Active vs Passive

Linton

NoviceInvestor1 said:

Linton said:

NoviceInvestor1 said:

10 carefully chosen active funds would be a closet tracker that most likely underperforms the index…..a bit of everything but with higher fees. 

But seeing this is the suggested course of action let me ask;

which 10 funds do you think will outperform the index over the next 5 years?

Look at the the largest holdings in the portfolios and the country and size allocations.  They hardly represent a closet tracker.

I have no idea which funds will outperform the index over the next 5 years and dont care. 5 years is little better than random and out-performing the index is not a criteria for choosing a fund.  I dont care what the index does.  The only consideration for my investments is that as a whole they continue to meet my on-going needs at a low risk.  The high level strategy to achieve this is to invest equity for the long term as broadly as possible, more broadly than a cap weighted index, and to allocate assets, both equity and non-equity to minimise risk in the short/medium term.

I think most people pick actives with the intention of outperforming an index. Fair enough if you have no intention to do so. 

If someone has no intention whatsoever of outperforming an index, then choosing actives is a very easy task to be fair. 

Which type of equity funds do you perceive as lower risk? I've seen people refer to the likes of Baillie Gifford Managed as low risk in the past which is mind boggling. 

CHoosing appropriate active funds is not straightforward if one is tagetting overall allocations. A particular example is that in the past 10 years plus a lot of "normal" funds that would be useful for particular characteristics have chased higher risk growth.  Competition I guess means they have had to.  So one may like say a particular European small companies fund.  Look into it more closely and you find out that it is highly invested in specualtive companies so you may have to choose a US small companies fund that is more defensive.  There is an optimisation problem to choose the set of funds that overall provide the best balance.

My safer funds are CGT and Troy Trojan, arguably the two main Wealth Preservation funds.  They include both equity and fixed interest and manage these to minimise medium term volatility.  I would guess a more cautious risk targetted multi-asset fund may do a useful job.

Looking at pure equity funds the best I can see for lower risk are those in the Equity Income sector as income is broadly a proxy for Value and Defensive.  Sadly although there are plenty of funds overweight in tech and other higher growth areas I do not know of any funds deliberately avoiding these.  One has to use Morningstar to look at the details of specific funds as there can be considerable variation within individual sectors.

NoviceInvestor1

I agree with your comments, and a lot of funds that were seen as safe have shown to be far from it now the macro environment has changed for the first time in over a decade. 

Trojan and CGT are definitely ones that enable holders to sleep at night for sure. I’m not quite ready for them but imagine I’d hold either/both in future. 

adindas

coastline said:

Much can happen in 10 years, 1987 crash ,gulf war , 1998 currency , dotcom 2002 , GFC 2008 , 2018 correction , covid 2020 and now another slowdown with rate rises and inflation. The window for equities realistically should be 15 years at least.
In the equity allocation I'd go with a global tracker as the core holding then I'd add a couple of funds alongside and see how it goes. Active allocation would go to Fundsmith as it's weathered many storms in it's 12 years history. 

Chart Tool | Trustnet

I'd also add in the momentum ETF as it's also ticking along nicely despite recent events. So active and passive with a bit of edge . ?

Chart Tool | Trustnet

Over the long run, it seems to me Baillie Gifford is better ??

MK62

NoviceInvestor1 said:

Fundsmith has a very short track record which coincided with low inflation, minimal interest rates and a resultant significant rerating of quality growth stocks/bond proxy stocks. The moment those factors have changed it's struggled badly (actually arguably it's struggled a few years if you look at the returns since 2019 compared to the MSCI World Quality Index which is a suitable benchmark). Really this is the first storm it has faced in 12 years and it's hardly weathered it well IMO.  

This is where the lines get quite blurry.......MSCI World Quality Index could easily be mistaken as the basis for an global active fund......and could easily be described as an active index.....

 "The MSCI Quality Indexes are designed to reflect a quality growth investment strategy by identifying stocks with historically high return on equity, stable year-over-year earnings growth, and low financial leverage"

This sounds very similar to an active strategy......a fund's fact sheet could easily read...

