Author Topic: Shadowing a Mutual Fund  (Read 1142 times)

frugal_c

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Shadowing a Mutual Fund
« on: November 13, 2019, 07:41:37 AM »
Mustachians I need your advice.

While I can see the benefit of ETF investing in larger markets I am more suspicious in smaller markets such as Canada.  In Canada the ETFs are basically banks, oil companies and mining companies.  I don't have any issues with these sectors but I don't feel comfortable making such concentrated bets on those sectors.

I have found mutual funds that are far more diversified across sectors than these ETFs.  The one I am looking at has a track record of over 15 years with excellent results and I have listened to commentary from the manager and like his approach.  That being said the fees are around 1.5% and I just can't justify paying that kind of money.

So long story short, the fund publishes their holdings twice a year.  How crazy of an idea would it be to simply buy their top 25 holdings?  These 25 holdings represent something around 80% of their total assets so I would come very close to getting their results just with those 25. 

The main issue I see is that there is a delay before the holdings are published so I will enter stocks later than they do.  However, the fund has low turnover, usually below 30% so it's maybe a bit less of an issue.  They also frequently buy too early so there are some positives to this.  I feel that even while I give something up by being late, I am hoping I make up for it by not paying the fees.
« Last Edit: November 13, 2019, 07:44:13 AM by frugal_c »

Buffalo Chip

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Re: Shadowing a Mutual Fund
« Reply #1 on: November 13, 2019, 01:23:42 PM »
Not crazy at all in a world of low to zero cost trades. But a lot of work if the only motivation is saving 1.5%*.  There is a term for it: direct indexing. The advantage I see is being able to pick and choose stocks within your personal index and time any trades for tax purposes. Iím waiting for fractional shares and no cost trades to do this myself.

Depending on the fund, you might be able to look up all their holdings on EDGAR as well as cost info.

*(Iím just as in favor of saving a buck is the next guy. But Iíve got to wonder about folks trying to save tenths of percentages on investment fees.  Especially if you find that the people in question have other, highly avoidable expenses that cost them a lot more over time.)

Watchmaker

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Re: Shadowing a Mutual Fund
« Reply #2 on: November 13, 2019, 01:37:01 PM »
But a lot of work if the only motivation is saving 1.5%*.
...

*(Iím just as in favor of saving a buck is the next guy. But Iíve got to wonder about folks trying to save tenths of percentages on investment fees.

I'd agree if we were talking about the difference between 0.2% and 0.1% ER, but a 1.5% ER is huge.

frugal_c, why not just invest in index funds with low fees and global weighting?

Buffalo Chip

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Re: Shadowing a Mutual Fund
« Reply #3 on: November 13, 2019, 03:49:25 PM »
But a lot of work if the only motivation is saving 1.5%*.
...

*(Iím just as in favor of saving a buck is the next guy. But Iíve got to wonder about folks trying to save tenths of percentages on investment fees.

I'd agree if we were talking about the difference between 0.2% and 0.1% ER, but a 1.5% ER is huge.

I wouldnít pay 1.5%. Iím paying .5% on some overseas indexes. But to me itís a matter of perspective. As compared to paying state income taxes in California? Makes 1.5% look cheap.

frugal_c

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Re: Shadowing a Mutual Fund
« Reply #4 on: November 13, 2019, 06:59:12 PM »
The reason for a fund over an ETF is it's small cap focused and non US. I am not convinced that this market segment is efficiently priced. There is a lot of sketchy stuff in the space. Bad management, excessive salaries, outright fraud.  I just want the fund to screen out the worst offenders.

I think of 1.5% as excessive.  Markets might only do 4 or 5% real.  The management fee could be a third of the return. In the past they always have beaten the market and by more than enough to pay the management fee. What if I am wrong and they don't beat it anymore.  I am in trouble if I'm paying fees.

I don't have zero fee trades but they are about 0.1% relative to my investment size.  If I hold these three years on average it's basically nothing. 
« Last Edit: November 13, 2019, 07:09:48 PM by frugal_c »

Buffalo Chip

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Re: Shadowing a Mutual Fund
« Reply #5 on: November 13, 2019, 07:39:57 PM »
The reason for a fund over an ETF is it's small cap focused and non US. I am not convinced that this market segment is efficiently priced. There is a lot of sketchy stuff in the space. Bad management, excessive salaries, outright fraud.  I just want the fund to screen out the worst offenders.

I think of 1.5% as excessive.  Markets might only do 4 or 5% real.  The management fee could be a third of the return. In the past they always have beaten the market and by more than enough to pay the management fee. What if I am wrong and they don't beat it anymore.  I am in trouble if I'm paying fees.

