Timing the market

BritishInvestor

NedS said:

Deleted_User said:

Yes, exactly.  Right now we can either do stock picking or fund/ETF picking.  But the former is hard to do well and the latter is never quite what you want.  Like all the proliferating "ethical" funds never provide the kind of ethics that the customers actually like. 

Or let's say, I have a hate on... Tesla.  Or rubber manufacturers.  Or that I work for Apple and don't want any APL in my ETFs to avoid extra risk.  Or that I like Emerging markets but not communist China or President Erdogan.   Would be nice to pick an all-world ETF and then subtract a few bits and pieces one wants to avoid.  

Basically, I am talking about customizable ETFs.  There will be some cost to it (compared to basically zero right now) but technology should be able to allow for it to be done very cheaply.  

These are the kinds of innovation that good fund providers might be offering next while the good old "trust in me" type of manager struggles. 

I've often thought exactly the same. Why would I want to buy the market knowing full well there are 10, or 20, or 50 companies I definitely don't want to own in that basket of stocks. I may not be able (or feel confident) to pick a portfolio of winners, but I'd love the opportunity to buy an ETF style basket of stocks and then have the ability to customise it by deselecting the stuff I know I don't want, and I'd be happy to pay a higher management fee for that ability to customise.

It's worth keeping an eye on what's going on across the pond

https://www.nasdaq.com/articles/charles-schwab-opening-its-gates-to-direct-index-investing-2021-10-21

Prism

BritishInvestor said:

I'm not clear how you undertake successful due diligence. I once raised a Roger Moore style eyebrow when a portfolio building firm said that part of their due diligence was looking a fund manager in the eye! I'm not also not clear how you avoid the companies that won't be winners - that implies a market mispricing unless I'm misunderstanding what you are saying?

In overall performance terms I guess that is what active management is mainly about - that the market is mispriced. Actually maybe its fairer to say that the stocks that they select are mispriced. Now whether that is a short term mispricing (value investor) or a long term mispricing (growth investor) its still the same idea, that those stocks will perform better than the market expects them too over some time period.

Of course most active investment managers will not focus totally on raw performance. So providing lower than market returns with lower volatility is a perfectly acceptable compromise. I am always wary of any fund that attempts to hit a particular benchmark but for example beating inflation over a particular period might be all you need.

For all of those scenarios the manager needs to believe that to some degree the market is wrong and/or they are better than the market or in some cases doing things so differently that the market doesn't really matter. Then all you need to do is select those managers

[Deleted User]

Especially now that bonds cannot provide effective risk mitigation with a useful diversifying return, management of risk requires control of asset allocation and tilts."
I don't really understand what an active manager would do here, and given that most star fund managers at the moment are in the large cap growth space, some would argue this is quite a risky space to be in given current valuations.

There is a lot more logic in active management of fixed income.  The way passive bond funds are designed is conceptually flawed, with the most indebted companies automatically providing the largest contribution.  An active manager can reasonably disagree about bond ratings. Plus there are fixed income tools which require buyers to read and understand a lot of small print. 

BritishInvestor

Prism said:

BritishInvestor said:

I'm not clear how you undertake successful due diligence. I once raised a Roger Moore style eyebrow when a portfolio building firm said that part of their due diligence was looking a fund manager in the eye! I'm not also not clear how you avoid the companies that won't be winners - that implies a market mispricing unless I'm misunderstanding what you are saying?

In overall performance terms I guess that is what active management is mainly about - that the market is mispriced. Actually maybe its fairer to say that the stocks that they select are mispriced. Now whether that is a short term mispricing (value investor) or a long term mispricing (growth investor) its still the same idea, that those stocks will perform better than the market expects them too over some time period.

Of course most active investment managers will not focus totally on raw performance. So providing lower than market returns with lower volatility is a perfectly acceptable compromise. I am always wary of any fund that attempts to hit a particular benchmark but for example beating inflation over a particular period might be all you need.

For all of those scenarios the manager needs to believe that to some degree the market is wrong and/or they are better than the market or in some cases doing things so differently that the market doesn't really matter. Then all you need to do is select those managers

"In overall performance terms I guess that is what active management is mainly about - that the market is mispriced. Actually maybe its fairer to say that the stocks that they select are mispriced. Now whether that is a short term mispricing (value investor) or a long term mispricing (growth investor) its still the same idea, that those stocks will perform better than the market expects them too over some time period."

