Timing the market

Linton

BritishInvestor said:

Linton said:

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.

Thank you

I'd wonder how close you could get to that implementation with a passive approach vs what you currently have

So for example, for equities

tilting towards small
https://www.msci.com/documents/10199/a67b0d43-0289-4bce-8499-0c102eaa8399

tilting away from US
https://www.msci.com/documents/10199/c0db0a48-01f2-4ba9-ad01-226fd5678111
https://www.msci.com/documents/10199/db217f4c-cc8c-4e21-9fac-60eb6a47faf0
(and others)


Wealth preservation trusts are an interesting one. The (popular) one I picked at random fell ~12% in late 2008 whereas a global bond benchmark fell by around 2%. Maybe that was an outlier.

Comparing the global small comnpanies index returns over the past 5 years with all the Small Company funds I have held in that timeframe.... 5 years is as far as I can go back with a MSCI Global small cap ETF:

SPDF MSCI Global Small Cap - 70.9%
Bailiie Gifford Japan Small Cap - 84.8%
Marlborough Special Situations - 93.8%
Theadneedle European Smaller Companies - 115.8%
Matthews Asia Small Companies - 128%
Artemis US Smaller Companies - 133.5%
Liontrust UK Smaller Companies - 136%
ASI European Smaller Comanies - 145%

So every single active fund across all geographies in the list outperformed the Global Small Cap Index Fund.  Perhaps I am a briliant fund picker or rather more likely Global Index funds are not the best way to invest in Small Companies.

On WP Funds see the following fraphs, with dividends re-invested:

I use CGT (Capital Gearing Trust) [B] and Troy Trojan [A]. CGT dates from before the tech boom/bust, Troy Trojan from 2004:





CGT [A] and FTSE World Index  [B]

jamesd

BritishInvestor said:

"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."

That may have been the case many years ago, but since trackers became available there are alternatives

Trackers don't even try to do any of that work, so they aren't an alternative to you or a fund manager doing the research and looking for opportunities.

jamesd

BritishInvestor said:

"What I did was look at the performance of the top ten funds in the global growth sector from around 2003 onwards"

But hasn't this been because growth has been on a roll for many, many years, or something more nuanced?

This discussion came up early in my time here so I looked at the past five years at the time of that discussion then followed up with some later years. That was largely a time of considerable market consistency, a fairly solid growth situation that would have rewarded such things as leverage. But that potential was there to exploit by all active funds in the sector and these were the ones who did whatever it was best, consistently. There are many potential reasons including manager style, factor (market segment) choices and whether a fund is really a tracker but these just kept on delivering.

I didn't look into what happened to them in 2008, though, and that would have spectacularly illustrated something as simple as leverage, though I'm not sure that sector existed by 2008, may have been redefined.

That was followed many years later by the much more recent accepting of the FCA of submissions by fund management houses showing consistent outperformance in some sectors. Not a finding I'd expect so see in the far more challenging US customer markets for US investments, though market segments and sizes can still be exploited there for those willing to deviate from tracking, I think - level rather than market cap possibly being one of the better known approaches, to the point that I've seen semi-automated passives doing different cap weightings.

(shrug) In a pure theoretical academic world this shouldn't be possible without varying risk but it does seem to be happening in the real world, whatever the reason for it is. It could really be higher risk within the funds concerned than average in the sectors involved.

I may try to dig it up again, since you'd probably find it interesting. Lots of posts in 15 years here, though...

jamesd

BritishInvestor said:

"A classic claim was the active manager who wen receiving an investment award thanked the passive fund managers he'd been front running."

Once an inefficiency like that becomes known, it tends to disappear. Can you please post the article and I'll have a look?

A fair few years back now but I mentioned it before here. Maybe I'll go looking for a mention of it. I assumed at the time that he was mostly trading around index constituent changes. Passive managers have become more active in their approach to that in recent years, at least reducing the opportunity.

jamesd

BritishInvestor said:

"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"

What's the market cap? I do wonder if there is more inefficiency at the lower levels, but question whether you are being paid to accept liquidity risk.

