In this week's email on index and ETF news, I was annoyed to read an article at IndexUniverse.com titled (linked), Do Active Funds Shine in Down Markets?, by Allan Roth.

Roth presents proof that exposes what appears to be the fallacy of the saying, index funds do very well in an up stock market but stumble during a bear market. The date of Roth's article is 5/5/08, just 4 days ago. Roth's proof consists merely of citing the YTD and 10-year ratings as of 4/25/08 for 3 simple index funds, VTSMX, VGTSX and VBMFX. The proof implies, in effect, that these index funds trounce easily 2/3 or more of all OEFs both longterm and even in the depths of a bear market.

Well, I can only conclude that Roth is an extremely wily biased indexer. I would have more respect for his "proof" if Roth had chosen to use a date that really reflects the effects of a downward swing such as 2/28/08, 3/14/08 or 3/31/08 for both the YTD and 10-year returns data. Somehow I doubt that VTSMX, VGTSX and VBMFX on 2/29/08, 3/14/08 or 3/31/08 would have shown ratings beating 2/3 or more of all OEFs for BOTH the YTD and 10-year returns data. Oops! I'm sorry... I'm showing my bias for actively-managed funds.

At the beginning of the article, Roth starts out with a statement that is both true and also misleading:

I think we can all agree that we are cur­rently in a down market, so let's examine how the index funds did versus their actively man­aged peers.

Yes, the market has behaved like a bear YTD and trended down. However, the market has been beating its way back UP from the losses of the whole 1st Quarter of 2008 --January, February and, most especially, March. Any data chosen while the market is working its way back UP is not presenting the true negative effect on index funds in the midst of a bear swing.

The way I see it, if you have proof-positive of the validity of the superiority of your funds, you should be confident enough to include data for the not-so-wonderful swings of the market that work against your favored funds, too. NOT doing so is misleading those investors who accept what you say at face value. If your readers are all indexers, why do you find it necessary to white-wash anything? An index fund is not designed to lead the market (OEFs), it is designed to be a reliable plain-Jane middle-of-the-road average of how the market (OEFs) performs.

I double-dog dare ya all to find out the YTD returns and 10-year returns calculated for Friday, March 14, 2008 for VTSMX, VGTSX and VBMFX. Based on the charts, 3/14/08 is what appears to have the worst-performing YTD results. I don't know the results for 3/14/08 either, but I can guarantee that it won't be pretty for anyone, active or indexed.

Regards,

Susan

P.S. When I have mentioned IndexUniverse.com's articles before, I have been told to NOT read them, that IndexUniverse.com is for indexers. I don't agree... I like ETFs; I like to use index funds on occasion; I like to know what new products are being developed; and I like to read anything and everything I find of interest. Ergo, I am subscribed to IndexUniverse.com's newsletter. I bet I'm NOT the only active-biased investor to do so.

For those visiting IndexUniverse.com for the first time, subscriptions are free --and so is their newsletter.

Regards, Susan

Susan,

Here's a link to stockcharts which will allow you to compare returns on a specific date

chart 

I tried to do the growth of 10k for the 10 year numbers comparing the funds and ending on that date w/o success.  The MSN charts no longer include distributions and the smartmoney and fido charts won't let you customize for specific dates and the difference in returns was significant between the two methods of growth of 10k and I couldn't figure if it was date specific or the lack of reinvestment.  The numbers were so different and so screwy that I'm not even trying to give results.

Roberta 

Hi Susan & Roberta: We don't have to look anywhere else other than M* for relative outperformance. VTSMX is almost the same performance as VFINX (which is S&P500 index less ~0.18 ER). Thus, if a fund outperforms the index on a 5 yr & 10-yr basis, we know how the IndexUniverse article is stretching the truth to suit their point of view thru the use of that mythical beast called "the average fund".

Here is just one active fund example vs its index : Fidelity Contra : 10 Yr Total returns thru 5/9/08 are at 8.59% for FCNTX, which is an outperformance of full 4.70% vs the S&P500 index. Thus, against VFINX, it is an outperformance of 4.88% (assuming VFINX has an ER of 0.18%). That is huge amount of outperformace. We can compare any fund that is commonly talked about on these boards, and will have a similar answer on whether it outperformed or not. Thus, the long term history does provide some indication of the quality of fund management. Hope that helps .... Anil

YEAH! Ditto Sue!  You Go Girl! LOL

FYI

My Equity Port of AMF's vs comparable Index funds Port?

past 10 yrs

AMF port = 19% apy

Index port = 9% apy

now if earning 9% apy is enough for someone? Go for it..

