Investing in one world fund vs multiple regional ones

Linton

IanManc said:

chiang_mai said:

JohnWinder said:

The ride up with an Index tracker can be fun but the ride down is uncontrolled, you have to go with it and you can't get out. It's for that reason alone that I much prefer a managed fund where the FM has some scope to switch funds around when things get rough in one area.’‘

Perhaps you need to finish the thought process there. You got as far as ‘I prefer a type of fund because it’s actively managed’, but what I suspect you prefer is to get the best returns you can for the level of risk you take. And that’s where the data on fund returns starts crashing into the apparent logic of your proposition.

Year after year, country after country, equity sector after equity sector, the results show that fewer than half the active managers’ funds can outperform a comparable index (ie in a similarly risky market). Here’s a recent report: https://www.evidenceinvestor.com/us-active-managers-continue-to-struggle/

Your challenge, if you prefer better than market returns without taking more risk, is to identify the small percentage of fund managers who will outperform the market over however long you’ll be investing for; or you’ll know how to choose when to abandon them if they underperform the market. When you come up with those answers you’re onto a winner choosing funds which switch around when things get rough in one area.

Lastly, one of my strict criteria for fund selection is the track record of the FM, I'm only interested in holding funds managed by FM's that are at the top of their game and have successful track records, that is after all what I'm paying for and a tracker won't allow me to meet that selection criteria.

Lots of fund managers are at the top of their game and have successful track records, e.g. Woodford. Then they are not and their successful track record shudders to a halt.

As John Winder has said, a majority of active managers underperform the market. You are not in a position to predict if or when your chosen individual's lucky/inspired results will end and, as the standard disclaimer says,  past performance is not indicative of future performance. 

Your "strict criteria" aren't strict at all. They're just a punt that someone's lucky run will last. Meanwhile, you're paying for their Porsche, which they get to keep even if you lose your shirt.

I do not think that the skills or not of the fund manager have much to do with it.  The important factor is what they invest in.  The successful managers tend to be those whose normal investment allocations happen to match the economic circumstances at the time.  That is how Woodford became a star manager.  He focussed on income and value shares.  During the Tech boom/crash his funds were barely affected and continued to produce the steady income and stability that his fund holders wanted.  In his later years he did  not go off the boil, he invested in very different types of asset.  His downfall was caused by chosing illiquid assets for a very large fund but that is another story.

So I choose active funds purely on the basis of the characteristics of their investments - geography, sector, value vs growth, size.  The aim is to keep the overall underlying structure of the portfolio constant despite the occasional excesses of the market.  This is difficult to manage with trackers whereas many active funds tend to be more consistent.

JohnWinder

It is difficult to find long term examples but comparing a straight  S&P500 index ETF as far back as the data allows with the extremely differently allocated S&P500 equal weight ETF illustrates my point.

Yes, it’s interesting that ‘equal weighting’ produces returns sometimes quite similar to cap weighting. As a result there’ll be a lot of ‘date dependence’ when comparing return figures. Looking at RSP fund vs SPY (both SP500 equal or cap weighted funds) on portfoliovisualizer with 20 years of data, the equal weighted underperformed by 0.05%/year (nothing in that) but had higher risk figures for a lower Sharpe ratio. I don’t think the trustnet graphic had risk data. And my ‘better allocation’ alluded to risk as well as return. Nonetheless, equal weighting wouldn’t be a hanging crime, although probably a bit more expensive and while ‘they’ can equal weight 500 of the biggest stocks, equal weighting the whole market means holding as much of Apple as of the smallest size stocks (of which there just isn’t enough to go around). Is the efficient market hypothesis living up to its name?

Linton

JohnWinder said:

It is difficult to find long term examples but comparing a straight  S&P500 index ETF as far back as the data allows with the extremely differently allocated S&P500 equal weight ETF illustrates my point.

Yes, it’s interesting that ‘equal weighting’ produces returns sometimes quite similar to cap weighting. As a result there’ll be a lot of ‘date dependence’ when comparing return figures. Looking at RSP fund vs SPY (both SP500 equal or cap weighted funds) on portfoliovisualizer with 20 years of data, the equal weighted underperformed by 0.05%/year (nothing in that) but had higher risk figures for a lower Sharpe ratio. I don’t think the trustnet graphic had risk data. And my ‘better allocation’ alluded to risk as well as return. Nonetheless, equal weighting wouldn’t be a hanging crime, although probably a bit more expensive and while ‘they’ can equal weight 500 of the biggest stocks, equal weighting the whole market means holding as much of Apple as of the smallest size stocks (of which there just isn’t enough to go around). Is the efficient market hypothesis living up to its name?

