I am not interested in a manager's style, just in what the fund says it will do and what it actually does.

2) True, a tilt to small companies coupled with a tilt to value/quality would be very helpful as some companies were big  and deserve to be small.  You would generally get this tilt with an active fund as the managers carry out due diligence.  How do you do it if you are restricted to passive funds?  Similar considerations also apply to income funds where some companies have a high yield because their price has fallen..  Look at the history of IUKD over the 2008 crash when up to that point it invested dangerously heavily in the banks.

On small companies I have looked at one of the few UK small company ETFs - the iShares MSCI one.  Over the past 5 years if the ETF had been an OEIC/UT its performance would have been 44th out of 45 funds.  

" Personally I am not interested in a manager's style, just in what the fund says it will do and what it actually does."

I worry that many investors look at the fund performance first and only then look at what the fund manager says. For example, there must be a value style fund manager with an equally good story to tell but no one is interested because headwinds mean his performance has lagged the overall market.

2. You should be able to fund factor funds that offer these tilts. Agreed on the potential concentration/style risk on the income funds.

Alexland

BritishInvestor said:

I would question whether Fundsmith would be defensive if the value factor came back into vogue. It might not be a crash, more a dreary decade of underperformance (relative to value etc).

Maybe but you would then have a collection of cheap shares that can reinvest their cashflows at a high rate of return which should be attractive enough to persuade almost any investor go buy them.

MarkCarnage

Thrugelmir said:

Prism said:

BritishInvestor said:

Prism said:

BritishInvestor said:

Linton said:

BritishInvestor said:

MarkCarnage said:

Deleted_User said:

JohnWinder said:

There has been various work showing that in practice owning a relatively small number of stocks (up to 30 or at most 50) will provide c90% of diversification benefit....however that is only against that particular universe benchmark within equities.

I'd be interested to see that research, firstly to learn how one quantifies the benefit of diversification but also to see how it stacks up against Bernstein's assertion that 50 stocks just doesn't cut it (unquantified). http://www.efficientfrontier.com/ef/900/15st.htm

It all comes down to stock pickers figuring out the optimum portfolio size and a lot of assumptions.  Managing a 50 stock portfolio is tough. The whole thing is mute now with ETFs giving you the whole world for the price of a few basis points. 

But even if its just 30 stocks, modern stock pickers would try to cover key sectors. 

Managing a 50 stock portfolio is tough, but probably less tough than managing a 200 stock portfolio if you know your holdings well. Most successful active managers run fairly concentrated portfolios, have low turnover and relatively long holding periods, and accept that there will be times when their performance is very different from the market. If you want passive, I agree that you can get that very cheaply now even on a global basis. I think it's moot not mute you mean though.....:) 
Not all stock pickers will attempt to cover 'key' sectors. If they fundamentally don't like them they won't hold them is my experience of several successful managers. 

"Most successful active managers"

I wasn't aware that there were many - Peter Lynch was definitely one. Have there been any since?

Define "successful".  Basing it on alpha is not very meaningful when a fund is not competing with an index.  Woodford was an extremely successful fund manager in his Invesco days as he stuck to his remit despite the attractions of the market.

I would define a successful fund manager as one whose fund meets its stated objectives.  How it performs aganst an index is irrelevent unless that is included in the objectives.

If you can replicate a fund manager's style using cheaply available factor funds, why would you pay the additional expense (and potential style drift risk) of an active fund manager?

I have certainly thought about that and decided in most cases its too difficult and the results wouldn't be accurate. For example to replicate Fundsmith you could split between

Healthcare medical devices - no pharma or insurance
Technology software - no hardware or telecoms
Consumer staples
Consumer disc - luxury brands only

Or for a macro based multi asset like Capital Gearing Trust, which does use passive funds, you would need to be agile and know when to move in and out of various markets, gold, property and bond types.

For smaller companies you would need to do significant research at the company level - besides, passive index funds are not available for small companies.

I think the first question is "why would I want to replicate a fund manager's style?" History has shown us that small-cap value has outperformed (outperform obviously means different things to different people), so you'd think a rational investor (on the assumption that factor timing isn't possible) would tilt to these factors over the long term assuming he didn't want to take "boring" broad market exposure.

Fundsmith is not a small-cap value investor, so using the above reasoning, I'm not sure why his style would be appealing over the long term.


"For smaller companies you would need to do significant research at the company level - besides, passive index funds are not available for small companies."

Depends how small, but there are funds that follow MSCI World Small Cap Index. But again I would question what a small cap tilt alone would bring (in the absence of a tilt to value/quality etc). 

Small caps certainly do seem to outperform over the long term but not always over the shorter term. The same with value investing which can work until it doesn't. Investing in both seems like a reasonable compromise. However small caps and value investing are both more volatile which I rate up there with pure performance. If someone really doesn't care about volatility then they should go fully for micro caps and private equity - but of course most people do care about such things.

Something like Fundsmith is not just for the long term. Its about crash protection, at least in theory.

MCSI World cap is a bit difficult to place. It includes companies which are over $50bn in size which is a bit of a stretch for anyone I imagine to think of as small. Small cap to me is less than £1bn, especially value which by its nature should be underpriced and even cheaper. I have never seen a passive index fund at that size. The closest seems to be Dimensional but I'm not sure that is really passive, although its pretty low cost.

My smallest individual holding is in a company worth just over £15m. I've always found sub £50m a fertile fishing ground. As companies grow and hit the higher £50m incremental levels then an increasing number of institutional investors step in. 

There is probably some sound rationale there. I recall explaining to some friends that as an institutional fund manager there was little value in looking at microcaps as they were not going to make a meaningful difference to portfolios given the relative size of both elements in the equation, and the need to treat customers fairly in deal allocation. Therefore at that end of the size scale there is likely to be scope for private investors to add value. 

Prism

BritishInvestor said:

I would question whether Fundsmith would be defensive if the value factor came back into vogue. It might not be a crash, more a dreary decade of underperformance (relative to value etc).

Coming into retirement that dreary performance would suit me fine. In fact its what I thought I might get 7 years ago when I started investing in Fundsmith.

I do agree too many people just look at raw performance which is of course historical. That is of some interest to me but only one characteristic.