Thanks, Norbert!  You've suggested some things I currently do not consider when in the "hold" situation like level of bloat and shareholder communications fall-off.  Bloat is easy to measure.  Shareholder communications implications must be one of those things of "art" (as you say) to fully understand and act on.  I must admit I'm not good at art and could probably do well spending more time reading and digesting all communications from the active fund managers for funds I hold.

Like another poster, I do not understand your rationale for "balancing" index and active funds.   

Yes, you and oildog both called that out.  Let me try and explain the rationale.  I explained earlier that I measure active funds against their asset class (or category) index.  I think this makes sense and was pointed out in a writing by William Sharpe which Taylor referenced.  http://www.stanford.edu/~wfsharpe/art/active/active.htm

[Sharpe] The best way to measure a manager's performance is to compare his or her return with that of a comparable passive alternative. The latter -- often termed a "benchmark" or "normal portfolio" -- should be a feasible alternative identified in advance of the period over which performance is measured. Only when this type of measurement is in place can an active manager (or one who hires active managers) know whether he or she is in the minority of those who have beaten viable passive alternatives.

That explains it from a measurement perspective.  From a risk (balance) management perspective, I hold both the index and an active within the same asset class and also rebalance the ratio between the two because:

• From risk perspective, I want to be able to manage the variance from overall market return on the downside (which I realize also limits the "boost" on the upside) based on probability that I'm able to maintain an active fund selection in the asset class which on average net of costs and taxes beats the particular index.  I'm much more likely to do that in domestic small cap and foreign which is why my active / index ratios in those asset classes are higher than those in domestic large cap.  And by definition, I know I will have a balance creep problem in that if I succeed on average (not every year) in holding active funds which beat their index, then by definition the percentage holdings of active vs index will increase over time.  If I let this go on for an extended period, then I'm reintroducing myself to risks I'm not comfortable with.  For example, the BJBIX / EFA (EAFE) ratio I mentioned earlier grew from 70/30 to 73/27 in the last year which is far from the strongest year in foreign.  Had I not rebalanced between active/passive from 2002 to now, it'd be over 90/10.  It may be a subjective thing, but I'm not comfortable with >90% of my foreign holdings banked on one active fund management team.
• From a managability perspective, if I reduce number of funds I'm holding by selecting "total market" funds, then I diminish my ability to manage the balance across asset classes.  And some "total market" funds are not a composite of indices but themselves have a bias towards small value or large growth and in a sense behave like an active fund but I don't want them to because it makes managing asset class balance harder not easier.  I feel I need to manage the balance across asset classes because one year international will be hot, the next year large value, the next year small growth, etc.  Rebalancing across asset classes is a continual process of selling high and buying low.  I think pure passive/index investors do the same.  My approach is just a bit more complicated because I incorporate an active component in each asset class (domestic large, domestic small, foreign, bonds) to "boost" returns and that then forces me to manage two ratios (across asset classes, active vs passive within each class), not one (across asset classes) based on my risk tolerance.

Hopefully the rationale makes sense.  If you see flaws, speak up.  I appreciate the constructive criticism and my aim is to increase total returns in a risk-managed way so I'm willing to evolve my approach if aspects are flawed.

Thanks for the feedback.

-Andy

Hi Andy,

We're all just amateurs chatting on the internet ... trying to pick up a few insights here and there. 

On the "art" of it, that's the best part!  I love reading economists' outlooks, studying stock market history, doing technical analysis, constructing bull vs bear debates with my investing friends, etc.  Then I try to put the fund managers' missives into that context and see if they are impressive or not.   The FT-London is my favorite daily read.

I'm with you on the measurement concept.  BUT: during the late 1990s some great funds underperformed the indexes because they never followed the tech bubble; but they certainly looked very good from 2000 to 2002!  So, I track the indexes, but do not rely on them to the extent that you seem to.  Generally in bull markets I hope to track the indexes; but think we should ignore them during bubble and bear situations (like now). 

Where I see it quite differently is the question of risk management. I'm more a disciple of the Warren Buffett school, which says that Mr. Market is a manic-depressive kind of guy.  I absolutely and totally reject any notion that markets are rational.   Therefore the biggest risk is not a variance from market returns, but the market itself.  Ergo, I own no market-cap based index funds - because I don't want to own the "market". 