I agree, but my point is that an active manager won't get a look in for short term inefficiencies, and longer-term "mispricing" (tilts to factors) can be accessed a lot more cheaply (and with less style drift risk and/or concentration risk).

"So providing lower than market returns with lower volatility is a perfectly acceptable compromise."

I struggle to understand why this would be optimal within a given asset class. So typically, high quality/low duration bonds dampen equity volatility. Can it be more efficient to try and damp within the asset class itself? Not sure about that.

"Then all you need to do is select those managers "

Yep   

Linton

BritishInvestor said:

Prism said:

BritishInvestor said:

I'm not clear how you undertake successful due diligence. I once raised a Roger Moore style eyebrow when a portfolio building firm said that part of their due diligence was looking a fund manager in the eye! I'm not also not clear how you avoid the companies that won't be winners - that implies a market mispricing unless I'm misunderstanding what you are saying?

In overall performance terms I guess that is what active management is mainly about - that the market is mispriced. Actually maybe its fairer to say that the stocks that they select are mispriced. Now whether that is a short term mispricing (value investor) or a long term mispricing (growth investor) its still the same idea, that those stocks will perform better than the market expects them too over some time period.

Of course most active investment managers will not focus totally on raw performance. So providing lower than market returns with lower volatility is a perfectly acceptable compromise. I am always wary of any fund that attempts to hit a particular benchmark but for example beating inflation over a particular period might be all you need.

For all of those scenarios the manager needs to believe that to some degree the market is wrong and/or they are better than the market or in some cases doing things so differently that the market doesn't really matter. Then all you need to do is select those managers

"So providing lower than market returns with lower volatility is a perfectly acceptable compromise."

I struggle to understand why this would be optimal within a given asset class. So typically, high quality/low duration bonds dampen equity volatility. Can it be more efficient to try and damp within the asset class itself? Not sure about that.

Reducing equity volatility whilst generating a medium term return at least 1% above inflation is precisely my objective.  Achieving this is the optimal outcome.

The reason is that in retirement the medium term timeframe is the most important for investment.  Short term doesnt matter since cash works fine.  The very long term is irrelevent as most people wont live long enough to really gain the benefits.  Under current circumstances high quality/low duration bonds provide zero return, medium term and long duration ones carry serious risk with their capital values and inflation can become a major concern.  Apart from a few niche investments there is nothing appropriate to invest in other than equity.

Linton

Prism said:

BritishInvestor said:

I'm not clear how you undertake successful due diligence. I once raised a Roger Moore style eyebrow when a portfolio building firm said that part of their due diligence was looking a fund manager in the eye! I'm not also not clear how you avoid the companies that won't be winners - that implies a market mispricing unless I'm misunderstanding what you are saying?

...

Of course most active investment managers will not focus totally on raw performance. So providing lower than market returns with lower volatility is a perfectly acceptable compromise. I am always wary of any fund that attempts to hit a particular benchmark but for example beating inflation over a particular period might be all you need.

For all of those scenarios the manager needs to believe that to some degree the market is wrong and/or they are better than the market or in some cases doing things so differently that the market doesn't really matter. Then all you need to do is select those managers

It isnt that the market is "wrong" but rather that the market may have different objectives and different objectives imply a different asset allocation.   So you dont need to pick the managers, but rather pick their asset allocation.  That is reasonably easy.

What the market's objectives are is difficult to say - I guess get maximum return as quickly as possible would cover a lot of it.

Thrugelmir

Linton said:

Prism said:

BritishInvestor said:

I'm not clear how you undertake successful due diligence. I once raised a Roger Moore style eyebrow when a portfolio building firm said that part of their due diligence was looking a fund manager in the eye! I'm not also not clear how you avoid the companies that won't be winners - that implies a market mispricing unless I'm misunderstanding what you are saying?

...

Of course most active investment managers will not focus totally on raw performance. So providing lower than market returns with lower volatility is a perfectly acceptable compromise. I am always wary of any fund that attempts to hit a particular benchmark but for example beating inflation over a particular period might be all you need.

