Is the era of passive index trackers over?

Linton

JohnWinder said:

One would choose IUKD if one wanted income. There is very little passive choice.

1) But there is VG's FTSE U.K. Equity Income Index Fund with 105 stocks, and VG's FTSE All-World High Dividend Yield with 1800 stocks.

Lest some newer readers are attracted to the idea of a ‘dividend’ fund, either to provide a regular income or to be reinvested, a couple of thoughts.
A widely diversified portfolio of many higher dividend paying stocks, cap weighted or thereabouts, probably won’t perform much differently from a portfolio with ‘every’ stock in it, might even be a bit better at times, or a bit worse.
But one risks getting less total return with dividend stocks because of a narrow selection which reduces diversification, and fees if they’re higher.  The higher the dividends you want, the more restricted your choice of stocks becomes.
For example, if high dividends were a feature of UK stocks, but not a feature of other global stocks (and they aren’t of US stocks), chasing dividends might tempt you to limit your stocks to UK stocks. That would cost you returns unnecessarily if UK stocks do badly for a long period while the rest of the world chugs on. That’s the cost of not taking the ‘free lunch’ of diversification’; although it’s not ‘free’ if you want a bigger dividend cheque every quarter rather than a small one and selling some stocks.
2) Secondly, spending only dividends and not capital does not protect the value of your holding from falling. Selling shares so you can eat leaves you with fewer shares; but holding the same number of shares doesn’t help if their price falls away badly - have a look at General Electric over the last 20 years or Enron. If a price drops 60% in 10 years, then the dividends/share have to increase 250% to keep up the income you were getting.

On the other hand if your needs are more complex control of medium term volatility say may be more important than maximising long term return.

The apparent inherent contradiction here is that stocks are widely considered not the best choice unless you’re investing for the longer term, and even though one might be well past one’s expected life span (without any long term prospects!) holding stocks still makes sense if they’re to be passed onto someone with a long term. So,

But is there a balance here, a ‘sweet spot’, where we need to a modest stock holding because they do have better expected returns (and we don't want volatility), but we'll hope to only take their dividends?

Volatility up is no problem; down is the problem. As Linton suggests, the returns may come too late for you, expressed as price falls during your holding period, but made up too late for you in your heirs’ time. Are ‘dividends only’ the answer to that, or is it a more diversified stock holding, total return and more bonds? I have no idea.
For some ‘head in the sand’ folk, the dividend approach means allowing you to ignore price changes; and for those who eschew the complexity of determining a SWR (and adjusting it as needed) and then making the withdrawals to fund spending, ‘dividends only’ makes sense. Still, I think we need to be aware of the risks of lack of diversification.

1) Claiming VG FTSE UK Equity income as an Index fund is pushing the concept to the limit ISTM.  I believe the "index" was commissioned by Vanguard from FTSE.   In calculating the underlying investment weightings it includes 2 fudge factors of value between 0 and 1 to ensure that individual shares and sectors are not over represented.  So it does not represent any real market.  Perhaps one could see it as being more of a robo fund than an index fund.

Sadly I cant find any info on the FTSE All-world Hgh dividend fund yield though the information about the index again shows the calculation as including a fudge factor between 0 and 1, so what market the "index" actually represents can be questioned. The fund is 42% US which I think is rather high for an income fund given that US dividends are generally low compared with some other countries.

2) At least in the UK company dividends are specified as a fixed amount per share, not as a % of the share price.  Directors are loath to cut the dividend as the share holders dont like it.  So fluctuations in share price are not reflected automatically in the dividends.  Though of course the company ruinning into difficulties could affect both the price and the dividend though aleady agreed dividends are often paid even in such circumstances.   The greater stability of dividends and the ease with which they can be automatically paid into one's current account makes them useful for helping cover essential expenditure.

Generally, you are assuming an either/or choice for taking steady money.  I believe in diversification in everything so would not advocate someone solely investing in dividend paying funds nor in solely taking the money from dividends.

Prism

RolandFlagg said:

You guys obviously haven't seen the stats on how poor active managers are.

Read Jack Bogle's Little Book of Common Sense Investing.

Or watch Ben Felix's videos:

Most active managers can't beat their benchmark over 10 years before fees. https://www.cnbc.com/2022/03/27/new-report-finds-almost-80percent-of-active-fund-managers-are-falling-behind.html

I would say that most of us are aware of the stats which tell us that somewhere between 60% and 95% (depending on the index) active funds fall behind over 10 years. That would suggest that picking randomly is a no-no. What is less clear is how well to individual investors actually pick ahead of time. In the mainline global, US and emerging markets active managers struggle. However there are still sectors that are either not indexed or are small and under researched enough for an active manager to still do reasonably well.

In the 'conservative' zone of multi-asset funds, active funds and trusts that have more scope to adapt to the economic situation often work better. For example Capital Gearing Trusts and Personal Assets both hold index-linked bonds rather than regular bonds to protect against the current inflation we are now seeing. Vanguard Life Strategy would not be able to do that.

Index linked real estate and infrastructure, small and micro cap companies and private equity are all areas that are not really covered by passive funds.

All in all, a blend of both seems good to me. If all I wanted was a global, diversified pot of equities I would go passive - however that is not what I want.