Like you, I don't put all my eggs in one basket.  I have about 15% in one fund now and it feels like a lot.  I'm overweight emerging markets, but make a point of picking specific funds for the various regions, plus try to achieve a balance between commodity-producing and commodity-consuming countries.  However, I know and respect a couple of investors who have very large portfolios and just five or six funds.  I don't think that there's one right answer here.

On manageability, I don't understand what you're saying. It sounds to me like you are talking about diversification.  If that's true, then I'm with you.  Also, I'm a bit more casual on asset allocation; when I see opportunity in an asset class or sector, I'll jump on it. But, I always maintain a certain balance among asset classes, sectors, and regions.

Bottom line:  each to their own!  I still don't consider an "active / passive" balance to have any value (because I reject the efficient market hypothesis), but whatever works for you.

Cheers,

Norbert 

"What do you take into account in those triggers?  How do you manage in light of taxes?  And finally how do you pick your replacement active mutual funds and feel confident that they will be able to beat their asset class index?"

Re: Well gee Andy? That's why they call them ACTIVE Managed Funds... You have to be Active in managing them..LOL

I follow the "Happiness is a Back Up Rule" of having at least a 2nd like  Fund already invested in it, in a smaller % allocation.. most are Also Newer and Just growing..(Much like if your 30 , do you want a 60 yr Old Doctor with not partners to take over? )

And it takes constant Researching and Keeping One's Eye Open for the Next fund to replace the one's you have, at the Ready and not wait until you get a Notice your Fund is going to do a Hard Close in 30 days..Or after a few yrs it slacks off and /or gets too big and is nothing more than a Glorified Index Port..

I've had 5 since Magellon days..ie: Fall apart to do Hard Closes..to change in Mgrs..etc.

So, alot can be said for just Indexing It ..( and espeically if you only need Index Rtns )

And  If you want your AMF's to continue being in your portfolio , but don't want to do the Constant Work?  Hire a Firm to do it for you, just pay them the ave of from 1-1.5% yr ( Most only require a $50-$100k Min to open one )

For me? Paying a Firm 1.5% on a Per $100 k = $1500 YR To make me ave of 4% more than comparable Index Port is worth it.. for others, it isn't..

Or you can go to a Firm with a Fund like WMRIX and let them do it..( $500k Min)

kerryvan:

Andy,

The sell decision is hard when times are good and easy after it becomes obvious when looking backward.

On another discussion, someone told me about http://stockcharts.com/

I've been putting in all my funds and looking at the rsi part of the chart.  anytime above 70 is near a peak, near 30 is a buy opportunity.  outside those limits are better decision points.  What I am thinking about trying is to remove some profit from the table when above 70 and buy some more of any fund I hold when near 30.

I haven't studied this enought to tell what the net effect would be, most of my holdings have been 45 to 65..  I have one fund getting near 30 right now, an india fund, so I may buy a little to test the theory.  When I look at history of a fund if I sold some at the 75 point, it seemed to drop after that, but not enought to signal a buy in the same fund.

I don't think index funds would work for me since I'm very intl loaded, country specific,  not much in the euro zone.

 

I like a little bit the RSI study in order to prioritize purchases on certain occasions, but I wouldn't use it in order to make sell decisions. Mainly because I don't "trade" mutual funds, I buy them for the long term, so unless something change I would not sell, and if something change (i.e. manager leaves) and I think it is time to sell I would do so without waiting for a technical indicator.

Now, having said that, purchases are a little bit different..since many of us add to the positions over time as we save money, the  RSI could arguably give some entry points (but I wouldn't wait for it to reach 30...I would wait for it to be bellow 50 and pull the trigger on a bad market day). Many think that it is better to just use DCA (and forget about timing), and I actually think it is better if you constantly put money in. 

The way I use the RSI is only to prioritize purchases if I have to add to several funds at a certain time. I add first to the ones that are bellow 50 (normally, I never make two purchases the same day...personal rule).   

It is just a tool that could somewhat help if you insist on trying to time the market (and there is overwhelming evidence that trying to time the market is extremely difficult).

Hope it helps,

JC 

Thanks, JC

I too am a buy and hold, and hold, and hold person.  Typical sells are way too late or I notice that they are under  performing based on M* peer group.  My buys have been driven by staying invested, not based on buying at low spots.

My DCA is limited to 401K money, and very limited choices due to what is offered... The balance of my portfolio is open for trades, since I'm full invested with only cash reserves to manage monthly cash flow situations.

