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TR, you said"I think you work for Vanguard. Do you live in Valley Forge? Are you related to John Bogle? Maybe he's your cousin."

 

THANK YOU VERY VERY MUCH FOR THE COMPLIMENT. It's one of the nicest things that you or anyone else on this board has said to me.

 

"So I guess your approach is to say "don't trust anybody who doesn't recommend low cost index funds from Vanguard". I also like funds that are not Vanguard, for example Fidelity Spartan funds at .1 and over 100k .07. You see I do like different funds from different companies.

 

"When you have a chance go look at the investment managers for some of the largest endowments in the world. Many of them consistently use investment managers that don't just index"

 

TR.......yes they do but if you look at the returns of these endowments the majority do not measure up to the returns of low cost indexing., " Remember, knowledge is power and freedom"

 

TR, you said, "indexing in every asset class has not proven to be a winning strategy all the time, either from a performance point of view or a risk management point of view. This information is well documented in the academic and investment communities and I have posted it on this board before."

 

I tend to disagree, although there may be an example that I don't know about. Can you please show the documentation for your statement where active funds in one category do better than index funds in that category........Thank you

 

Ira

 

 

 

 

 

 

 

 

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Guest TR1982

TR,

 

1) I am well aware that GFA is a growth fund, and not a value fund.

 

"As for your point that some funds keep putting up the numbers year after year after year: You are probably referring to some of the value-oriented American Funds. Yes, they have done quite well, in large part because value stocks have been outperforming. When the worm turns, however, and growth funds take off, those funds will tend to underperform."

 

I'm sorry, I just do not understand your point. I was always referring to the GFA. Somehow you changed the subject and started talking about other funds.

 

2) I did not imply or state anywhere that value has had a 25 year run, for Pete's sake. Value has done well in the past several years, especially during the market decline of 2000-2002.

 

3) "Indexing in every asset class has not proven to be a winning strategy all the time ..." It depends upon how you define winning. If, over the long haul, I match market returns across several different asset classes in a mix that is appropriate for my risk tolerance, I consider myself to have won.

 

How convenient. Let's redefine winning when we don't win. Come on, that's ridiculous. You don't mind pointing out the advantage of index performance when you're winning. Sounds like grading on a curve to me.

 

4) "...either from a performance point of view or a risk management point of view." I would suggest that the use of index funds and Modern Portfolio Theory provide an efficient method of managing both.

 

That's what's interesting about the discussion. MPT has never advocated passive over active management. In fact, it suggests that security selection has little impact on return over long periods of time.

 

5) "I have an OBLIGATION as an advisor and fiduciary to make sure that every possible avenue is utilized to help clients reach their goals." Fair enough. In that obligation, do you explain to your clients how a mix of index funds from several asset classes can enhance performance and mitigate risk? Is that an avenue that you explore with your clients?

 

That's my point. There is CLEAR research that documents that passive management in every asset class has NOT always provided superior performance and risk reduction. The problem is not the availability of the information, it is the refusal of some to acknowledge it's existence and act accordingly. For example, we know that indexing in the international equity markets has not consistently outperformed the majority of actively managed funds in that asset class and the index funds in that category have carried much higher risk on average. So should an advisor ignore that information? I think not. Why would you? I would suggest that you read all sides of these discussions, not just the ones that you agree with.

 

 

TR, you said"I think you work for Vanguard. Do you live in Valley Forge? Are you related to John Bogle? Maybe he's your cousin."

 

THANK YOU VERY VERY MUCH FOR THE COMPLIMENT. It's one of the nicest things that you or anyone else on this board has said to me.

 

"So I guess your approach is to say "don't trust anybody who doesn't recommend low cost index funds from Vanguard". I also like funds that are not Vanguard, for example Fidelity Spartan funds at .1 and over 100k .07. You see I do like different funds from different companies.