 "Acme Select Global Equity is designed to reflect a quality growth investment strategy by identifying stocks with historically high return on equity, stable year-over-year earnings growth, and low financial leverage"

older_and_no_wiser

adindas said:

Over the long run, it seems to me Baillie Gifford is better ??

Well, if you dumped in £100,000 in that BG fund in Nov 2021 you may be on the verge of a breakdown currently. If you put that money before 2020, then you'll be sitting fine. We have no idea how any fund will perform in the future. BG hit lucky with Tesla - finding them at the right point. I think that explains the dramatic rise in fund value. Same with their American fund. It has dropped dramatically though recently (around 40-50% in the last 18 months).  Can they find the next Tesla? Personally, I would rather stay slow and steady with a passive global index or multi asset fund. 

adindas

older_and_no_wiser said:

adindas said:

Over the long run, it seems to me Baillie Gifford is better ??

Well, if you dumped in £100,000 in that BG fund in Nov 2021 you may be on the verge of a breakdown currently. If you put that money before 2020, then you'll be sitting fine. We have no idea how any fund will perform in the future. BG hit lucky with Tesla - finding them at the right point. I think that explains the dramatic rise in fund value. Same with their American fund. It has dropped dramatically though recently (around 40-50% in the last 18 months).  Can they find the next Tesla? Personally, I would rather stay slow and steady with a passive global index or multi asset fund. 

The current price is 789p, the NAV value is currently 861p.

https://www.hl.co.uk/shares/shares-search-results/s/scottish-mortgage-it-plc-ordinary-shares-5p

But we should not be entirely rely on the NAV as they often wrong and also keep changing.

This is a concentrated portfolio containing high growth stocks. They are very volitile, for that reason, imo it is not a good idea to dump lumsump £100k in one go. High growth stocks will suffer the most in the period of high interest rate and fear of recession.

To me if they fall below the previous support level e.g around 722p I will restart my DCA generator again around that area. If they rise reaching the [previous resistance level at around 930p I will sell a fraction of it. This is just my personal preference.

Linton

Deleted_User said:

Linton said:

NoviceInvestor1 said:

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?

Personally, I also want less exposure to the USA than a global equities tracker would give. But why does that require going active? You can use trackers for regions of the world (which are very cheap!) to give you your desired exposure to each region. So why active?

Increasing small cap exposure (which I also do) is IMHO more of a reason to go active, though it's not the only way. There are small-cap trackers. However, the global ones are heavily weighted to the USA again, and the regional ones are often not all that cheap. So I can see more reason to use active here. I have a global small cap trackers, supplemented with active vehicles for non-USA regions.

I do have separate regional large and small company funds. That requires perhaps 6-12 funds in total depending on how one allocates to the UK, Japan and SE Asia vs EM. But then managing value vs growth and other factors adds further, probably global, funds. These will need to be active as factor passive funds do not seem very successful and are limited in availability.

To keep the number of funds and the management effort to a minimum it is easiest for the geographic funds to also assist with the factor allocations.  So one major criterion for shortlisting a geographic fund at the moment is recent performance as this weeds out those with higher growth allocations than I want. Obviously normal index funds would fail at the first hurdle.

If the data showed that using a passive fund did not did not make overall allocations more difficult and provided clear performance advantages then I may use one.  

However I cannot get excited about annual charge differences smaller than the normal daily variation in fund value. For example my active US large company fund was bought many years ago and kept as there has been no need to change.   It returned 334.5% over the past 10 years. The Vanguard US index fund returned 335.4% over the same time.  

noclaf

Linton said:.

I do have separate regional large and small company funds. That requires perhaps 6-12 funds in total depending on how one allocates to the UK, Japan and SE Asia vs EM. But then managing value vs growth and other factors adds further, probably global, funds. These will need to be active as factor passive funds do not seem very successful and are limited in availability.