If you'd like to look into that, my main pension pot:

% at platform % pens overall
At SL 100 89.13
Stan Life Vanguard FTSE Developed World Hedged Pn S4 29.64 26.42
Stan Life ASI Global Smaller Companies Pn S4 23.91 21.31
Stan Life ASI UK Smaller Companies Pn S4 16.63 14.82
Stan Life Merian (Jupiter) UK Mid Cap Pn S4 11.61 10.35
Stan Life JPM Emerging Markets Equity Pn Series 4 9.49 8.46
Stan Life Fidelity Asia Pn S4 8.72 7.77

The other one is now of limited value because I've been selling to withdraw but the main funds have been:

Jupiter UK Smaller Companies - selling for drawdown

Jupiter UK Smaller Companies Focus - all now sold for drawdown

Janus Henderson European Smaller Companies 

As you can see there's a LOT of smaller companies focus in my investing for the last few years. And a fair bit elsewhere in even smaller VCT companies.

Whether I'm being paid for the volatility or any liquidity risk or not is an interesting question. I think yes and they didn't do as badly as they might have done generically back in the 2020 crash.

Of course it shouldn't surprise you that a passive fund is my largest single holding. The underweight US position is deliberate, it's a posture I put in around three years ago. The UK mid cap was postulating a UK post-brexit recovery and that's not something which has truly delivered.

The SL funds aren't a fully free choice but I haven't overall been too unhappy with the combination of them and HL to fill any gaps. Ignore SL published prices. I'm on a 0.75% discount there, via extra units added each month.

BritishInvestor

Linton said:

BritishInvestor said:

Linton said:

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.

Thank you

I'd wonder how close you could get to that implementation with a passive approach vs what you currently have

So for example, for equities

tilting towards small
https://www.msci.com/documents/10199/a67b0d43-0289-4bce-8499-0c102eaa8399

tilting away from US
https://www.msci.com/documents/10199/c0db0a48-01f2-4ba9-ad01-226fd5678111
https://www.msci.com/documents/10199/db217f4c-cc8c-4e21-9fac-60eb6a47faf0
(and others)


Wealth preservation trusts are an interesting one. The (popular) one I picked at random fell ~12% in late 2008 whereas a global bond benchmark fell by around 2%. Maybe that was an outlier.

Comparing the global small comnpanies index returns over the past 5 years with all the Small Company funds I have held in that timeframe.... 5 years is as far as I can go back with a MSCI Global small cap ETF:

SPDF MSCI Global Small Cap - 70.9%
Bailiie Gifford Japan Small Cap - 84.8%
Marlborough Special Situations - 93.8%
Theadneedle European Smaller Companies - 115.8%
Matthews Asia Small Companies - 128%
Artemis US Smaller Companies - 133.5%
Liontrust UK Smaller Companies - 136%
ASI European Smaller Comanies - 145%

So every single active fund across all geographies in the list outperformed the Global Small Cap Index Fund.  Perhaps I am a briliant fund picker or rather more likely Global Index funds are not the best way to invest in Small Companies.

On WP Funds see the following fraphs, with dividends re-invested:

I use CGT (Capital Gearing Trust) [B] and Troy Trojan [A]. CGT dates from before the tech boom/bust, Troy Trojan from 2004:





CGT [A] and FTSE World Index  [B]

"Perhaps I am a briliant fund picker or rather more likely Global Index funds are not the best way to invest in Small Companies."

I might be missing something obvious here, but looking at one of the funds, there's a big tilt to growth, so I'm not really sure it's a valid comparison.

PE ratio of 15
https://www.morningstar.co.uk/uk/etf/snapshot/snapshot.aspx?id=0P00011EX4&tab=3&InvestmentType=FE

PE ratio of 31
https://www.morningstar.co.uk/uk/funds/snapshot/snapshot.aspx?id=F00000P8DK&tab=3

You can see here the "outperformance" on the benchmarks
https://www.msci.com/documents/10199/71483ec6-c345-4551-b6ff-ee2b48f8d632


"I use CGT (Capital Gearing Trust) "

If you look at how it performed from 11th September 2008 (I still remember that weekend) to 10th November, you can see the falls.

