Author Topic: Dogmatism towards Active Management  (Read 6989 times)

tj

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Dogmatism towards Active Management
« on: March 30, 2015, 01:12:11 PM »
I'm not sure if it's a lot of people or a couple of really loud people, but i've noticed some dogmatism towards active management on this board, though certainly not at the level of Bogleheads, but it's getting there.

I have to disagree with those who will just categorically reject active management. There's a lot of garbage out there to be sure, and the argument is usually that most actively managed funds have not survived, but how many of those had low management costs e.g. those at Vanguard?


Wellington Management and PRIMECAP Management are two firms in particular who have been vetted by Vanguard for a long time. In some cases, these funds have the same expense ratio as a LifeStrategy or Target Date Fund. Unfortunately, you can't go back in time and invest, but are we really going to discount the success of these types of funds to "they got lucky" ? Someone who went all in with Vanguard Health Care Fund, managed by Wellington, back in 1984 would have been rewarded quite well today.

If I want to invest in dividend stocks and corporate bonds, I can try to manage my own indexes, or I can just pay Wellington to do it for me. I don't think that Wellington is a terrible fund choice, but I do think that paying Wellington to micromanage your portfolio via Wellington Fund is a whole lot cheaper in the long run than paying some financial advisor to put you in various index funds...I could be wrong.

I think that for an institution, indexing is a no brainer - because of the sheer volume of capital inflow, but for the individual investor, I think they would be wise to consider some of the Vanguard active offerings rather than be dogmatic towards them because "active is bad".

marty998

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Re: Dogmatism towards Active Management
« Reply #1 on: March 30, 2015, 02:16:31 PM »
Yes there are a few here and there that say "you must index or you will die".

I can pick several active mangers that have outperformed over the very long term in various asset classes. Magellan and Platinum in Australia, and First State Investments in the UK spring to mind.

Sure you pay through the nose for it, but geez, if you can outperform by several % after fees over 10+ years it makes an astonishing difference.

surfhb

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Re: Dogmatism towards Active Management
« Reply #2 on: March 30, 2015, 02:25:15 PM »
It's not index or die but the fact I've never met anyone who has been investing a longer period of time that was able to beat the street.      There are plenty of books which explain the math behind it.   

I don't take chances like that with my investment portfolio.    If it's a passion, hobbie or just plain challenge for you, then go for it.   

tj

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Re: Dogmatism towards Active Management
« Reply #3 on: March 30, 2015, 02:27:07 PM »
It's not index or die but the fact I've never met anyone who has been investing a longer period of time that was able to beat the street.      There are plenty of books which explain the math behind it.   

I don't take chances like that with my investment portfolio.    If it's a passion, hobbie or just plain challenge for you, then go for it.

Do you invest 100% VTWSX? If not, why not?

seattlecyclone

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Re: Dogmatism towards Active Management
« Reply #4 on: March 30, 2015, 02:31:02 PM »
It's not that active management is "bad" necessarily. However I've seen studies showing that the average actively-managed fund performs about the same as an index fund before management fees are added. Also, I've seen other studies showing basically no relationship between whether a fund outperformed over the past N years and whether it will continue to outperform for the next N years...therefore we can only conclude that outperformance is more often attributable to luck than skill.

Given all of that, when I'm looking at all of the funds that have outperformed an index recently, how am I supposed to pick out the very rare skilled manager out of a sea of lucky ones?

I don't have time to do that much research into these people. Give me an index fund and I'll be happy enough with the results over the long term. Your mileage may vary.

mtn

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Re: Dogmatism towards Active Management
« Reply #5 on: March 30, 2015, 02:40:35 PM »
Actively managed funds can be better than the index funds. Some, maybe many, are, even in the long term.

The index funds though are hitting the easy button.

Jags4186

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Re: Dogmatism towards Active Management
« Reply #6 on: March 30, 2015, 03:05:37 PM »
I have no problem with active funds.  In the mutual fund world they are your only chance of beating the index you choose to mirror.

What you have to realize is that something like only 10% of active mutual funds beat the broad market over the very long term.  So if you just pick 1 actively managed mutual fund to invest in you have a 10% or so chance of outperforming the market.  If you are investing in multiple active mutual funds you have an even smaller chance of beating the market.

tj

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Re: Dogmatism towards Active Management
« Reply #7 on: March 30, 2015, 03:15:09 PM »
I have no problem with active funds.  In the mutual fund world they are your only chance of beating the index you choose to mirror.

What you have to realize is that something like only 10% of active mutual funds beat the broad market over the very long term.  So if you just pick 1 actively managed mutual fund to invest in you have a 10% or so chance of outperforming the market.  If you are investing in multiple active mutual funds you have an even smaller chance of beating the market.