I don't have zero fee trades but they are about 0.1% relative to my investment size.  If I hold these three years on average it's basically nothing.

Fees are all in what you get out of them. Not saying that 1.5% in this case is a good deal. It probably isnít. But heresís something to consider. The Renaissance Medallion was charging I think 5 and 40? Youíd be completely crazy not to pay it. The returns were that good.

The strategy of checking out underlying investments sounds very similar to what I do at times. I look at funds I admire then dig into what they hold and buy what I like. A question I would have is that since these are foreign companies, what are the transaction costs to purchase?

Watchmaker

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Re: Shadowing a Mutual Fund
« Reply #6 on: November 14, 2019, 08:08:23 AM »
The reason for a fund over an ETF is it's small cap focused and non US. I am not convinced that this market segment is efficiently priced. There is a lot of sketchy stuff in the space. Bad management, excessive salaries, outright fraud.  I just want the fund to screen out the worst offenders.

I'm still confused about what you're actually aiming for-- can you be clearer? Are you looking to invest in the Canadian market, Canadian small cap, ex-us small cap? Is this your whole portfolio or a portion?


frugal_c

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Re: Shadowing a Mutual Fund
« Reply #7 on: November 14, 2019, 09:30:54 AM »
watchmaker I am trying to invest a portion (about 15%) in canadian small caps.  When I look around the world, this seems to be one of the best current opportunities, especially if you can avoid oil/mining small caps which tend to be much more volatile.

BuffaloChip my fees are around 0.1% per purchase given the position size.  I would be willing to pay up to maybe 1% for active management in this space but once you get up to 1.5% it starts to push me away.  They HAVE more than earned the fees in the past but I just can't bring myself to put the buy order in on the mutual fund.  I literally punched it in, stared at the screen for awhile while imagining how much fees they are getting each year and eventually closed out my browser.  :)

To put things into perspective regarding the fees and the weighting, we are mostly funded for a basic FIRE at 4% withdrawal.  We have about 5 or 6 years left for a more comfortable FIRE and one with a lower withdrawal rate.  An extra percentage in fees really does add up.  Depending on the returns it can add an extra year to my career.

One more comment to Buffalo and whoever else is listening.  I am very open to suggestions for investments.  I looked up this Medallion and i think it is a hedge fund that I won't have access to, however if you have other ideas / funds to follow please let me know.
« Last Edit: November 14, 2019, 09:40:04 AM by frugal_c »

Watchmaker

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Re: Shadowing a Mutual Fund
« Reply #8 on: November 14, 2019, 11:20:00 AM »
watchmaker I am trying to invest a portion (about 15%) in canadian small caps.  When I look around the world, this seems to be one of the best current opportunities, especially if you can avoid oil/mining small caps which tend to be much more volatile.

Okay, thanks! Are you investing from Canada, or just looking to invest in Canada companies?

It looks like iShares S&P/TSX SmallCap Index ETF is designed to cover Canadian small caps and has a fairly reasonable ER of 0.6%. Now, I note that it is 40% materials+energy so that's not avoiding the oil/mining stocks you are worried about. 

frugal_c

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Re: Shadowing a Mutual Fund
« Reply #9 on: November 14, 2019, 01:17:27 PM »
Yes, there is the ER and then there is the 40% material/energy allocation. That is exactly what I don't want.  Those companies either tend to go bankrupt or prices spike and they go up 10 fold.  It's not a game I want to play.  There is also, as mentioned, the 0.6% ER.  It's just a touch high.

I really want to own the good quality companies in Canada, and nothing else.  Basically companies that have profits, ideally some dividends just so they don't waste the earnings and fairly consistent growth.  Most of the small cap funds buy that type of company but there is no ETF that has that.

Watchmaker

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Re: Shadowing a Mutual Fund
« Reply #10 on: November 14, 2019, 01:25:28 PM »
I really want to own the good quality companies in Canada, and nothing else.

This isn't possible to do with certainty. If it was, everyone would just do that.

If you're set on this, I think your idea of directly buying stocks is a good one, and using the holdings of a small cap mutual fund you like to choose what to buy is reasonable.

I wouldn't go this route, but at least that way you're saving the 1.5%.

Buffalo Chip

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Re: Shadowing a Mutual Fund
« Reply #11 on: November 14, 2019, 02:05:56 PM »

One more comment to Buffalo and whoever else is listening.  I am very open to suggestions for investments.  I looked up this Medallion and i think it is a hedge fund that I won't have access to, however if you have other ideas / funds to follow please let me know.

