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Active v Passive Funds - Some Tests
Harry Trout
Posted: 24 March 2018 13:30:53(UTC)
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Much is written to persuade investors toward passive funds, the mantras include:

• “you can’t beat the market”
• “everything reverts to the mean in the end”
• “fund managers are overpaid and know no more than monkeys”
• “charges will kill your returns”

Even the legend Buffett is at it with his support for an S&P 500 tracker and of course there was his 10-year bet with hedge fund managers.

Last year I started an experiment in a separate portfolio where I have pitched my favourite and long held active funds versus a relevant passive / tracker. I wanted to do this with real money so I can be 100% sure of the impact of charges which can be a minefield to accurately decipher.

I now have 4 tests on the go, all of which are being run on Hargreaves Lansdown’s platform and all are in accumulation units of OEICs:

1. Fundsmith Equity v Vanguard SRI Global Stock. This test started in February 2017. As at this morning Fundsmith is up 4.5% and Vanguard is down 2.1%.

2. Old Mutual UK Mid Cap v HSBC 250 Index. This test started in February 2017. As at this morning Old Mutual is up 3.6% and HSBC up 0.6%.

3. Old Mutual North American Equity v Vanguard US Equity Index. This test started in February 2017. As at this morning Old Mutual is up 4.1% and Vanguard is at 0%.

A week ago I started a 4th test with Fidelity Emerging v Vanguard Emerging Markets Stock Index.

The rule is that if I add money to one of the active investments in this separate portfolio, I always add on the same day the same amount to its equivalent passive partner.

So far the actives are marginally winning. The purpose of doing this is not because I have nothing against passives, far from it. I just wanted some reassurance that the time spent selecting and monitoring actives is worth it. There are some very persuasive people (including on this forum) who argue against actives and I find it helpful to refer back to my concrete real life tests for sanity. Of course, the tests haven’t been running that long yet ….

In anticipation of Tony praising me for my public spiritedness in supporting active fund manager’s lifestyle, I should say that my portfolio of directly held stocks has grown this week to 6 with the addition of Microsoft. My lofty aim is that this stocks portfolio will outperform my active funds one day. After all, as someone once said, you owe it to yourself to be your own fund manager!!

Welcome any comments and I will update this thread from time to time with performance updates. I may start a 5th test with Lindsell Train Global Equity next week.

Have a good weekend all

Harry
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King Lodos
Posted: 24 March 2018 17:24:19(UTC)
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The passive argument is overplayed.

– We've been proving for decades that there are investing styles that beat the market (read What Works on Wall Street);

– Not everything mean reverts (companies that can reinvest at a high rate of return, with a competitive advantage, will simply do better);

– Fund managers might struggle to outperform monkeys, but their work is what makes markets efficient (the problem is they have access to so much information, it's hard for them to beat each other);

(Charges are a problem.)


What you'll typically find is funds that have done well in recent history tend to continue to do well .. But when a certain fund or style does well, more people start investing in it, and valuations get higher, and funds get larger and become very different entities (or in the case of ITs, premiums get higher).

And it's what happens through market cycles, as styles come and go, and managers thrive and fail .. and over the very long term, the fee may be the only thing that's consistent .. If you went back 25 years and bought all the top funds then, you might find a lot of them since folded, and you probably don't recognise many .. And if you're buying today's top funds, you have to hope there's more outperformance ahead than underperformance – which is a bit of a coin toss
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Aminatidi
Posted: 24 March 2018 18:00:06(UTC)
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Why did you need to put real money in?