But, if it isn't? guess you don't have anyother choice ( or Marry a Richer Spouse or one with a Rich Uncle ) ..

Or kick the Old man out to work a 2nd job... most are uselsess after age 40 anyway hanging around the house or Going to the Golf Course..and waste ave of $2,000 yr there.

Butt? If want my AMF Port? Will cost one a coupon for a Dozen Dunki Donuts and For 2 coffees at starbucks !

Hi Susan,

In the words of Ronald Regan: Well, there you go again.   : -- )

Phew, At least I didn't write this one!

Anyway, you should not get all steamed up about this article or the data. What Roth presents is a fact. Is it data mined? I don't know, maybe. But it's still a fact. I have seen several articles presenting similar data over the years for different time frames. The fact is that index funds do not appear to do so bad in down markets as people think. 

Susan wrote;
Yes, the market has behaved like a bear YTD and trended down. However, the market has been beating its way back UP from the losses of the whole 1st Quarter of 2008 --January, February and, most especially, March. Any data chosen while the market is working its way back UP is not presenting the true negative effect on index funds in the midst of a bear swing.

 

If you say index funds did worse at some earlier date, then you have to say they have done a lot better than active funds on the rebound to the date Roth uses, which is 4/25/08.  This would be questionable too.

An index fund is not designed to lead the market (OEFs), it is designed to be a reliable plain-Jane middle-of-the-road average of how the market (OEFs) performs.

Another undeniable fact is that index funds do beat a good majority of active funds over longer periods of time, so they do not occupy the middle of the road long-term.  No, you won't see them in the top quintile in shorter time frames. About 60-65% (my estimate) of the time they move up the rankings because of low costs. The other 35-40% is due to a good percentage of active funds tripping themselves up and falling out of the high rankings.

Susan, If an investor is going to be good using active funds, he or she has to first understand how things work. And he or she has to know what they are up against. There are some regular posters on MF who do understand this. They don't fight the facts: they know using active funds demands more work in both fund selection and monitoring if they want to have any chance of beating the benchmark index. They know it's isn't all that easy.

Can it be done? Yes, some investors do it. There are some active funds that have outperformed their benchmark, but buying them does not guarantee success. I think those investors who have been successful will be the first to tell you you have to know what you're doing. If you don't, you may pick good funds, but if you pick them for the wrong reason, your chances of long term outperformance are seriously diminished.

Paul

 

Hi Paul:

Who do you think will be a more successful investor; an index only investor with a diversified portfolio who panics every time the market corrects 10-20% and sells (usually at the bottom), or an active investor with a diversified portfolio who believes in the management and culture of the funds he is in and stays the course when the market corrects 10-20% because he has confidence that his managers will find opportunities in those dips?

The index/active debate always seem to leave out the way individual investors may understand and accept their investments.  Indexers rely 100% on theory.  But many of us have come to rely on humans in other walks of our lives (our doctors, teachers, religious leaders) and we are more comfortable knowing a human is watching over our funds, not a silicon chip somewhere.

So while index proponents can always find way to make the argument seem compelling from a "odds of success" standpoint, they can't change human nature.

In the end, anyone with a good plan that can stay with it, be it indexed or active, will be fine.  It seem active investors understand this, but too many indexers don't.

best,

Bill

Hi Bill,

Obviously, knowing and following proper fundamentals is important for all investors. I considered adding some comments about index investing, but thought is was a bit off my subject for that post.

Bill wrote;
Who do you think will be a more successful investor; an index only investor with a diversified portfolio who panics every time the market corrects 10-20% and sells (usually at the bottom), or an active investor with a diversified portfolio who believes in the management and culture of the funds he is in and stays the course......

The active fund investor, of course. Index investors also have to know proper fundamentals and follow them. They are not immune to all the behavioral errors. But active funds investors actually have to know a little more. They have to know how to properly choose their individual funds.

The index/active debate always seem to leave out the way individual investors may understand and accept their investments.  Indexers rely 100% on theory.  But many of us have come to rely on humans in other walks of our lives (our doctors, teachers, religious leaders) and we are more comfortable knowing a human is watching over our funds, not a silicon chip somewhere.