Changing to a different investment style, meaning actively selling and buying based on other criteria is a foreign practice for me, hence something to try for amusement?  test theories? 

I think the paradigm has shifted due to the EM shift to almost developed nation status.  US currency won't be the safe haven that it once was.  Beside the last 7 months of the market for a buy and hold style has been un-exciting...

Just a few quick comments since it was mentioned.

Even if you don't believe that the markets are extremely efficient -- it doesn't mean you have to ignore index funds.  There are people who believe that the markets are moderately efficient but don't trust their fund picking abilities and the abilities of the manager to outperform over costs -- and may also don't want to get trapped in the fund-picking merry-go-round that happens to many people.  You can probably easily name 20 highly touted market-beating funds with smart managers and with "downside protection" skills on these forums between 2001 and 2004 that now all of sudden are no longer getting rave reviews and have gone silent.    

Furthermore -- a belief in EMH also doesn't necessarily mean though must buy & hold the TSM.  The people behind Dimensional/DFA believe in EMH for the most part (whether it be strong or moderate) but yet they're not selling TSM.  In fact -- they're selling value and size tilted funds.  They're not saying they can provides hopes of better returns for lower-risk -- but they're upfront in saying is that you can probably achieve higher returns for higher risk and by spreading the risk beyond just market factors. 

Moreover, you're not realizing that many of the really good investors respect the market's efficiency.  They know that the market is quite efficient and not a simple system to exploit because many people are in the same game.  But they believe they have the skill to outperform and that it is not an easy task.  Others believe they can beat the market but not by stock-picking but by balancing with a disciplined & balanced diversified asset allocation that many people can't do it themselves properly. 

So even if you reject EMH outright -- realize that many of the best managers you invest in respect the market's efficiency and understand plus recognize the difficulty of the game.  If you fail to recognize the difficulty of the game & the competition -- you'll soon realize a little late that it was you who's the sucker at the Poker table.

To reiterate what I mentioned above -- there are people like many here who don't want to dump their money just into the S&P500 but not everybody believes in running to actively-managed funds.  Some people overweight say Midcap Value and Smallcap Value using index funds. 

Finally -- many people actually do use both index & active funds.  Just ask those in the DH forums.  For one thing -- some people have limited choices in their 401k's.  The assumption here is that the 401k plan is wide open but someone may use actively-managed bond, small-value and large-value funds in their 401k due to limitations but prefer to use index funds given their freedom outside of their 401k plan.  And again -- there are different flavors of indexers as well because some indexers do reject investing in the S&P500 but turn to investing in US & International value and small oriented index funds. 

And then there are those who use actively-managed funds but have also added a Gold (GLD), Commodities (DBC) or Alternative Energy ETF -- and these are simply indexes and I have seen a number of people across a number of forums who have done this and so yes they are mixing actively-managed and index funds.

OT to Kenster:

Thanks for your excellent post!  It's good reading.

It's true that people like me who rely on active funds also use index-based ETFs: RSX (Russia), NLR (nuclear) and GEX (alt energy) for example.  I can't find a really good alt energy fund, so have been falling back on these ETFs. GEX provides the international sector exposure I simply can't find elsewhere.  RSX is a pure Russia play, which is not easy to find in a no-load mutual fund.

You are correct that indexing is not just the S&P 500 or TSM. I have noticed, for example, that the Vanguard emerging market index fund has almost kept up with the various actively-managed EM funds. 

--- 

However, I stand my ground.  Being risk-averse, I constructed my active fund portfolio with much attention to the managers' past return / volatility performance (especially in bear markets), to their shareholder missives, a liking for their portfolio strategies, etc. 

I am delighted with how well these guys have performed since the credit bubble started deflating last July!  They put in a very good 2007 and are performing very strongly in 2008.  No surprise, it's the same guys who did well during the 2000 - 2002 mess.  So, if anything, my convictions are reinforced.  Was it luck?  Don't tell them that. 

I simply do not accept that I should EVER let a computer pick stocks based on market cap!  Over and over again the computer will ignore the fundamentals and buy overpriced stocks!  Just look at the performance of the Vanguard collection of index funds during 2000  - 2002 and again since last July!

Even John Bogle cut his equity exposure in half in 2000 because - as he said - the market was ridiculously overvalued and going to go down.