I use Trustnet's portfolio to "have a look at what I could have won" and I assumed that other than broker fees that takes into account net returns?
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Harry Trout on 24/03/2018(UTC)
Simon Cook
Posted: 24 March 2018 18:03:20(UTC)
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Funnily enough I have been keeping daily records of gain/loss since the 5th Feb (with the exception of 7th Feb) on a range of active and passive funds, ETFs and ITs that I either hold or am considering. I hold mostly OEICs with HL but I got a reduced fee after RDR so do not pay 0.45% so am happy to hold them (although I would swap to certain ITs if they were on better discounts). Here are some totals to date if they are useful to people:

Global:
SWDA: -8.73%
VWRL: -8.34%
Vanguard FTSE word dev ex uk: -6.14%
Vanguard global all cap: -5.97%
L&G international index: -6.02%
Bankers: -8.05%
FRCL: - 8.08%
Rathbone global: -3.04%
BG global alpha: -4.64%
Troy Trojan global: -7.35%
Lindsell Traiin global: -3.78%
Old Mutual Global: -5.58%
Fundsmith: -5.91%

Global small cap:
FCS: -9.17%
XXSC: -5.84%
CUKS: -4.5%
ISP6: -2.96%
WOSC: -3.74%
SLI global smaller: 1.7%
BG global discovery: 0.47%
Vanguard global smaller: -4.21%

So the managed global OEICs have generally lost less, especially in the global small cap area which itself has fared better. The Vanguard trackers haven't done too badly and I wonder if this is because they are valued at the end of the day where as the OEICs and ETFs are valued at midday and therefore miss any afternoon US rise (my records so show this happening).

I have also done this for what I would call safer funds and ones like PNL and CGT have lost 4.24% and 3.05% respectively (so what is the point?). Strategic bond funds have lost anything between 0.2% and 1.2% but Old Mutual Global Equity Absolute (R hedged) has gained 1.31%.

In the Asia and emerging markets since Feb 16th when my complete records for these start), IAT (-5.49%) and SDP (-4.97%) have lost the most. Supposedly safer Stewart Investors have not been safer than other managed OEICs and until the last two days sell off were languishing well behind:

SI Asia Pacific Leaders ex Japan: -1.39%
SI Global Emerging Markets Leaders: -2.93%
Vanguard emerging markets index: -3.43%
Hermes Global emerging markets: -2.62%
Veritas Asian: 0.53%
BG Developed Asia: -1.59%
First State Asia Focus: -1.09%
Fidelity Asia: -1.62%
Old Mutual Asia Pacific: -1.29%

I hold the Stewart funds but have been considering swapping them as their performance in the last two years has been poor as they have no China exposure. However, that may well help with the potential coming trade war so I might hold on a little longer. Veritas Asian looks good but it has a steep fee of 1.42%.




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King Lodos
Posted: 24 March 2018 18:12:16(UTC)
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Aminatidi;59314 wrote:
Why did you need to put real money in?

I use Trustnet's portfolio to "have a look at what I could have won" and I assumed that other than broker fees that takes into account net returns?


There are always biases at play, doing it backwards.

If we went back to 2015, I'd suggest Woodford Equity Income as one of the most surefire funds to pit against a tracker .. a few years earlier, I'd have picked Murray International.

Backfitting, survivorship bias, data-mining, etc. In any kind of active strategy, the only real proof is whether you can do it going forwards.

Extreme example of this was a type of ETF, called a hedge fund replication strategy .. And these tracked big hedge funds using signal analysis on their price data (the kind of maths used to turn chaotic sound waves into understandable speech by computers).

And you could fine tune these to work on past data – and it would break a hedge fund down into 30% Japanese Stocks, 21% Long-term Treasuries, etc. – yet as soon as they launched, they tended to fail miserably .. some even became like chaotic machines, shaking themselves apart .. And it just shows how easily even engineers and mathematicians can trick themselves working with past data
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Harry Trout
Posted: 24 March 2018 18:31:23(UTC)
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Aminatidi;59314 wrote:
Why did you need to put real money in?

I use Trustnet's portfolio to "have a look at what I could have won" and I assumed that other than broker fees that takes into account net returns?

It's just me wanting to be 100% sure. I am a big fan of Buffett (I hold Berkshire Hathaway) and so was rattled by his support of an S&P 500 tracker. I still find it interesting and challenging that he should say this.

And of course "everything reverts to the mean in the end" is an elegant theory as ultimately "the market" is the mean of all prices.

There is another mantra I missed - "don't search for the needle in the haystack, buy the haystack". This is also an appealing concept.