For all of those scenarios the manager needs to believe that to some degree the market is wrong and/or they are better than the market or in some cases doing things so differently that the market doesn't really matter. Then all you need to do is select those managers

It isnt that the market is "wrong" but rather that the market may have different objectives and different objectives imply a different asset allocation.   So you dont need to pick the managers, but rather pick their asset allocation.  That is reasonably easy.

What the market's objectives are is difficult to say - I guess get maximum return as quickly as possible would cover a lot of it.

Benchmarks after all are in themselves little more than an arbitary human invention. For most investors it's more a question of meeting their own desired outcome and objectives. How many people buy stocks on the 1st of the year and sell on the 31st. There's a constant flux of movement in between. Follow an individual stock for a whole day within a trading session and the outcome can be illuminating. Not nearly as smooth/flat as you might expect. 

BritishInvestor

Linton said:

BritishInvestor said:

Prism said:

BritishInvestor said:

I'm not clear how you undertake successful due diligence. I once raised a Roger Moore style eyebrow when a portfolio building firm said that part of their due diligence was looking a fund manager in the eye! I'm not also not clear how you avoid the companies that won't be winners - that implies a market mispricing unless I'm misunderstanding what you are saying?

In overall performance terms I guess that is what active management is mainly about - that the market is mispriced. Actually maybe its fairer to say that the stocks that they select are mispriced. Now whether that is a short term mispricing (value investor) or a long term mispricing (growth investor) its still the same idea, that those stocks will perform better than the market expects them too over some time period.

Of course most active investment managers will not focus totally on raw performance. So providing lower than market returns with lower volatility is a perfectly acceptable compromise. I am always wary of any fund that attempts to hit a particular benchmark but for example beating inflation over a particular period might be all you need.

For all of those scenarios the manager needs to believe that to some degree the market is wrong and/or they are better than the market or in some cases doing things so differently that the market doesn't really matter. Then all you need to do is select those managers

"So providing lower than market returns with lower volatility is a perfectly acceptable compromise."

I struggle to understand why this would be optimal within a given asset class. So typically, high quality/low duration bonds dampen equity volatility. Can it be more efficient to try and damp within the asset class itself? Not sure about that.

Reducing equity volatility whilst generating a medium term return at least 1% above inflation is precisely my objective.  Achieving this is the optimal outcome.

The reason is that in retirement the medium term timeframe is the most important for investment.  Short term doesnt matter since cash works fine.  The very long term is irrelevent as most people wont live long enough to really gain the benefits.  Under current circumstances high quality/low duration bonds provide zero return, medium term and long duration ones carry serious risk with their capital values and inflation can become a major concern.  Apart from a few niche investments there is nothing appropriate to invest in other than equity.

I think maybe an example of an offering that reduces equity volatility would be useful - I don't necessarily disagree with your reply so interested what you had in mind.

Linton

BritishInvestor said:

Linton said:

BritishInvestor said:

Prism said:

BritishInvestor said:

I'm not clear how you undertake successful due diligence. I once raised a Roger Moore style eyebrow when a portfolio building firm said that part of their due diligence was looking a fund manager in the eye! I'm not also not clear how you avoid the companies that won't be winners - that implies a market mispricing unless I'm misunderstanding what you are saying?

In overall performance terms I guess that is what active management is mainly about - that the market is mispriced. Actually maybe its fairer to say that the stocks that they select are mispriced. Now whether that is a short term mispricing (value investor) or a long term mispricing (growth investor) its still the same idea, that those stocks will perform better than the market expects them too over some time period.

Of course most active investment managers will not focus totally on raw performance. So providing lower than market returns with lower volatility is a perfectly acceptable compromise. I am always wary of any fund that attempts to hit a particular benchmark but for example beating inflation over a particular period might be all you need.

For all of those scenarios the manager needs to believe that to some degree the market is wrong and/or they are better than the market or in some cases doing things so differently that the market doesn't really matter. Then all you need to do is select those managers

"So providing lower than market returns with lower volatility is a perfectly acceptable compromise."

I struggle to understand why this would be optimal within a given asset class. So typically, high quality/low duration bonds dampen equity volatility. Can it be more efficient to try and damp within the asset class itself? Not sure about that.