 

"When you have a chance go look at the investment managers for some of the largest endowments in the world. Many of them consistently use investment managers that don't just index"

 

TR.......yes they do but if you look at the returns of these endowments the majority do not measure up to the returns of low cost indexing., " Remember, knowledge is power and freedom"

 

TR, you said, "indexing in every asset class has not proven to be a winning strategy all the time, either from a performance point of view or a risk management point of view. This information is well documented in the academic and investment communities and I have posted it on this board before."

 

I tend to disagree, although there may be an example that I don't know about. Can you please show the documentation for your statement where active funds in one category do better than index funds in that category........Thank you

 

Ira

 

 

Ira,

I posted that information a couple of times on this site, even started a thread one time. This is indicative to me of the problem of some on this site. You don't want anyone to challenge your premises at any time. I have no allegiance to passive or active investing. I want to use the methods that help my clients achieve their goals.

 

Ira,

Since you obviously didn't read this article, I post it here for your enjoyment. In case you fail to notice, it is WRITTEN BY PEOPLE AT VANGUARD.

 

Portfolio with index and actively managed funds has advantages

 

Indexing and active management can sometimes seem like opposite sides in a debate. For some investors, if one strategy is right, the other must be wrong. But in Vanguard's view, this framework is too simplistic and overlooks the value that combination strategies deliver to many investors. In constructing portfolios to meet investing goals, there can be clear diversification benefits to mixing active and passive components—including less variable investment returns, relative to all-active and all-index portfolios.

 

Vanguard has long promoted the power of indexing because it offers investors market exposure and diversification at very low cost. It can be an extremely effective long-term strategy. But with the right managers and reasonable costs, active funds can add value and complement an index portfolio.

 

"Indexing and active management are not opposing ideologies or all-or-nothing decisions," said Catherine Gordon, head of Vanguard Investment Counseling & Research (IC&R). "While many investors can be better off with 100% indexing, others prefer some combination of risk control and opportunity to outperform."

 

Because indexing and active management strategies can complement each other, a properly structured mix can be beneficial. Some initial IC&R analysis has suggested that a 50-50 mix of active management and indexing may be the preferred solution for investors seeking reduced variability in a portfolio's investment returns.

Indexing has proven benefits

 

The advantages of indexing include diversification, predictable performance relative to a benchmark, and a history of tax efficiency (for taxable accounts). Indexing is also applicable to virtually any market segment or asset class—large stocks or small stocks, U.S. markets or international markets, stocks or bonds—and is a relatively easy concept to understand and implement in a portfolio as well.

 

Perhaps most notably, while active management offers the potential for outperformance, index portfolios enjoy an inherent performance advantage to most active strategies. If an index fund is successful at tracking its index, its investors should only underperform the market because of expenses—and in the past, index investors have outperformed the majority of active investors over the long term. What's more, average mutual fund performance has been inversely related to fund expenses—that is, the lower the expenses, the better the performance, as shown in the table below.

General equity fund returns by expense ratios

Expense Ratio Average Annual Total Return

0.50% and below 12.05%

0.51%–1.00% 11.67%

1.01%–1.50% 11.23%

1.51% and above 9.16%

 

Note: Data are for 10 years ended December 31, 2004.

Source: Lipper Inc.

The performance data shown represent past performance,

which is not a guarantee of future results.

 

This data suggests that the underperformance of active managers in aggregate potentially can be explained by higher costs, not necessarily any lack of stock-picking skill.

Foregoing outperformance

 

For these benefits, index investors are willing to forego the key value that only active management can offer, which is the possibility (but with low probability) of outperforming the market.

 

"Unless markets are perfectly efficient, which they are not, active management creates the opportunity to add value above the benchmark," Ms. Gordon said. "With indexing, you're not participating in those kinds of opportunities."