OK, I'm a sucker for an open mind.  I'm not an investment advisor nor do I play one on Netflix, so I'm very loathe to provide specific investment advice.  Also, by FI standards I probably fit somewhere in that gray area between "contrarian" and "batch*t crazy."  Reader beware.  What I will do is tell you what I see and like based on what I've seen of your scenario. 

- I really like that you're looking outside the US and looking at using other people's strategies on the cheap.  What's not to like?  I don't know whether you go on Edgar and look at the holdings of funds using their form 13 filings, but it seems that you're looking at that sort of strategy. I do wonder though why Canada versus other first world markets?  Here is a resource to look at to compare overall markets by PEs, CAPE ratios, etc.  Some things will jump out at you. 

 https://www.starcapital.de/en/research/stock-market-valuation/

- I like that you're discerning between the types of holdings you're interested in within a fund versus just buying it at face value.  I also like that you're critically looking at the fees.  I'm a bit more fee agnostic than a lot of folks here.  To me it's a question of what I get for what I pay.  I brought up Renaissance Medaliion as an extreme example of when you'd be a fool NOT to pay what were insanely high fees were you able to so (only employees of the company can invest now, sorry).

- I like the fact that you're discriminating between profitable companies and not profitable ones in the underlying market you're looking at.  I don't understand why people buy stock in unprofitable companies during a relative economic boom.

- I noticed that you're 6 years away from RE. I'm not seeing an asset allocation and wondering if you're winding down the risk to match your relatively short time horizon until you plan to pull the plug.  There are some who believe in a "balls to the wall" approach up until RE.  I'm not a fan of scrambling a nest egg just before RE.   
« Last Edit: November 14, 2019, 04:28:28 PM by Buffalo Chip »

frugal_c

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Re: Shadowing a Mutual Fund
« Reply #12 on: November 14, 2019, 06:57:14 PM »
I don't have an official AA but I do keep a healthy amount in bonds.  The bonds get slowly invested as the market drops.
 
I also try to find investments which aren't as correlated to the market, when I can.

For global investments I would need a managed fund or an ETF. There too I am hesitant with ETFs if it's small cap focused.  Right now I guess I have a bunch in vxus which is in the space but I'm not super confident in it.   

secondcor521

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Re: Shadowing a Mutual Fund
« Reply #13 on: November 14, 2019, 09:43:34 PM »
I agree 1.5% is high.

Not sure how big of a factor it would be in terms of cost and effort, but if you wanted to follow their investment as closely as possible, not only would you buy their top 25, but you would make the relative proportion of each holding as similar as possible given that you are not buying all of their holdings.

What this means is that even if their top 25 positions were to remain the same, if they decide to shift their weighting among those top 25, and you wanted to follow that, you'd have to do buys and sells in order to match their new weighting.  Since these trades would be smaller, if your trading costs are fixed, then your expenses as a percentage would go up.  Maybe even at or above 1.5%.

So as an example, and just using three stocks, if they held 20% in stock A, 25% in stock B, and 55% in stock C in period 1, then changed to 25%, 30%, 45%, then you'd have to sell some of your holding in C to increase your holdings in A and B.  Just looking at your buy of A, it would be 5% vs 20%, so with constant trading expenses it would quadruple your expense ratio (20% / 5% = 4x).

vand

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Re: Shadowing a Mutual Fund
« Reply #14 on: November 15, 2019, 01:34:22 AM »
It's a perfectly legit way of building your own direct exposure.

In fact, its a great way to broaden your knowledge of where you might want to put your money.
For example, you can look at this global multi-asset fund which not only lists all the instruments it invests in, but also gives you a breakdown of its system and the signals it is currently giving:
https://plainenglishfinance.co.uk/funds
(This is from "How To Own The World" by Andrew Craig, which is a book I highly recommend).

MustacheAndaHalf

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Re: Shadowing a Mutual Fund
« Reply #15 on: November 17, 2019, 01:01:47 AM »
You mentioned paying 0.1% on the starting investment.  What about ongoing investments?  How do you rebalance, and still pay 0.1%?

Back when I thought of doing something similar - making my own index fund - I looked closely at "Motif Investing".  It's been awhile, but I think you can build a portfolio (a "motif") of 30 stocks, and then invest in all of them for $10.  The trick is it's not real time, which costs $20.  Unfortunately it looks like they haven't opened in Canada yet.  A big competitor of theirs is "folio investing", which only seems to offer a few Canadian stocks.