First off, Bill, I want to make it clear that I am not debating the use of active funds. And there seems to be some indexers who don't understand the theory and do not set up good portfolios. They are just as prone to performance chasing as any investor.  

So while index proponents can always find way to make the argument seem compelling from a "odds of success" standpoint, they can't change human nature.

I agree, and again, I'm not knocking active investing. The point in writing my first reply was simply that before anyone decides on the best way to invest, they need to understand the game. 

In the end, anyone with a good plan that can stay with it, be it indexed or active, will be fine. 

Yes, I agree with that.

It seem active investors understand this, but too many indexers don't.

This is your only comment that I would question. I would have to say the majority of active investors don't have any idea what they are doing. And I am not counting the members of M* forums because they are not a majority nor are they average. Indexing is not an intuitive choice and most investors don't understand it, but for those that do, I would not think they understand less about having a good plan and staying with it.

regards,

 

Paul 

 

 

Well, over the yrs, I found that btwn may thru Aug, news seems to get pretty boring and These Columnist have to print something,, And to try to stir up Interest as well..

And you think Roth is going to Hype Funds like CGMRX, CGMFX,FAIRX, etc?   and put them on investors radar screen...?  ( I hope not)

Thus I hope These columnist stick to Hyping Index Funds and thus Keep Directing Most Investors into them... and thus not Overload/Bloat Up our Favorite AMF's..and they end up like D&C funds... So let's Support These Guys and other Index Advocates.. and not condemn them...It's to our own self benefit..

 

 

I have most of my investments in my 401k and most of the funds in an actively managed balanced fund that, thankfully, has performed well (Fidelity Balanced).  However, for my taxable account, I have to say that I'm heavily influenced to put together an index portfolio based on the many, many prominent finance experts who advocate indexing.  I know there are many experts who advocate active funds, however, for a novice, like myself, who is not equipped to do in-depth analysis of actively managed funds, index funds give me solace knowing others who have done historical analysis say indexing is a profitable approach to investing.  Granted, there may be actively managed funds that outperform index funds, but indexing can be a viable option for making money over the long haul for the averageinvestor. 

Here's some more Short-Term performance data-mining:

In Kiplinger's annual Mutual Funds 2008 magazine they compared the short-term and long-term performance of over 3000 mutual funds.  In one column they used the Oct.-Nov. 2007 correction; it being the very short period October 9 to November 26, 2007.

VFINX...............................-9.5%
VTSMX.............................-9.6%
Average US Stock Fund......-8.3%

VGTSX..............................-5.4%
Avg.Diversified Inter'l Fund...-5.9%

In American Association of Individual Investors latest Quarterly Low-Load Mutual Fund Update their Bear Return column uses the period 11/01/07 to 3/31/08.  (I believe their database only includes about 1445 stock and bond funds.)

VFINX.................................-13.8%
VTSMX...............................-14.0%
Large-Cap Stock Cat. Avg......-14.6%

VGTSX...............................-15.0%
Foreign Stock Cat. Avg.........-15.6%

Coy

Although the Indexuniverse article brags about the high 10-Year Category Rating of 26 of VTSMX, they don't tell you that those 10-Year Returns were only in the neighborhood of about 4.3%.  Now, that's something to jump up and down with joy about!;^)

Coy

Hi again Paul,

"It seem active investors understand this, but too many indexers don't.

This is your only comment that I would question. I would have to say the majority of active investors don't have any idea what they are doing. And I am not counting the members of M* forums because they are not a majority nor are they average. Indexing is not an intuitive choice and most investors don't understand it, but for those that do, I would not think they understand less about having a good plan and staying with it."

OK, not very clear on my part.  I WAS talking about the members of M*, because, to the best of my knowledge, my opines have not reached the legendary stage as yet that they are required reading by all investors everywhere :o} 

What I was really getting at is that there is a much higher percentage of indexers who will automatically question a good active plan, than active investors who will automatically question a good index plan.

It is my opinion, after having read all the "good books", that the reason is because all these books spend a good amount of time disparaging active investing, calling it a losers game, and so on, while the good active books like those from Neff or Dreman barely mention index funds and when they do it is in at least a neutral way.