 

Indexing is also sensitive to market cycles. In a deep, broad-based bear market, such as from 2000 to 2002, generally everyone suffers—both index investors and active managers. But there are cycles stemming from differences in performance among index groupings. For example, when large-cap companies did well in the run-up in stocks during the bull market of the 1990s, indexes that were segmented by the sizes of stocks (large-cap, small-cap, etc.) tended to outperform active managers. When the reverse is true, as has been the case over the last few years, more active managers might outperform the index.

 

Index investors should also consider the differences in how an index is constructed. For example, each index provider has its own definition of growth and value, as well as different parameters for stocks it classifies as large-, mid-, or small-cap.

Active management: Opportunities and caveats

 

As long as behavioral and informational errors of some investors exist, so will opportunities to outperform the market. The question becomes: How can you identify those opportunities?

 

First, many investing decisions are emotionally driven, and human beings sometimes behave irrationally. On any day investors may underreact or overreact to news, trading securities at prices unequal to their real values. Second, investors vary considerably in their ability to assimilate and interpret data and in their discipline and insight. These behaviors and the range of investor capabilities create inefficiencies and opportunities in the marketplace. A disciplined, insightful manager, who can identify enough of these opportunities, can add value. If the manager's costs are reasonable, an investor may be able to beat the market.

 

As difficult as it can be to find successful active managers, it may be even more difficult to pinpoint those who are consistently successful. For example, the top U.S. equity fund from 1984 to 1994 was ranked 1,214th in performance the subsequent decade. Of the top 20 funds, the average rank was 679th in the 1994–2004 period (Lipper Inc.).

 

The real value of active management depends on manager talent and competitive costs—and both demand effective due diligence from the investor. "High costs and fees can be a tough hurdle to overcome if you are relying on active management," Ms. Gordon said. "When selecting managers, you have to ask if they can effectively implement a sound strategy and not lose too much of the potential return to costs."

Another level of diversification

 

Because index and active strategies behave differently, they can complement each other in portfolios, offering the powerful benefits of another level of diversification. There are periods when indexing outperforms and periods when active management outperforms—suggesting that mixing the two strategies might moderate the variability of returns.

 

In creating combination portfolios, investors need to understand the trade-offs between these strategies. For example, Ms. Gordon said, "When you add actively managed investments to an index portfolio, you sacrifice something in cost containment and the predictability of the market's return. When you add indexing to an active portfolio you surrender some opportunity to beat the market."

 

The table below shows the relative trade-offs that can be expected in an all-active or all-index strategy—and how a split portfolio can offer a more moderate approach.

Vanguard's view of indexing and active management trade-offs

Tracking Error Portfolio Return Variability* Expected Excess Return** Potential for Tax Efficiency

100% index Lower Higher Lower Higher

50% index/50% active Medium Lower Medium Medium

100% active Higher Higher Higher Lower

 

*Relative to 100% index and 100% active portfolios.

**Higher returns relative to the market or benchmark.

Finding the right balance

 

While a 50-50 split between indexing and active management can be a reasonable starting point, the most appropriate combination for a portfolio depends on a number of factors, primarily the investor's goals. There is no single answer for everyone; investors must make decisions based on their own circumstances and comfort level.

 

Once an appropriate percentage of indexing versus active management is chosen, decisions can then be made in selecting managers. Characteristics important in active managers include skill, experience, and a solid long-term track record of performance. However, factors such as low costs, a clearly defined investment philosophy, and a consistent approach regardless of market cycles can be just as important.

 

Another consideration in identifying general groups of active managers is to categorize their funds by benchmark sensitivity. Active funds can be index-sensitive, index-aware, and index-agnostic, and these varying philosophies could have an impact on the portfolio.

 

Some active managers, for example, are highly index-oriented, typically targeting a modest amount of excess return and acceptable deviation from the benchmark. However, index-agnostic managers attempt to get the highest return possible with little concern for a fund's volatility relative to the market.

 

"Both approaches are legitimate strategies, and there are many managers who take an approach somewhere along the spectrum," Ms. Gordon said. "Investors need to consider how different active managers align with their own objectives and complement the other investments in their portfolio."