Yes, if the efficient market hypothesis applies then there is no advantage in market cap weighting.  Each stock is priced at the "correct" level to give the same returns. You could use any allocctions you wanted as long as you are sufficiently diversified to avoid major hits from single point failures and to catch localised gains.  But you do need a reason for doing. I cannot see the risk for which equal weightng is the answer and it does seem intuitively wrong.

Which supports my point that market cap weighting is not uniquely optimal.  You can can allocate to meet other objectives such as avoiding single point failures or reducing volatility without sacrificing performance.

JohnWinder

Prism said:

For someone who wants the probability of the best returns for a given level of risk, then either a simple global tracker or a multi-asset fund of regional trackers and bonds, is all that anyone needs.

However many of us have other goals in addition to getting some decent returns. It could be to provide a certain level of dividend income (not for me but some like this approach). Or attempting to avoid some of the largest downturns by under weighting sectors of the market, like tech or energy. Some like to hunt for lower valuations which can be another way of reducing risk and/or boosting returns. 

For those aspects of investing, throwing out the option of managed funds simply because most of them underperform at any given time, seems a bit blinkered to me.

Other goals is a good point. I think choosing market cap weighting is about trying to get the best risk adjusted returns; the efficient market hypothesis suggests there’s no better selection of stocks if you want the highest return for the least risk. But if you want dividends paid fortnightly, and only a non-tracker will do that, then certainly you need the non-tracker. Some folk might like to make an estimate of what they’re giving up in terms of returns/risk for those frequent dividends.

But underweighting tech or energy to miss the big downturns might mean missing the big upturns; so you finish with lower returns and lower risk, but which dropped the more? I think you need to see some historical data or have some theoretical basis for thinking that that approach is better than simply holding less in stocks (lower risk) and getting lower returns. 

Finally I think it’s easy to test what the history has been with respect to choosing lower valuation stocks to get a better risk/return mix; in fact if it worked there’d be dozens of active funds doing it and beating the cap weighted indexes year after year.

JohnWinder

Linton said:

‘I do not think that the skills or not of the fund manager have much to do with it.  The important factor is what they invest in

So it’s more luck than skill, you’re suggesting. I think the research supports this.

So I choose active funds purely on the basis of the characteristics of their investments - geography, sector, value vs growth, size.  …….The aim is to keep the overall underlying structure of the portfolio constant despite the occasional excesses of the market.  This is difficult to manage with trackers whereas many active funds tend to be more consistent.

What this leaves us with is a whole smorgasbord of funds to choose from, and we choose funds on the basis of sector, size, geography etc. That’s simply moving the choice of ‘how do we get the best risk adjusted returns?’ fromthe fund manager to the consumer. On reflection, I suppose that’s always been the case, but if the customer doesn’t have the skill, the wisdom of their choice comes down to luck. Not for this little brown duck.

Prism

coastline said:

Two of your funds set below with the global index as a marker and at which point did you identify the successful trend/outperformance. At some point you might have to lock in profit as it's no good holding if they start to underperform the benchmark. There's not much in it from 2018-2021.

Chart Tool | Trustnet

Good example here with investment trusts and a BG trust SMT. Three IT's are now underperforming over 5 years. SMT went parabolic then crashed although it's still ahead over 5 years. Think everyone would have been kicking themselves not selling SMT at some point recently. So a stop loss/protect profit is needed I reckon. 

Chart Tool | Trustnet

I use technical analysis ( not for everyone ) and trade short term. A longer term view here of SMT set to monthly timeframe and selling at the 5 month moving average would have kept you out of trouble in the crash. There's other points on there which would have resulted in short term sales but damage limitation is key. Nothing stopping buying and selling funds using similar methods.

  Scottish Mortgage Investment Trust PLC, UK:SMT Advanced Chart - (LON) UK:SMT, Scottish Mortgage Investment Trust PLC Stock Price - BigCharts.com (marketwatch.com)

I would think differently about it. When a fund underperforms the index I would usually look to add more rather then lock in some profit or get out. Unless something has changed about the way that the fund allocates capital or something else in the world has changed fundamentally which makes the original investment case problematic.