In other words, part of getting folks to believe indexing is good is convincing them that active investing is futile.

I think they both work and that picking good funds still comes down to asset allocation that works for you within your risk tolerance.

best,

Bill

 

NewBoglehead wrote:
I have most of my investments in my 401k and most of the funds in an actively managed balanced fund that, thankfully, has performed well (Fidelity Balanced).  However, for my taxable account, I have to say that I'm heavily influenced to put together an index portfolio based on the many, many prominent finance experts who advocate indexing.

For a taxable account, tax efficient index funds are a very good choice.
-----------------------------------------------------------

Bill wrote:
What I was really getting at is that there is a much higher percentage of indexers who will automatically question a good active plan, than active investors who will automatically question a good index plan.

I would have to agree with that.  

It is my opinion, after having read all the "good books", that the reason is because all these books spend a good amount of time disparaging active investing, calling it a losers game, and so on, while the good active books like those from Neff or Dreman barely mention index funds and when they do it is in at least a neutral way.

I think Larry Swedroe uses that losers game idea the most. If is often misunderstood to mean that investors using active funds are losers. It does not mean that. (Note Bill, I feel like I'm talking down to you and I don't mean to. I think you know all this, but I'm explaining for others who might read it.)  

Anyway, investing in the market is a zero sum game before expenses—half of the investors will do better than average and half worse than average. Once you add costs, it becomes a losers game because the half and half split is zero sum minus the cost. If average cost is 1.5% then that becomes the half way point.

In other words, part of getting folks to believe indexing is good is convincing them that active investing is futile.

I think the main thrust is that high costs are bad. I would like it a lot better if another term beside loser could be used. Investors using lower cost active funds have a much better chance of success. But there are other problems to overcome too. And some of those are simply beyond the investors control.  

Active fund investing is not futile, but it takes a lot of skill in my opinion. You can't simply pull some funds off last month's top 20 list.  I don't deny that there are some successful active fund investors here on M*, but they remain a minority as far as I can tell simply because they refuse to do any reading or study.

I think they both work and that picking good funds still comes down to asset allocation that works for you within your risk tolerance.

If AA, risk management, costs, and behavior are in order, the investor will be successful.

cheers,

 

Paul 

 

The truth is most active funds are crap, so I am inclined to believe that an index does outperform 2/3rds even in a down market.  People buy all kinds of overpriced load funds, and most also buy growth funds.  The question isn't whether index funds are better than the majority of funds, because they are, it's whether it's impossible to select good funds. Maybe most can't but I do believe it is possible to do. 

The other point is that most indexers are not buy and hold investors either.  Just as many indexers as active fund investors buy high and sell low, pile into the most recently hot asset class, and so on. 

That said, I'm not sure I'd even go so far as to say the majority of active fund investors on M* necessarily are equipped to outperform the indexes.  There is a whole lot of performance chasing around here as well.  Plus, even if you do anything right there is no guarantee you will outperform the indexes.  There is always some degree of uncertainty, and even just having good or bad luck can play a part.  It should be noted that even index funds in fact lag the market after expenses, and taxes if in a taxable account (tax efficient is not the same as tax free). 

Overall I believe the whole index/active debate is seriously overblown.  Most investors engage in self-destructive behavior that far exceeds any potential gain or loss from active or passive investing.  The most important thing is to have a realistic plan that doesn't change from one moment to the next.   

[quote user="Nagorak"]

The truth is most active funds are crap, so I am inclined to believe that an index does outperform 2/3rds even in a down market.  People buy all kinds of overpriced load funds, and most also buy growth funds.  The question isn't whether index funds are better than the majority of funds, because they are, it's whether it's impossible to select good funds. Maybe most can't but I do believe it is possible to do. 

The other point is that most indexers are not buy and hold investors either.  Just as many indexers as active fund investors buy high and sell low, pile into the most recently hot asset class, and so on. 

[/quote]

I agree, most active funds aren't worth their expenses and tax inefficiency but that doesn't mean that all aren't worth it.  And the fact that not everyone can pick a good active fund doesn't mean that no one can.

I think that the average poster here is not representative of the average investor and that most people make bad investing decisions regardless of whether they invest in active or passive funds.  Most people who invest in passive funds can't buy and hold when they see their investments drop sharply due to market conditions.  But not all of us are average.