To keep the number of funds and the management effort to a minimum it is easiest for the geographic funds to also assist with the factor allocations.  So one major criterion for shortlisting a geographic fund at the moment is recent performance as this weeds out those with higher growth allocations than I want. Obviously normal index funds would fail at the first hurdle.

If the data showed that using a passive fund did not did not make overall allocations more difficult and provided clear performance advantages then I may use one.  

However I cannot get excited about annual charge differences smaller than the normal daily variation in fund value. For example my active US large company fund was bought many years ago and kept as there has been no need to change.   It returned 334.5% over the past 10 years. The Vanguard US index fund returned 335.4% over the same time.  

Hi Linton,

Re. Fund fees, what are your parameters in terms of what you would be willing to pay for a fund e.g: is there a max upper limit for fees? Interested in this as face a similar dilemma in my work pension choosing between active/passive funds.

Linton

noclaf said:

Linton said:.

I do have separate regional large and small company funds. That requires perhaps 6-12 funds in total depending on how one allocates to the UK, Japan and SE Asia vs EM. But then managing value vs growth and other factors adds further, probably global, funds. These will need to be active as factor passive funds do not seem very successful and are limited in availability.

To keep the number of funds and the management effort to a minimum it is easiest for the geographic funds to also assist with the factor allocations.  So one major criterion for shortlisting a geographic fund at the moment is recent performance as this weeds out those with higher growth allocations than I want. Obviously normal index funds would fail at the first hurdle.

If the data showed that using a passive fund did not did not make overall allocations more difficult and provided clear performance advantages then I may use one.  

However I cannot get excited about annual charge differences smaller than the normal daily variation in fund value. For example my active US large company fund was bought many years ago and kept as there has been no need to change.   It returned 334.5% over the past 10 years. The Vanguard US index fund returned 335.4% over the same time.  

Hi Linton,

Re. Fund fees, what are your parameters in terms of what you would be willing to pay for a fund e.g: is there a max upper limit for fees? Interested in this as face a similar dilemma in my work pension choosing between active/passive funds.

I dont consider fees at all.  All published performance data is after fees.  If two funds investing in the same way achieve similar results does it matter that one manager may make greater profits, hire more expensive staff etc etc? These days the difference in fees between similar funds is normally marginal, less important than say the choice of day on which to buy or sell. My choice of funds is overwhelmingly based on what they invest in determined either directly or through proxy data.

Some sectors are inherently expensive.  The most obvious example is directly held property where owning property is obviously more expensive than owning shares.  However directly owned proprety may have investment characteristics that are important to you.

When doing your weekly shopping do you choose the supermarket with lowest gross profit so as to minimise the "fees"?  After all the fees go directly onto the price of the baked beaqns.  Or perhaps you go to the one that sells the products you want to buy at prices you are prepared to pay.  Another example is savings accounts.  Banks dont tell you their fees, but you can be pretty sure they are higher than with many equity funds. That does not prevent you using savings accounts if that is the product you want.

These considerations dont apply to passive funds since once you have chosen your desired index and replication method then the product has been pretty much fully defined.  You may as well use the charge level as the differentiator.  With active funds, each one is unique. That is what makes them useful.

NoviceInvestor1

Fees are the only reliable tool that gives an indication of future performance - lower cost funds perform better than higher cost according to various studies.

It's all well and good saying "x fund delivered y performance after fees" but we know for a fact that there is no such thing as performance persistence in active management. As such keeping costs down seems an important aspect to maximising returns.

If a fund charges 1.5% then to outperform an index then they have to beat that index by 1.5%+ a year just to break even.

If someone is hoping for say 2% p/annum outperformance (seems reasonable for taking on the manager risk of active management, though your mileage may vary) then you'd need the fund to deliver 3.4% more than the index (assuming a passive tracking that index can be bought for 0.10%) to deliver 2% net outperformance. 

That seems wildly optimistic when we know that 90% of funds don't beat the index over the long run (i.e. S&P 500).

Other indexes have different success rates, and some posters may not mind paying big fees for active management to underperform against an index i.e. lower risk is more important than higher returns. Some funds don't have a suitable benchmark too which is worth keeping in mind.