 

Still, the important point, according to Ms. Gordon, is to aim to construct a portfolio that stands the best chance of delivering on a chosen allocation. "It all stems from the asset allocation decision, both among and within asset classes. Indexing is a proven strategy, and active management can complement it. But when you're using a combined strategy, the emphasis should be on well-chosen active managers."

 

Notes

 

* Diversification does not protect against a loss in a declining market or ensure a profit.

* Prices of small- and mid-cap stocks often fluctuate more than those of large-company stocks.

* The performance of an index is not an exact representation of any particular investment, as you cannot invest directly in an index.

* There is no guarantee that any particular asset allocation or mix of funds will meet your investment objectives or provide you with a given level of income.

* Mutual funds are subject to risk.

* Foreign investing involves additional risks including currency fluctuations and political uncertainty.

 

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TR.....Thank you for sharing the article...........there were some very good points, many of which, we at this site have frequnetly discussed, and will continue to do so.

 

As you know, I personally lean toward indexing when ever possible, however there are many investors who I respect who invest in low cost active funds. I do believe that funds whose annual costs are lowest tend to perform better over time.................Ira

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TR,

 

1) Regarding "winning," I previously posted the following:

 

"I am not seeking market-breaking returns. I am quite happy to match market returns. If I am successful, this will put me ahead of a large percentage of actively-managed funds. That will make me very content."

 

My object is not to swing for the fences and beat 99.99% of all funds; rather, it is to meet my objectives. I try to accomplish this with the proper asset allocation that maximizes returns with a minimum of risk. If I meet my goals, then yes, that constitutes "winning" in my book. My book is the only one that counts for me.

 

Even if you do not accept my definition of winning, the truth is that index funds generally outperform a large majority of actively managed funds of a comparable asset class over time. You don't dispute this, do you?

 

2) You stated that, "MPT has never advocated passive over active management. "

 

Proponents such as Malkiel, Ferri, Swedroe, and Bernstein all use index funds to implement MPT.

 

3) You stated that, "For example, we know that indexing in the international equity markets has not consistently outperformed the majority of actively managed funds in that asset class and the index funds in that category have carried much higher risk on average."

 

I refer you to the studies of David Booth, as reported in Larry Swedroe's The Only Guide to a Winning Investment Strategy You'll Ever Need, pages 83-84:

 

"We have further empirical evidence against the often heard arguments that because international markets are not as well researched and therefore not as efficient as the US markets, active managers can add value when investing globally ...

 

Booth's ... study covered nine countries and twenty six funds in developed markets, and eighteen countries and thirty funds in emerging markets ... Booth found that the average developed market country fund underperformed its benchmark by 7.9 and 1.4 percent per annum over three and five year periods, respectively ... The average emerging market country fund also underperformed its benchmark country index by 5.8 and 1.6 per annum over three and five year periods, respectively ... The average underperformance for all fifty six funds covering twenty seven countries was 6.6 and 1.5 percent per annum ..."

 

4) You previously stated that you have an "OBLIGATION as an advisor and fiduciary to make sure that every [my italics] possible avenue is utilized to help clients reach their goals." So I ask you once again, do you explain the advantages of MPT using index funds as an alternative to your clients? If not, why not?

Edited by apteacher

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Guest TR1982

TR,

 

1) Regarding "winning," I previously posted the following:

 

"I am not seeking market-breaking returns. I am quite happy to match market returns. If I am successful, this will put me ahead of a large percentage of actively-managed funds. That will make me very content."

 

My object is not to swing for the fences and beat 99.99% of all funds; rather, it is to meet my objectives. I try to accomplish this with the proper asset allocation that maximizes returns with a minimum of risk. If I meet my goals, then yes, that constitutes "winning" in my book. My book is the only one that counts for me.

 

Even if you do not accept my definition of winning, the truth is that index funds generally outperform a large majority of actively managed funds of a comparable asset class over time. You don't dispute this, do you?