[quote user="Nagorak"]

That said, I'm not sure I'd even go so far as to say the majority of active fund investors on M* necessarily are equipped to outperform the indexes.  There is a whole lot of performance chasing around here as well. 

[/quote]

True, true.  It is hard to resist the urge.

Nagorak,

Thank you for your post. You are one of the regulars on the MF forum who does see the big picture and who understands what makes a successful investor. Investors, both active and passive, can easily shoot themselves in the foot if they don't have a good plan and stay with it.

I like to look at smart investing as efficient (not to be confused with tax efficiency). Efficient investing simply means the market provides returns, but it's up to the investor to harvest as much as they can of that return. Making behavioral mistakes is probably the number one reason that a significant portion of those returns are lost. It certainly applies to both active and passive investors alike.

I suspect the fundamental that is most abused is performance chasing. The irony here is that the harder an investor tries to maximize returns, the less likely his is to do it.

Agree, disagree? Anyone else see another fundamental as being  most ignored?     

 

Paul 

 

 

Wel thanks to all of you " experts" at this game and the Bottom Line after reading all this is?

either deovte 50-100+ hrs reading a bunch of Books and devote A Major part of your Life/Time towards Managing your Money and you might have a 50% chance at succeeding..Or?

1. The New, Ave and Moderately experienced Investor is DOOMED To Fail! ( and those that do Learn? Learn too late in their lives to make much difference)

2. Be they invest in Anything, be they  Indexes or AMF's..

3. Are better off Just Owing a Few Active Managed Balanced Funds and let those Mgrs make the decisions and Emotions for you and leave it alone..( and not invest in anything else that you can get access to and change at moments notice )

4. Be they AMIBF's (Active Managed Index Bal Funds) like VWELX, VWINX or AMBF's such as FPACX,LAALX, OAKBX, DODBX, PRWCX,etc..

Build your FP around their past 10-15 yr rtns and that's it..

And only "try your luck" with only Money you won't be needing for Retirement.. Since, again, your are doomed in the end..to beat anyone, except yourself..

and spend more time with the Family at Camping, Boating, Hiking and play golf instead...

At least? That's the path I Chose..

and let's get the Fed to Privatize our SS into Whatever Funds,  so our kids won't have to spend half their lives trying to figure out how to " Loose" their Money on investing...and have SS really do the job and take it to the next Level..and make it 75% of ones FP and only 25% come from private Investing ( #401k's, IRA's, etc.) since more and more Co.;s are not offering #401ks anymore..( Probably since they have been exposed to be con games and a false sense of secuirty for so many who have found out the hard way)

 

[quote user="pkcrafter"]

I like to look at smart investing as efficient (not to be confused with tax efficiency). Efficient investing simply means the market provides returns, but it's up to the investor to harvest as much as they can of that return. Making behavioral mistakes is probably the number one reason that a significant portion of those returns are lost. It certainly applies to both active and passive investors alike.

I suspect the fundamental that is most abused is performance chasing. The irony here is that the harder an investor tries to maximize returns, the less likely his is to do it.

[/quote]

I think that buying when other investors are euphoric and selling when other investors are afraid is a big problem.

However, I do not agree smart investing is efficient investing ( i.e. obtaining market returns); or attempting to maximize returns is futile.  It all depends on how you do it.

I think Warren Buffett put it well:

• Remember that the stock market is manic-depressive.

• Risk comes from not knowing what you're doing.

• The investor of today does not profit from yesterday's growth.

• You are neither right nor wrong because the crowd disagrees with you. You are right because your data and reasoning are right.

• Growth and value investing are joined at the hip.

Warren Buffett is a smart investor.  A market indexer is an average investor.  A "performance chaser" is a poor investor.

IMHO, Buffett is 100% correct that the "market" is often foolish.  Thus seeking market returns would make us foolish too. 

Smart investing is about looking around corners and identifying value before the market has priced it in.

---

On whether active funds shine in down markets - that's a bit like asking, "Are the French better lovers?"  Some are and some aren't.

A well-managed active fund will shine in down markets because the manager will avoid owning falling stocks (think year 2000-2002 tech or 2007-2008 finance / housing / retail). 

Several of the managers who excelled 2000 - 2002 have so far also excelled 2007 - 2008: McGregor, Berkowitz, and Heebner for example.