Chickereeeee

It is easy to beat 'the market' over the long term with a racker IF you believe markets always increase. Just invest in a leveraged tracker e.g. XS2D (2X S&P500) - around twice the gains, with twice the volatility. But over 10 years it is up 600% versus S&P 500 gain of 200%...

JohnWinder

Whoa, that needs a bit of qualifying, from what I read. 'easy' and 'long term' seem the bits to trip one up.

Try this: 'This is a way of saying that over periods of more than a day, your (leveraged tracker ) ETF could go down even when the inverse or leveraged index it is tied to goes up.

Try searching 'leveraged tracker site:bogleheads.org' before you dip your toes in that water.

bd10

IMHO, I'd say yes and no to the question whether passive/tracking investments are "over". Yes in the sense that now more than ever we need to time markets and no in the sense that index funds can get us straight forward exposure to a sector or asset class.
By market timing I don't neccessarily mean timing the top and bottom, that's almost impossible, but we need to make an active decision in which asset classes we seek exposures. It's more than just bonds vs equities vs alternatives.
Questions on my to-do-list: When will commodities peak? When will we see first signs of stagflation? What are bonds doing? What is inflation doing? Based on what we see, I tweak my exposures accordingly, and index funds can be part of that process, but a pure passive play with a pre-defined (esp. prior to 2022 sell off) asset allocation, I fear that might be too costly.

Aminatidi

Prism said:

In the 'conservative' zone of multi-asset funds, active funds and trusts that have more scope to adapt to the economic situation often work better. For example Capital Gearing Trusts and Personal Assets both hold index-linked bonds rather than regular bonds to protect against the current inflation we are now seeing. Vanguard Life Strategy would not be able to do that.

Index linked real estate and infrastructure, small and micro cap companies and private equity are all areas that are not really covered by passive funds.

All in all, a blend of both seems good to me. If all I wanted was a global, diversified pot of equities I would go passive - however that is not what I want.

Similar to what I do.

A big slug in Capital Gearing and Ruffer and then a slug in a cheap dumb world tracker.

I've been doing a lot of reading about behaviour and psychology recently and with many years of working ahead to accumulate I'm trying to "just keep buying" and the new money goes into Vanguard FTSE Global All Cap.

I think what's interesting is that already having that big slug in the "wealth preservers" it's proving hard to find enough of a reason to do anything about it.

But if I had my time again (and I've only been investing for four years) and without the benefit of a crystal ball I think I could have done worse than stick the lot in a Vanguard account.

bostonerimus

I basically don’t believe that active managers have any ability to consistently beat the markets and over time everything reverts to the mean. Active managers have good times and bad and many of them actually believe the marketing they use to hype their funds. But I think it’s mostly numerology and pseudo science and so I always said to avoid Woodford and I would never buy Fundsmith. I think there is an argument for conservative multi-asset funds like CGT as long as the fees aren’t too high. So I look to minimize costs and that means using trackers. I use trackers for growth and rent and a DB pension for income. My trackers throw off between 2% and 3% in dividends every year which is reinvested right now, but I could spend them if I needed to. If you own active funds you could easily have lost.a lot more that the big indexes and to add insult to injury still be paying big fees for the privilege. 

bd10

I don't expect active managers to consistently beat the market. Some manage an impressive long term sharpe ratio such as Peter Spiller & team. My choice for active at present is simply for outsourcing or diversifying asset allocation in the current environment which is anything but straight forward to say the least. Going active offers also access to other strategies and alpha rather than just beta. If I wanted beta, passives have it on the cheap and cheerful. Working on the assumption that this bout of inflation and volatility across asset classes is not over yet and with a likely recession on the horizon, I would not find passive market returns of some form of bond equity blend agreeable. Right now, their tracking error is horrible but am shielded from most of the market downside. But fast forward a few years, sure, there will be plenty of trackers in my portfolio again. Am just using money managers and trackers to my advantage, not subscribing to either camp as right choice for all times.

JohnWinder

I would not find passive market returns of some form of bond equity blend agreeable (at present).

Being a ‘passive’ investor is about accepting market returns. If there’s a way to get better than market returns we should use it whether present returns are agreeable or disagreeable, surely?

‘active offers also access to other strategies’

Just be a bit careful of the ‘logic’ that:

Passive is disappointing at present,

Active is not passive, 

Therefore active will be better.

‘My choice for active at present is simply for outsourcing ….‘ 

Is this saying ‘outsourcing = better than passive’? Do we have any evidence for that, or theory that might support it?

Linton

JohnWinder said:

I would not find passive market returns of some form of bond equity blend agreeable (at present).

Being a ‘passive’ investor is about accepting market returns. If there’s a way to get better than market returns we should use it whether present returns are agreeable or disagreeable, surely?

‘active offers also access to other strategies’

Just be a bit careful of the ‘logic’ that:

Passive is disappointing at present,

Active is not passive, 

Therefore active will be better.

‘My choice for active at present is simply for outsourcing ….‘ 

Is this saying ‘outsourcing = better than passive’? Do we have any evidence for that, or theory that might support it?

There is more to investing than maximising returns.