BritishInvestor

Prism said:

BritishInvestor said:

In 2021, it's quite tough (to put it politely) to find inefficiencies if you're an active fund manager, for a number of reasons:

1. Competition: The resources available to fund managers in terms of brainpower, computer capacity, historical data (quality and quantity) is far, far behind the quant-style hedge funds, and I'd assume a fair way behind investment banking prop desks (I don't know how many of these are still in existence to be fair). The best talent (certainly in the City (London)) tends to gravitate to IBs or hedge funds.
2. Scalability: Inefficiencies tend to be limited in scale, with more volume tending to move the market, therefore, eliminating the edge. A large fund run by an active fund manager (with effectively one strategy) is unlikely to be able to exploit inefficiencies at this scale.
3. Reaction time: Hedge fund computers react in near real-time to remove the inefficiency before Mr active fund manager has finished his cornflakes

There may be some fund managers that still try to compete in this area with small agile funds and a trading rather than investing stance but I don't know any.

Most completely agree that market timing is pointless and wouldn't compare themselves quants or traders. It can take several weeks if not a few months to build up a position in a new holding so any inefficiencies they see must be long multi year ones. The most effective fund houses in this area seem to be the ones that do their own analysis and completely ignore sell side data or others opinions. If you reduce the importance of the current share price then moving the market and reaction time become less of a concern. Due to the work required to do in house analysis this tends to limit the number of holdings of those funds making them more concentrated.

This theoretically indicates a higher risk due to less diversification but this seems pretty rare to find an example. One is JEO which had a 17% top holding drop to zero (Wirecard) and yet the performance has still kept pretty close to the index over the last 5 years and easily beats it over 10 years. I find it quite interesting that a fund can shrug off a permanent 17% loss in capital.

My thoughts in general are that some fund managers, and their teams, are pretty good at this in spite of the huge sums at money thrown at their hedge fund competitors. Most of them seem to be relatively small teams who try and do something a bit different, whether that be Scottish Mortgage with their ideas about companies in 10-20 years, Fundsmith with its obsession of cash producing stalwarts or the large variety of UK small cap funds working in under researched areas. 

"Fundsmith with its obsession of cash producing stalwarts"

But as we've discussed previously, it's debatable whether there's any alpha there. 

BritishInvestor

jamesd said:

BritishInvestor said:

"What I did was look at the performance of the top ten funds in the global growth sector from around 2003 onwards"

But hasn't this been because growth has been on a roll for many, many years, or something more nuanced?

This discussion came up early in my time here so I looked at the past five years at the time of that discussion then followed up with some later years. That was largely a time of considerable market consistency, a fairly solid growth situation that would have rewarded such things as leverage. But that potential was there to exploit by all active funds in the sector and these were the ones who did whatever it was best, consistently. There are many potential reasons including manager style, factor (market segment) choices and whether a fund is really a tracker but these just kept on delivering.

I didn't look into what happened to them in 2008, though, and that would have spectacularly illustrated something as simple as leverage, though I'm not sure that sector existed by 2008, may have been redefined.

That was followed many years later by the much more recent accepting of the FCA of submissions by fund management houses showing consistent outperformance in some sectors. Not a finding I'd expect so see in the far more challenging US customer markets for US investments, though market segments and sizes can still be exploited there for those willing to deviate from tracking, I think - level rather than market cap possibly being one of the better known approaches, to the point that I've seen semi-automated passives doing different cap weightings.

(shrug) In a pure theoretical academic world this shouldn't be possible without varying risk but it does seem to be happening in the real world, whatever the reason for it is. It could really be higher risk within the funds concerned than average in the sectors involved.

I may try to dig it up again, since you'd probably find it interesting. Lots of posts in 15 years here, though...

"Lots of posts in 15 years here, though..."

Yep, fair point

BritishInvestor

jamesd said:

BritishInvestor said:

"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"

What's the market cap? I do wonder if there is more inefficiency at the lower levels, but question whether you are being paid to accept liquidity risk.

