Active vs Passive

Cus

This is an interesting subject. Would the average DIY investor have removed their funds in Woodford later than the knowledgeable DIY investor, and would they be later than an IFA, and would they be later than a personal wealth manager (with full discretion).  I think, in general, yes.

Prism

Cus said:

This is an interesting subject. Would the average DIY investor have removed their funds in Woodford later than the knowledgeable DIY investor, and would they be later than an IFA, and would they be later than a personal wealth manager (with full discretion).  I think, in general, yes.

Well the average investor shouldn't have touched Woodford funds in the later years if they were following any semblance of the do not invest in what you do not understand guidance. However, that clearly didn't happen, both in the case of large investors like county councils and small investors following glossy adverts and recommendations.

bostonerimus

If you invest in an active fund you might beat the closet benchmark - and you might not. I see indexing as a way to get market returns and control risk. I'm never tempted by the likes of Woodford or go off chasing returns in risky small markets. I use a simple portfolio of mostly index funds and don't actively manage it to keep my blood pressure down and to stop me from doing stupid things. I used some of it to buy into a DB plan (could have been an annuity) so that I did not have to worry about income generation from drawdown. My portfolio is built for a quiet life whatever the markets are doing.

Linton

Deleted_User said:

Prism said:

I'm not sure anyone said that nobody could beat it and the main focus at the time was that idea that because of high fund fees, those that could beat it tended to reap the benefits and their clients still underperformed.

………

Or, if you prefer: some investment strategies are better suited to different investment conditions, and so all strategies will have unrepresentatively good, and unrepresentatively bad, periods of performance. ….. 

This is the key point. Looking for good or bad managers is a secondary matter.  And it is not simply a matter of luck. Different strategies will be optimal at different times.  Different strategies will be appropriate for different objectives.  It is the strategies on which we need to focus.

As with much of investing, the difficulty is with timing. Unless one has remarkable skills at predicting the future, the answer is diversification. Which is where my primary concern with index investing lies. The positive side of indexing is that it protects investors from their instinctive reaction to go overboard on what seems to  have worked in the recent past. On the other hand the markets themselves are not immune to this failing. Also, the strategies adopted by the average investor as represented by the index may not be those most appropriate to the objectives.

So in the same way as one may seek to maintain a balance across equities and bonds it is important to ensure that a portfolio encompasses a balanced range of strategies appropriate to one’s objectives.

Of course there are a relatively small number of factor based index funds. But in general they seem not to perform well. The reason I believe is that choosing appropriate underlying investments requires some judgement and due diligence.

Simple criteria applied blindly may not distinguish between genuine characteristics and temporary artefacts. A possibly desirable features such as a high yield may have arisen from recent falls in the share price or may be maintained despite deep financial issues.  What is the difference between high Momentum and over-enthusiasm? 

There is also the matter of diversification. For example until the 2008 crash the banks were major dividend payers and formed what turned out to be a catastrophically high % of at least one index funds’ portfolios.

NoviceInvestor1

Linton said:

As with much of investing, the difficulty is with timing. Unless one has remarkable skills at predicting the future, the answer is diversification. Which is where my primary concern with index investing lies. 

Are you suggesting the MSCI ACWI index (a vanilla global tracker) with 3000 ish holdings across growth, value and everything in between is LESS diverse than an active fund which typically has 30-40 holdings and a big overweight to a single factor?

The lack of diversification in global funds is the reason that a massive % have underperformed the index this year during the market rotation. 

JohnWinder

 Also, the strategies adopted by the average investor as represented by the index may not be those most appropriate to the objectives.

So, just one example of that would be informative.

banks were major dividend payers and formed what turned out to be a catastrophically high % of at least one index funds’ portfolios.

Do you recall which fund that was, or what the index was?

Linton

JohnWinder said:

 Also, the strategies adopted by the average investor as represented by the index may not be those most appropriate to the objectives.

So, just one example of that would be informative.

banks were major dividend payers and formed what turned out to be a catastrophically high % of at least one index funds’ portfolios.