Reducing equity volatility whilst generating a medium term return at least 1% above inflation is precisely my objective.  Achieving this is the optimal outcome.

The reason is that in retirement the medium term timeframe is the most important for investment.  Short term doesnt matter since cash works fine.  The very long term is irrelevent as most people wont live long enough to really gain the benefits.  Under current circumstances high quality/low duration bonds provide zero return, medium term and long duration ones carry serious risk with their capital values and inflation can become a major concern.  Apart from a few niche investments there is nothing appropriate to invest in other than equity.

I think maybe an example of an offering that reduces equity volatility would be useful - I don't necessarily disagree with your reply so interested what you had in mind.

My strategy is high diversification.  So for the latest version of the 100% equity portfolio alongside income and Wealth Preservation portfolios:
 - US allocation 40% 
 - Large companies (as classified by Morningstar) 50%.  50% small/medium.  
 - Total of top 10 underlying holdings is <10% of portfolio. 
 - Funds chosen to avoid excessive dependence on particular industry sectors, particularly tech.
 - I check Value vs Growth but cant do much about it as there are very few funds with a high Value component around at the moment.

Backtesting performance shows 117% return over 5 years compared with MSCI World's 90% but over the past year it has returned 26% to the MSCI Worlds 27% perhaps due to the relaively low holding in tech giants. However this tells us nothing about the next 5 years.  We will see. In any case high performance is a secondary concern to appropriate allocations and those numbers are way above the requirement.

jamesd

BritishInvestor said:

"Why should fund managers try to react to the latest news or profit from long term inefficiencies? "

If you're not paying them for alpha, what are you paying for?

" Far more important is the objective and  management of the risk in achieving it"

Agreed, but if you accept that risk and return are related, and costs are a drag on returns, an active manager has to take more risk to generate the same return as a tracker, in theory.
...
There's nothing to stop you using a small cap passive fund (for example) if you want to tilt away from overall market cap.
...
" One can choose the ones that together create the portfolio one believes will achieve objectives at sufficiently low risk. It is impossible to do this with the range of passive funds that are available in the UK at the moment."

Would be useful to see some examples of how this has worked historically (if we accept that tactical asset allocation doesn't work), and also what you cannot do with the available passive/factor funds.

"The second and simpler risk reduction role is to provide due diligence.  Choosing next years winner is impossible but trying to avoid the companies that wont be is much easier."

I'm not clear how you undertake successful due diligence. I once raised a Roger Moore style eyebrow when a portfolio building firm said that part of their due diligence was looking a fund manager in the eye! I'm not also not clear how you avoid the companies that won't be winners - that implies a market mispricing unless I'm misunderstanding what you are saying?

You're paying them to do the work that you don't want to do, or aren't capable of doing, whether through ability or lack of time.

If active managers are identifying inefficiencies then there isn't inherently more risk. Of course adding risk is one way to increase returns, say a small cap tilt or tilt towards even weighting from market cap weighting. A classic claim was the active manager who wen receiving an investment award thanked the passive fund managers he'd been front running. (for others, this means loosely trading in advance of the known trades of someone else, in possibly its nastiest for it's a trading house trading just ahead of its own customers so it gets a better price and they get a worse one).

You can choose a small cap passive fund if you like, but personally I rather like my selection of small cap active funds. That's because they seem to be soundly beating their indexes and have been for a long time - easily enough time for me to identify them and confirm that as usual persistence of outperformance exists.

Avoiding dogs starts out by avoiding 1.5% AMC funds in a limited selection offered by a pension company that's really a passive tracker fund. When you get rid of those you've shifted the average above the average including dogs.

So far as persistence of outperformance goes, someone got to add an exception to their book based on work I did here when this came up around 2006-7. What I did was look at the performance of the top ten funds in the global growth sector from around 2003 onwards. What I found and posted about here was that the top ten were highly likely to still be in the top ten in succeeding years and even if not, the drop was still to outperformance. With some help from other posters it turned out that every case where that was not true was due to a change in human manager.

Naturally enough, this and continued reliability of this approach has rather skewed my thoughts about whether you can pick winners, having demonstrated that you can, in at least some circumstances.

Of course this also identifies a systematic flaw in lots of studies, which don't control for change in human manager.