I agree with this, but the universe of funds includes funds with loads, funds with 2% management fees.


I'm not aware of any studies that has focused solely on low-ER active funds vs index funds.

I've always believed that the goal is to keep your costs low, but that the difference between 10bps index fund and a 30 bps no-load active fund is much smaller than the difference between a 2% active fund with a 5% load.

tj

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Re: Dogmatism towards Active Management
« Reply #8 on: March 30, 2015, 03:16:18 PM »
It's not that active management is "bad" necessarily. However I've seen studies showing that the average actively-managed fund performs about the same as an index fund before management fees are added. Also, I've seen other studies showing basically no relationship between whether a fund outperformed over the past N years and whether it will continue to outperform for the next N years...therefore we can only conclude that outperformance is more often attributable to luck than skill.

Given all of that, when I'm looking at all of the funds that have outperformed an index recently, how am I supposed to pick out the very rare skilled manager out of a sea of lucky ones?

I don't have time to do that much research into these people. Give me an index fund and I'll be happy enough with the results over the long term. Your mileage may vary.

Vanguard has doen the research for you. See http://www.vanguard.com/pdf/s356.pdf

Dodge

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Re: Dogmatism towards Active Management
« Reply #9 on: March 30, 2015, 05:31:06 PM »
Also, I've seen other studies showing basically no relationship between whether a fund outperformed over the past N years and whether it will continue to outperform for the next N years...therefore we can only conclude that outperformance is more often attributable to luck than skill.

Precisely.  Considering the overwhelming data we now have on active vs. passive, I sometimes wonder why people advocate for active management at all...then I remember.  It's the same reason why we have so many newcomers to the forums asking about Betterment (0.31-0.51% ER), and not LifeStrategy (0.16% ER) or WiseBanyan (0.11% ER), despite their offerings being largely the same.  The reason why people in the 1930's suddenly started getting the idea that a diamond ring (worth a certain multiple of the man's monthly salary) is a requirement to get married.  The reason why people work til the day they die to buy clown cars, when there are cheaper cars available which are largely alike (and you could claim this is a clown car too).  I could go on and on...I think we all know the answer here:

Marketing.

rpr

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Re: Dogmatism towards Active Management
« Reply #10 on: March 30, 2015, 05:41:59 PM »
...
I could go on and on...I think we all know the answer here:

Marketing.

Plus people associate getting the return from the index as being average. We all want to be above average.  Reminds me of Garrison Keillor's Lake Wobegon:

Quote
"where all the women are strong, all the men are good-looking, and all the children are above average."

tj

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Re: Dogmatism towards Active Management
« Reply #11 on: March 30, 2015, 05:46:32 PM »
....what marketing has Wellington (or Vanguard) done for the Wellington fund?


I haven't seen any.

Indexer

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Re: Dogmatism towards Active Management
« Reply #12 on: March 30, 2015, 06:03:48 PM »
....what marketing has Wellington (or Vanguard) done for the Wellington fund?


I haven't seen any.

Your argument that active funds aren't popular just based on marketing is that an index company that spends very little on advertising to begin with didn't advertise its active fund that is so big it has had to refuse new investments in recent history. 

"Here let me take my minimal advertising money and spend it advertising something that can't actually take in any new money anyway instead of spending those advertising dollars advertising my core business...."[/sarcasm]

Lets compare that to American Funds/Putnam/Franklin Templeton/etc. who pay advisors and brokerage firms about 5% up front and 0.25%-1% ongoing to sell their crap.  Then the brokerage firms and the mutual fund companies spend billions on advertising.  I wonder which group Dodge was referring to. ;)

tj

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Re: Dogmatism towards Active Management
« Reply #13 on: March 30, 2015, 06:11:26 PM »
....what marketing has Wellington (or Vanguard) done for the Wellington fund?


I haven't seen any.

Your argument that active funds aren't popular just based on marketing is that an index company that spends very little on advertising to begin with didn't advertise its active fund that is so big it has had to refuse new investments in recent history. 

"Here let me take my minimal advertising money and spend it advertising something that can't actually take in any new money anyway instead of spending those advertising dollars advertising my core business...."[/sarcasm]

Lets compare that to American Funds/Putnam/Franklin Templeton/etc. who pay advisors and brokerage firms about 5% up front and 0.25%-1% ongoing to sell their crap.  Then the brokerage firms and the mutual fund companies spend billions on advertising.  I wonder which group Dodge was referring to. ;)

Only an idiot would invest in something with a 5% load, a 1% 12b1 and a 2% expense ratio. I was talking about low cost actively managed funds that could be beneficial. it's not necssarily just Vanguard. You could look at Dodge & Cox, PRIMECAP or Mairs & Power. You are never oging to see these firms advertise on TV. They don't pay advisors to bring in assets.