Do you recall which fund that was, or what the index was?

a) High growth tech vs value.

b) IUKD which invests in uk dividend paying companies, so nothing obscure. It fell by 60% in 2008 and without dividends re-invested has yet to recover. With dividends re-invested (IIRC) it passed its 2006/7 high in around 2017.  However I doubt people bought it to re-invest the dividends.

adindas

Prism said:

Of all of the markets, the US is the most well researched and efficient - very difficult to beat an index over time. Other areas of the world offer better chances of success mainly due to being less well known. That said, beating a low return index isn't especially cause for celebration

There are plenty of examples of really good fund investors who have achieved such results, however the question as always is can we pick them ahead of time? Individual investors trying to select their own stocks might get lucky for a while but would really have a hard time up against the mass data of the institutional investors.

Market well research does not necessarily mean the market is efficient. The billionaire, proven investors such as Warren Buffet, Peter Lynch, Howard Marks do not believe in Efficient Market Hypothesis (EMH)

Many people could see that we are currently in the bear market. Inflation is soaring, particularly index with high content of growth stock such as Nasdaq fall significantly. But the people interpret and thus react to the market differently.

There is exuberance in the market. While some people are doing panic selling, the contrarian might see that as an opportunity to get quality investment at a bargain price. This might lend to a better understanding of the market, fundamental analysis of particular asset / investment, and technical analysts by analysing anything in relation to the volume/price action.

JohnWinder

a) High growth tech vs value.

b) IUKD which invests in uk dividend paying companies,

It seems like your concern with index fund investing is that there are not-so-good indexes that some funds track, and so say all of us.

I suspect that as investor money has poured out of active funds into index funds the financial services industry has seen there’s money to be made offering investors index funds, but as established index managers were already offering good broad index funds different new products were needed, both new indexes and new funds. There’s a lot of dross there.

Here’s some thoughts on how to choose a good index, for a USA investor; there’ll be something similar in the UK space which is likely to be ‘go broad and global cap weighted’.

https://www.bogleheads.org/blog/2022/05/06/bogleheads-live-episode-03-picking-index-funds/ 

High tech or value are choices to tilt away from cap weighted; fine if you go into it with your eyes open.

IUKD would be another example of moving away from cap weighted to a tilt towards a particular characteristic of stocks. They have their time in the sun, and out of the sun compared with a broad cap weighted fund.

Neither are evidence that index fund investing should be cause for concern.

Linton

NoviceInvestor1 said:

Linton said:

As with much of investing, the difficulty is with timing. Unless one has remarkable skills at predicting the future, the answer is diversification. Which is where my primary concern with index investing lies. 

Are you suggesting the MSCI ACWI index (a vanilla global tracker) with 3000 ish holdings across growth, value and everything in between is LESS diverse than an active fund which typically has 30-40 holdings and a big overweight to a single factor?

The lack of diversification in global funds is the reason that a massive % have underperformed the index this year during the market rotation. 

Rather a strawman type of argument....

1) No-one suggests that a single small  active fund is more diversified than the NSCI ACWI index.  No sensible inbvestor would buy a single niche 30-40 holding active fund with a big overweight to a sibgle factor.  I would suggest that say 10 carefully chosen active funds could provide a more diversified portfolio than the MSCI ACWI.

2) Many active funds have more than 30-40 holdings.  Acording to Morningstar ishares version of ACWI has 1621 holdings.  The interesting figure would be what % of the total value is taken up by say the smallest 50% of the holding but I cannot find ther numbers.  It would be expceted that an active fund's allocation would be much more broadly spread sibnce the is no point in it holding an extremely small % of an individual share.

3) Diversification is difficult to quantify.  However It is clear to me that Cap Weighting does not help. Looking at Morningstar data in my own portfolio the largest 10 underlying holdings represent about 7% of the total.  For the MSCI index it is 14%.  The MSCI Index's allocation to Microsoft and Apple alone is larger than the whole of my top 10.  All the MSCIs top 10 are US companies compared to my 6.

Looking at country allocation, North America is 64% of the MSCI index and Asia ex Japan 10 %, mine North America 42% and Asia ex Japan 16%.

Sector allocations are comparable.

Company size - MSCI large companies is 82% mine 51%.  However I am looking to increase the 51% to around 60%.

Which portrfolio is the more diverified?  What other measures wold you use?