These sorts of messages from highly respected sources have just made me want to be sure what the real money returns of active funds are after charges when compared with appropriate passives.

I hope this answers your question, thanks for posting.
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Aminatidi on 25/03/2018(UTC)
King Lodos
Posted: 24 March 2018 18:46:31(UTC)
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Harry Trout;59320 wrote:
There is another mantra I missed - "don't search for the needle in the haystack, buy the haystack". This is also an appealing concept.


Also you know that for every buyer there has to be a seller.

e.g. There are always as many stocks sold at the top of the market as bought – likewise the bottom .. Whenever you buy BRK.B, someone else has to want to sell.

That's what they mean by a 'zero sum game' .. And most market participants are fund managers .. So when you look at the trading active funds do, 99% of it is just exchanging stocks between each other .. And so they can't really outperform, as a group .. Between them, they ARE the market .. But when you buy them, you're the market minus the fee.

So the rule of markets is you HAVE to be adding something to the system in order to beat it .. e.g. You have to be able to identify the manager who's going to outperform. You can't just say active does better – because it can't.


On the haystack line though .. Buffett, Smith, Lindsell and Train have a different approach .. Rather than looking for the next Amazon, they stick with the tried and tested .. The rest of the market is willing to pay a premium to find tmrw's winners, and if you just avoid all that speculation, you do very well
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xcity
Posted: 24 March 2018 20:30:25(UTC)
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The big advantage of passive only really comes through in the long term, when the small % lower costs have compounded.

Though saving the time it takes worrying about whether your fund managers are about to enter decline is another advantage.
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Harry Trout on 24/03/2018(UTC)
B B
Posted: 24 March 2018 22:38:53(UTC)
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Your time span isn't long enough. Take a look at what Lars Kroijer says in his short bite size videos, backed up by many former active fund personnel including a Nobel prize winner. Then read some.

https://www.youtube.com/watch?v=gM4KEJQ_Z5U
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King Lodos
Posted: 25 March 2018 07:08:16(UTC)
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Just to play devil's advocate again, re: the Lars Kroijer videos.

The theory behind why active loses most investors money is very solid (and backed up by plenty of evidence) .. The more time you spend around Efficient Markets advocates, the more cynical you become about active management .. That fund you're paying for has the same information as everyone else.

But there is another way to look at it, and it's that you don't HAVE to own 500 stocks .. 75% of the stocks in an index tracker will lose you money .. And if you can identify the 25% that won't go bankrupt or have their margins destroyed by competition, you can get the market return minus the detractors .. And there's no reason you can't do that.


In an efficient market, what would happen is those very safe businesses would become more expensive, until risk and reward balance out .. So your portfolio of 'safe' stocks would be on PEs of 50 (returning 2%), while all the bad businesses would be on PEs of 10 (returning 10%).

But the valuation gap isn't that wide .. It has been in the past (the old Nifty Fifty got very expensive), and it is with some tech giants – but as Smith says: 99 times out of 100 people ask him if the business is 'cheap', not if it's 'good' .. And that might tell a lot about why markets still aren't efficient .. And throw Smart-beta and algorithmic traders into the mix, and things get more chaotic, not less
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Harry Trout
Posted: 25 March 2018 09:04:45(UTC)
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B B;59336 wrote:
Your time span isn't long enough. Take a look at what Lars Kroijer says in his short bite size videos, backed up by many former active fund personnel including a Nobel prize winner. Then read some.

https://www.youtube.com/watch?v=gM4KEJQ_Z5U

Thanks B B, I have watched the video, a brilliant example of the persuasiveness of the argument that is put forward. And it is an elegant one as I've said.

It was through reading the posts on this forum that I have gleaned much of what Lars says and so a while back bought Vanguard World ETF (VWRL) to act as my benchmark. Each month I calculate the compound annual growth rate on my investments and compare to VWRL. Over time those that consistently underperform don't get topped up and may ultimately be sold. Those that out-perform get added to. I monitor how much of my overall portfolio is beating VWRL.

Thus inevitably the tests I am doing are on funds that have survived over the years and I don't talk about the ones that got binned !!!