If you'd like to look into that, my main pension pot:

% at platform % pens overall
At SL 100 89.13
Stan Life Vanguard FTSE Developed World Hedged Pn S4 29.64 26.42
Stan Life ASI Global Smaller Companies Pn S4 23.91 21.31
Stan Life ASI UK Smaller Companies Pn S4 16.63 14.82
Stan Life Merian (Jupiter) UK Mid Cap Pn S4 11.61 10.35
Stan Life JPM Emerging Markets Equity Pn Series 4 9.49 8.46
Stan Life Fidelity Asia Pn S4 8.72 7.77

The other one is now of limited value because I've been selling to withdraw but the main funds have been:

Jupiter UK Smaller Companies - selling for drawdown

Jupiter UK Smaller Companies Focus - all now sold for drawdown

Janus Henderson European Smaller Companies 

As you can see there's a LOT of smaller companies focus in my investing for the last few years. And a fair bit elsewhere in even smaller VCT companies.

Whether I'm being paid for the volatility or any liquidity risk or not is an interesting question. I think yes and they didn't do as badly as they might have done generically back in the 2020 crash.

Of course it shouldn't surprise you that a passive fund is my largest single holding. The underweight US position is deliberate, it's a posture I put in around three years ago. The UK mid cap was postulating a UK post-brexit recovery and that's not something which has truly delivered.

The SL funds aren't a fully free choice but I haven't overall been too unhappy with the combination of them and HL to fill any gaps. Ignore SL published prices. I'm on a 0.75% discount there, via extra units added each month.

Thanks, will take a look.

Prism

BritishInvestor said:

Prism said:

BritishInvestor said:

In 2021, it's quite tough (to put it politely) to find inefficiencies if you're an active fund manager, for a number of reasons:

1. Competition: The resources available to fund managers in terms of brainpower, computer capacity, historical data (quality and quantity) is far, far behind the quant-style hedge funds, and I'd assume a fair way behind investment banking prop desks (I don't know how many of these are still in existence to be fair). The best talent (certainly in the City (London)) tends to gravitate to IBs or hedge funds.
2. Scalability: Inefficiencies tend to be limited in scale, with more volume tending to move the market, therefore, eliminating the edge. A large fund run by an active fund manager (with effectively one strategy) is unlikely to be able to exploit inefficiencies at this scale.
3. Reaction time: Hedge fund computers react in near real-time to remove the inefficiency before Mr active fund manager has finished his cornflakes

There may be some fund managers that still try to compete in this area with small agile funds and a trading rather than investing stance but I don't know any.

Most completely agree that market timing is pointless and wouldn't compare themselves quants or traders. It can take several weeks if not a few months to build up a position in a new holding so any inefficiencies they see must be long multi year ones. The most effective fund houses in this area seem to be the ones that do their own analysis and completely ignore sell side data or others opinions. If you reduce the importance of the current share price then moving the market and reaction time become less of a concern. Due to the work required to do in house analysis this tends to limit the number of holdings of those funds making them more concentrated.

This theoretically indicates a higher risk due to less diversification but this seems pretty rare to find an example. One is JEO which had a 17% top holding drop to zero (Wirecard) and yet the performance has still kept pretty close to the index over the last 5 years and easily beats it over 10 years. I find it quite interesting that a fund can shrug off a permanent 17% loss in capital.

My thoughts in general are that some fund managers, and their teams, are pretty good at this in spite of the huge sums at money thrown at their hedge fund competitors. Most of them seem to be relatively small teams who try and do something a bit different, whether that be Scottish Mortgage with their ideas about companies in 10-20 years, Fundsmith with its obsession of cash producing stalwarts or the large variety of UK small cap funds working in under researched areas. 

"Fundsmith with its obsession of cash producing stalwarts"

But as we've discussed previously, it's debatable whether there's any alpha there. 

I agree at the index level. I think there was a smallish window after 2008 when quality growth investing was the place to be. Around that time a few passive funds launched to take advantage too. That outperformance has dropped away a little though. The world quality index and passive funds are still pretty much top of the pile over all time periods but not by much. It does come at a small price premium though so rising interest rates may well level things out. The historical out performance of funds like Fundsmith has come from stock picking.

One of the problems we have here is that if someone truely believes that growth investing is the best place to be they are somewhat limited in their choices of passive funds - there are basically none. So if, rightly or wrongly, you want to follow a growth strategy then you end up looking at active funds. Morningstar classes a few momentum funds as growth but that isn't correct. Momentum is simply what has done well recently and therefore is currently full of oil companies and banks to go along with stuff like Tesla and Apple.