I don't accept the premise that the only reason active management should exist is because some companies have ridiculous marketing budgets and take advantage of the uneducated.

Dodge

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Re: Dogmatism towards Active Management
« Reply #14 on: March 30, 2015, 08:09:21 PM »
....what marketing has Wellington (or Vanguard) done for the Wellington fund?


I haven't seen any.

Your argument that active funds aren't popular just based on marketing is that an index company that spends very little on advertising to begin with didn't advertise its active fund that is so big it has had to refuse new investments in recent history. 

"Here let me take my minimal advertising money and spend it advertising something that can't actually take in any new money anyway instead of spending those advertising dollars advertising my core business...."[/sarcasm]

Lets compare that to American Funds/Putnam/Franklin Templeton/etc. who pay advisors and brokerage firms about 5% up front and 0.25%-1% ongoing to sell their crap.  Then the brokerage firms and the mutual fund companies spend billions on advertising.  I wonder which group Dodge was referring to. ;)

Only an idiot would invest in something with a 5% load, a 1% 12b1 and a 2% expense ratio. I was talking about low cost actively managed funds that could be beneficial. it's not necssarily just Vanguard. You could look at Dodge & Cox, PRIMECAP or Mairs & Power. You are never oging to see these firms advertise on TV. They don't pay advisors to bring in assets.

I don't accept the premise that the only reason active management should exist is because some companies have ridiculous marketing budgets and take advantage of the uneducated.

Indeed, that's not the premise.  I believe the reason active funds have continued to survive, despite their horrible performance, is because of marketing, and Survivorship bias (which just leads to more effective marketing).  Survivorship bias should not be overlooked, in my opinion it is the single greatest fallacy in investing.

It revolves around the tendency for failed companies to be excluded from performance studies due to the fact that they no longer exist. Survivorship bias causes the results of studies to skew higher because only companies which were successful enough to survive until the end of the period are included. Similarly, mutual fund performance may be misleading due to Survivorship bias when underperforming funds are merged or discontinued.

Here's an incredible article which vividly explains the pitfalls of Survivorship bias, and not just in investing.  While I'm sure most here won't spend the 15 minutes or so reading it, I'd rather not spoil the stories!  I'll just give the opener as a teaser:



http://youarenotsosmart.com/2013/05/23/survivorship-bias/
« Last Edit: March 30, 2015, 08:18:57 PM by Dodge »

rpr

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Re: Dogmatism towards Active Management
« Reply #15 on: March 30, 2015, 09:03:14 PM »

Here's an incredible article which vividly explains the pitfalls of Survivorship bias, and not just in investing.  While I'm sure most here won't spend the 15 minutes or so reading it, I'd rather not spoil the stories!  I'll just give the opener as a teaser:



http://youarenotsosmart.com/2013/05/23/survivorship-bias/

That was a great read. Thank you for this link.

Kalergie

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Re: Dogmatism towards Active Management
« Reply #16 on: March 30, 2015, 11:23:07 PM »

Here's an incredible article which vividly explains the pitfalls of Survivorship bias, and not just in investing.  While I'm sure most here won't spend the 15 minutes or so reading it, I'd rather not spoil the stories!  I'll just give the opener as a teaser:



http://youarenotsosmart.com/2013/05/23/survivorship-bias/

That was a great read. Thank you for this link.

+1
Probably the best read I have had in a long time. Sounds like a great basis for a movie. I can already envision Tom Hanks play the role of Abraham Wald.

Scandium

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Re: Dogmatism towards Active Management
« Reply #17 on: March 31, 2015, 07:37:11 AM »

Only an idiot would invest in something with a 5% load, a 1% 12b1 and a 2% expense ratio. I was talking about low cost actively managed funds that could be beneficial. it's not necssarily just Vanguard. You could look at Dodge & Cox, PRIMECAP or Mairs & Power. You are never oging to see these firms advertise on TV. They don't pay advisors to bring in assets.

I don't accept the premise that the only reason active management should exist is because some companies have ridiculous marketing budgets and take advantage of the uneducated.
It's not just the ER. The wellington funds I looked up had a turnover of 70%. VTSAX has 2%. That will be a huge hidden cost.
I looked up DODGX and it shows a slight outperformance around 2000, but other than that looks similar to the S&P. Turnover is only 17%, which is not as bad, but the ER is 10x VTSAX.. This will cost you over decades. I really don't see much appealing with either of these.

691175002

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Re: Dogmatism towards Active Management
« Reply #18 on: March 31, 2015, 08:19:47 AM »
Well it is a simple mathematical truth that active managers as a group cannot outperform the index.  Every dollar an active manager makes relative to the benchmark is a dollar some other active manager has lost.  That being said, there is no reason why a small group of skilled active managers cannot outperform over time.