I think in part it's a question of how much time you want to put to it. The purpose of my tests is to be able to say with certainty whether or not my long term choices are out-performing their benchmarks. It's probably overkill but it's simple and quick to do and I thought I would share and then update over time.
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B B
Posted: 25 March 2018 09:15:39(UTC)
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Vanguard FTSE Dev World ex UK Equity Index Acc. made 84% for the past 5 years with an ocr of 0.15 as opposed to a normal 0.75 / 1.plus %. Although it's weighted to the US, they're the biggest market.

The OCR for £20k in that fund would cost £150 over 5 years, whereas in an active fund £850, more if inflation was taken into account.

My regret is that I became aware 20 years too late.
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King Lodos
Posted: 25 March 2018 09:26:27(UTC)
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Harry Trout;59348 wrote:
Each month I calculate the compound annual growth rate on my investments and compare to VWRL. Over time those that consistently underperform don't get topped up and may ultimately be sold. Those that out-perform get added to. I monitor how much of my overall portfolio is beating VWRL.


Well there's some more good news for you.

Although academics take Efficient Markets as the base case, they also recognise there are anomalies.

Fama and French demonstrated that Value and Size predict outperformance – but they explain it by saying cheap stocks and small stocks are inherently riskier .. So it doesn't break the theory: you simply get paid more to take more risk .. So the official line isn't that passive beats active in returns; it's that it beats active in risk-adjusted returns.

The other example of beating the market easily is leverage (as ITs do) – and this simply increases risk and return together (but with fees, gives you a slightly lower risk-adjusted return).

The strongest and most persistent anomaly, however, is Momentum .. Which Fama and French can measure, but isn't generally included as a 'risk factor' as it's not clear that these stocks are riskier .. So Momentum's a big problem for academics – it sort of proves markets aren't efficient .. Bitcoin's an example of a Momentum-driven market (people are more likely to pile in as returns go higher and higher).

And what YOU'RE doing, adding to winners and dropping losers, is a Momentum tilt .. So you're adding some controlled momentum to your 'beta' (market return), and there's plenty of evidence that this can work .. And my recommendation would be to use a 6-12 month measurement period – as momentum's quite a short-term phenomena .. It's like riding waves
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Harry Trout
Posted: 25 March 2018 14:54:26(UTC)
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King Lodos;59352 wrote:
And what YOU'RE doing, adding to winners and dropping losers, is a Momentum tilt .. So you're adding some controlled momentum to your 'beta' (market return), and there's plenty of evidence that this can work .. And my recommendation would be to use a 6-12 month measurement period – as momentum's quite a short-term phenomena .. It's like riding waves

Thanks for your notes. I would probably hang on to winners longer than 6-12 months but I take your point. I tend to find that when I have built up a position in a fund that is beating it's own benchmark then as long as the manager doesn't change and as long as it is also beating VWRL then I am unlikely to change it.

I am for example looking for a home for my River & Mercantile UK Smaller. At 7% of my portfolio the departure of Phillip Rodrigs has given me a job to do. I already have Old Mutual UK Smaller and may add to that but also have my eye on the UK Buffettology fund.
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King Lodos
Posted: 25 March 2018 15:46:16(UTC)
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Harry Trout;59379 wrote:
Thanks for your notes. I would probably hang on to winners longer than 6-12 months but I take your point. I tend to find that when I have built up a position in a fund that is beating it's own benchmark then as long as the manager doesn't change and as long as it is also beating VWRL then I am unlikely to change it.

I am for example looking for a home for my River & Mercantile UK Smaller. At 7% of my portfolio the departure of Phillip Rodrigs has given me a job to do. I already have Old Mutual UK Smaller and may add to that but also have my eye on the UK Buffetology fund.


It's a good idea comparing all these funds to a standard benchmark too (FTSE World) .. That's what a lot of people get wrong.

If you're comparing them to VWRL, you can potentially rotate your portfolio towards growth regions, sectors and styles, with a very simple system.