I don't currently hold SMT but did for a few years. I used to to access some IPO ready private equity more than anything else. When Schiehallion and Chrysalis launched I sold SMT to buy those. Schiehallion became problematic to buy (no sellers) so stuck with Chrysalis. Chrysalis is an example of a very volatile trust, more so than SMT, with huge rises and falls. It is currently down 75% from its peak but I still hold, have bought a bit more and I am not kicking myself - never even thought of it. No stop losses required, just invest long term and ignore the price along the way.

chiang_mai

Firstly, I have no axe whatsoever regarding trackers vs managed funds, I merely have a view that I have developed over time which suits my personal circumstances. People often cite the failure of actively managed funds to outperform trackers and that trackers consistently provide the best return. I think this misses the point in that most people are not looking for the very best return, most people are looking for an acceptable or good level of return, within the constraints of their personal risk. In the case of older people and others who still invest in equity funds but may not have the time horizon needed to reach the target return, trackers don't always make sense. They also may not make sense to others who can't wait five or seven years for effective fund maturity. If the market turns down, the tracker will follow it down and it will take time to recover. I don't know what others think an FM's job comprises but in reality it includes avoiding the full impact of any correction or crash, where ever possible and there are many ways to do that. This is extremely important to me currently because markets are so volatile. Once again, I think trackers for the US market are a perfect solution for many people, because it is so huge but for other markets it is unclear to me. The important part is that trackers are perfect for many but not for all, depending on your age and circumstances which must be factored in.

Somebody asked earlier about tactical allocation which is a technique that some FM's use but it's also one that I use. I follow US economics quite closely, on a daily basis, with 48% invested in US markets I think this is essential. This means spending a lot of time watching bond and equity markets, watching and listening to the Fed, reading all the releases, watching the US DI and the VIX, it's very time consuming. Sometimes I develop a different view from some of the funds I hold, sometimes my view is correct and sometimes it's not. I took a view in late July that markets would turn down so I went heavily into Money Market funds and my equity holdings fell to just 29%. Only one other FM that I hold shared the same view, JPM went heavily into cash also. This was a tactical move based not on fund performance but on my forward view of the economic state of play in the US, which is really the role of equities in the first place. It turned out to be the right thing to do and I avoided loss. Other younger investors that I know beat me up for coming out, mostly they did so because they rigidly adhere to the buy and hold philosophy, which for them, is probably the right thing to do. 

In another example of tactical investing, one of my FM's switched out of one geographic market and into another, because all the indicators were that the initial market was going to stall, this is Japan vs China and is WIP but the switch has been made and I think it was a good move. But you can only make moves like that, if you hold funds that allow the FM  to switch, if you hold a single country fund, the FM may have nowhere to go.

JohnWinder

You clearly know where you’re going, but I see some of that from a different side.

 I think this misses the point in that most people are not looking for the very best return, most people are looking for an acceptable or good level of return, within the constraints of their personal risk’

That makes no sense to me. Most people, having accepted a level of risk would want the best return for that risk, otherwise why not take less risk? Yes, a few will prefer the fund that pays frequent dividends which might compromise their opportunity for the best risk adjusted return, but that doesn’t include any sizeable minority.

‘. In the case of older people and others who still invest in equity funds but may not have the time horizon needed to reach the target return, trackers don't always make sense. They also may not make sense to others who can't wait five or seven years ’

Indeed, but no equity fund would for such short periods surely.

‘an FM's job … includes avoiding the full impact of any correction or crash, where ever possible’

Yes, but how many achieve that, and how do we identify in advance those who will?

‘Active funds underperformed their passive benchmarks during the COVID-19 crisis.’

‘— 57.6% of funds underperformed their FTSE/Russell benchmark indices and 54.2% of funds underperformed their prospectus benchmarks. The average fund underperformance relative to the FTSE/Russell benchmark was −2.1% (t = −3.90), or −11% on an annualised basis. Relative to the prospectus benchmark, the average underperformance was −1.5% (t = −2.49), or −7.7% annualised.’

 https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3648302&download=yes 

Qyburn

JohnWinder said:

‘Active funds underperformed their passive benchmarks during the COVID-19 crisis.’

They're picking a very short and specific period from which to draw their overall conclusion. From the high point in Feb to end of April. Wouldn't real investors be more interested in performance over the whole year or longer? If this was science I'd be suspecting the authors of cherry picking a period thst supported their prior views.

By the way, in the UK did anyone's fund recover by end of April? I don't think my pension did until more like July.

JohnWinder

That’s a valid point. The authors might have chosen that period because it was the biggest steepest fall in equity market values in the last ?10 years when it was written. Nonetheless, one swallow does not a summer make.