My biggest problem with active management is a lack of transparency.  How are you supposed to identify skilled managers ahead of time?  When researching a company, you can look at their financial statements, read the management analysis/discussion, and can form an opinion based on economic realities that are likely to persist going forward.

If you try to perform due diligence on a mutual fund you are lucky to get a graph of performance and a few bullet points written by the marketing team.

Picking stocks is already hard, picking fund managers has got to be nearly impossible.

tj

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Re: Dogmatism towards Active Management
« Reply #19 on: March 31, 2015, 09:25:48 AM »

Only an idiot would invest in something with a 5% load, a 1% 12b1 and a 2% expense ratio. I was talking about low cost actively managed funds that could be beneficial. it's not necssarily just Vanguard. You could look at Dodge & Cox, PRIMECAP or Mairs & Power. You are never oging to see these firms advertise on TV. They don't pay advisors to bring in assets.

I don't accept the premise that the only reason active management should exist is because some companies have ridiculous marketing budgets and take advantage of the uneducated.
It's not just the ER. The wellington funds I looked up had a turnover of 70%. VTSAX has 2%. That will be a huge hidden cost.
I looked up DODGX and it shows a slight outperformance around 2000, but other than that looks similar to the S&P. Turnover is only 17%, which is not as bad, but the ER is 10x VTSAX.. This will cost you over decades. I really don't see much appealing with either of these.

Wellington has a ton of bonds, so that would effect the turnover rate. VPMCX and MPGFX are a few that have had very low turnover. Primecap of course if closed, but you can buy POGRX direct from PRIMECAP which is very similar, but has a higher ER.

Everyone always says that higher ER will "cost you more", but someone who invested in some of these funds for the last 20-30 years haven't done any worse than the index, and in some cases they have done better.

The turnover of Wellington hasn't seemed to have hurt it over the past 23 years vs Vanguard Balanced Index. What I see is a higher return with the same standard deviation. It could of course underperform the for the next 20 years....

https://www.portfoliovisualizer.com/asset-correlations?s=y&numTradingDays=60&endDate=03%2F30%2F2015&timePeriod=1&symbols=VWELX+VBINX+DODBX+MAPOX
« Last Edit: March 31, 2015, 09:36:04 AM by tj »

Kaspian

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Re: Dogmatism towards Active Management
« Reply #20 on: March 31, 2015, 09:35:16 AM »
I think actively managed funds have had their day in the sunshine and don't really need any defenders.  The pendulum has swung in their favour for a very long time and in that time they (generally) managed to leech a helluva lot off the common investor.  Backlashes often serve a valuable purpose in resetting a more fair playing field toward center.
« Last Edit: March 31, 2015, 09:38:02 AM by Kaspian »

691175002

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Re: Dogmatism towards Active Management
« Reply #21 on: March 31, 2015, 09:37:10 AM »
The turnover of Wellington hasn't seemed to have hurt it over the past 23 years vs Vanguard Balanced Index. What I see is a higher return with the same standard deviation.
Turnover reduces returns due to taxation.  By trading more frequently, you are forced to realize capital gains early and pay taxes before your money has the opportunity to fully compound.

Taxes are not included in charts of historical performance.  If you went back and pulled out capital gains distributions for both funds you could figure the exact rate of return out for an investor at some particular marginal rate but that is a lot of work.

tj

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Re: Dogmatism towards Active Management
« Reply #22 on: March 31, 2015, 09:44:28 AM »
The turnover of Wellington hasn't seemed to have hurt it over the past 23 years vs Vanguard Balanced Index. What I see is a higher return with the same standard deviation.
Turnover reduces returns due to taxation.  By trading more frequently, you are forced to realize capital gains early and pay taxes before your money has the opportunity to fully compound.

Taxes are not included in charts of historical performance.  If you went back and pulled out capital gains distributions for both funds you could figure the exact rate of return out for an investor at some particular marginal rate but that is a lot of work.

Definitely - and those in the highest tax brackets would be best served with low-dividend investments (e.g. Berkshire Hathaway, Vanguard Tax Managed Capital Appreciation) and Muni Bonds, but for the average joe who is in low tax brackets, I think tax efficiency of index vs active is overmarketed - and tax efficiency is irrelevant in an IRA. I only use actievly managed funds in tax sheltered space at this time, as I agree that index funds tend to be more tax efficient - plus if an actively managed fund manager retires, you are stuck with capital gains in a fund you might not want to keep - not an issue in an IRA.
« Last Edit: March 31, 2015, 09:50:51 AM by tj »