I did rolling 50% annual returns in stocks for a couple of years straight (up until this year, when I decided to stop trading and sit it out in Quality) – by far my best trading period – and that was basically doing what you're doing .. Except I'd use my own portfolio as the benchmark, and I'd always want to bring things in that were doing better, and throw things out that were lagging .. I learnt a lot doing that – mainly I always needed to limit how many ideas I pursued and funds I held, so I'd be forced to throw things out in order to bring better things in .. If I'd limited myself to 3 funds, total, I could've done much better I think – I tended to have too many
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JohnW
Posted: 26 March 2018 16:18:48(UTC)
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The thing about advocates of passive investing is that they always compare with the average fund/trust. But we all know of plenty of funds and trusts which have made very little, if anything, for years. And if you have left your money in poor investments then it would ne no great surprise if you would have done better elsewhere. If anyone is going to compare the best of the passive funds then to compare it with anything but the best of active funds is to me cheating! I only compare my portfolio with the FT100 and FT All Share and I have substantially beaten those.
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King Lodos
Posted: 26 March 2018 16:27:20(UTC)
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I'd say you should compare to the FTSE World or US index – as those represent the whole market better.

The FTSE 100/AllShare is a really weird, niche index, full of low quality and cyclicals


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Harry Trout
Posted: 26 March 2018 18:48:30(UTC)
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As a 5th test I have today added Lindsell Train UK Equity and Vanguard FTSE 100. Both are in accumulation units.

I will update from time to time on the results of all 5 tests on this thread.

Thanks for all your posts, it's been interesting to get different views.
Tim D
Posted: 26 March 2018 20:05:53(UTC)
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King Lodos;59316 wrote:
If we went back to 2015, I'd suggest Woodford Equity Income as one of the most surefire funds to pit against a tracker .. a few years earlier, I'd have picked Murray International.


Haha... back in April 2015 I did exactly that and set up one of these experiments/tests/contests or whatever you want to call it myself, investing some significant transferred-to-SIPP funds into equal tranches of Vanguard Lifestrategy 80, Vanguard FTSE UK Equity Income (yield-oriented UK passive) and Woodford Equity Income. All "Inc" units, but they've all been set to reinvest their own dividends since purchase.

Since then, VLS80 is up 24%, the UK equity income one is up 3% and Woody is down 3% (if those seem surprisingly low, bear in mind April 2015 was a bit of a local maximum over the 2014-2016 period).

If I buy something, I buy it for 5 years so I'm letting this lot run as-is until at least April 2020. Really hoping Woodford can redeem himself over that period, but if he can't beat or at least match Vanguard's UK Equity Income passive by then it'll be bye-bye.
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King Lodos
Posted: 26 March 2018 20:29:28(UTC)
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Tim D;59464 wrote:
Haha... back in April 2015 I did exactly that and set up one of these experiments/tests/contests or whatever you want to call it myself, investing some significant transferred-to-SIPP funds into equal tranches of Vanguard Lifestrategy 80, Vanguard FTSE UK Equity Income (yield-oriented UK passive) and Woodford Equity Income. All "Inc" units, but they've all been set to reinvest their own dividends since purchase.

Since then, VLS80 is up 24%, the UK equity income one is up 3% and Woody is down 3% (if those seem surprisingly low, bear in mind April 2015 was a bit of a local maximum over the 2014-2016 period).

If I buy something, I buy it for 5 years so I'm letting this lot run as-is until at least April 2020. Really hoping Woodford can redeem himself over that period, but if he can't beat or at least match Vanguard's UK Equity Income passive by then it'll be bye-bye.


I bought Woodford Equity Income just after launch, and it was my largest position .. I also told friends it was the no-brainer fund to buy.

And when I was first in it, it outperformed well – it was well ahead of Fundsmith, from what I remember .. I bought it on the suggestion that a lot of fund managers were planning to copy Woodford's holdings – so that would push his positions higher.

But my success with active funds has come down to being completely intolerant of underperformance .. Even now, I'll start selling something if it underperforms for a month .. That comes from the experience of being in an underperforming fund, and holding on too long .. Waiting for performance to turn around is probably not a good strategy – because at some point you'll be left holding a pig of an investment
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