 

Yes, I do. There is considerable research that has shown that in the large cap arena that indexing has been the superior approach. I DO NOT DISPUTE THIS. But the same researchers have consistently shown that passive approaches have not been nearly so convincing in other asset classes.

 

2) You stated that, "MPT has never advocated passive over active management. "

 

Proponents such as Malkiel, Ferri, Swedroe, and Bernstein all use index funds to implement MPT.

 

I hate to break it to you. There are more people in the research and investment community than these folks. They did not propose, invent, or theorize about MPT. They simply advocate passive investing.

 

3) You stated that, "For example, we know that indexing in the international equity markets has not consistently outperformed the majority of actively managed funds in that asset class and the index funds in that category have carried much higher risk on average."

 

I refer you to the studies of David Booth, as reported in Larry Swedroe's The Only Guide to a Winning Investment Strategy You'll Ever Need, pages 83-84:

 

"We have further empirical evidence against the often heard arguments that because international markets are not as well researched and therefore not as efficient as the US markets, active managers can add value when investing globally ...

 

Booth's ... study covered nine countries and twenty six funds in developed markets, and eighteen countries and thirty funds in emerging markets ... Booth found that the average developed market country fund underperformed its benchmark by 7.9 and 1.4 percent per annum over three and five year periods, respectively ... The average emerging market country fund also underperformed its benchmark country index by 5.8 and 1.6 per annum over three and five year periods, respectively ... The average underperformance for all fifty six funds covering twenty seven countries was 6.6 and 1.5 percent per annum ..."

 

Well, there is consistent evidence, some published on their own websites, casting doubt on these assertions. Plus, people in the academic and investment community disagree on these issues all the time. You think because you've read one book that advocates one position, that the issue is now settled. Nothing could be further from the truth. The problem is that no one on this website is willing or cares to look at a different point of view. Witness the article I attached written by people at Vanguard. They advocate the very position I am suggesting and yet you dismiss it because you've read the BOOK.

 

4) You previously stated that you have an "OBLIGATION as an advisor and fiduciary to make sure that every [my italics] possible avenue is utilized to help clients reach their goals." So I ask you once again, do you explain the advantages of MPT using index funds as an alternative to your clients? If not, why not?

 

I do, that's MY POINT. You are the one who has decided that there is ONE WAY, not me! I am open to other possibilities, you are not. If you want to index your way to heaven, that's fine with me. I just ask that people here stop telling me and others that the issue of passive investing has been settled and the debate is over. Nothing could be further from the truth.

 

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TR,

 

1) Sounds like you have data that suggest indexing is superior in large cap only. I have data suggesting otherwise.

 

2) Obviously, there are other MPT practicioners besides Malkiel, Ferri, Swedroe, and Bernstein. I never suggested that they were the first to develop MPT. They do, however, use index funds to implement MPT.

 

3) More disagreement on data with international indexing. We'll have to disagree on that one, too.

 

4) I am most impressed that you do explain the advantages of using index funds to implement MPT with your clients. That puts you way, way, way ahead of the advisors of whom I am aware. You are to be commended for this. Do most of your clients opt for this, or do they opt for actively managed funds? Just curious.

 

Lastly:

 

1) How can actively managed funds overcome the cost advantages of index funds?

 

2) With so much information so widely available to the public, how is it possible for actively managed funds to market inefficiencies?

 

I am sincerely interested in your responses to these last two questions. You have (falsely) accused me of paying attention to only one side of these issues. Hey, I was an active investor for years. I read everything I could get my hands on to try and outperform the markets. I finally came to the conclusion that it was not possible (for me, anyway), but it wasn't for lack of information on the point of view that you are espousing. That does not mean that I am unaware of the other side. I just disagree with it. I am open to hearing more, and that is why I am asking these questions.

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Guest TR1982

TR,

 

1) Sounds like you have data that suggest indexing is superior in large cap only. I have data suggesting otherwise.

 

2) Obviously, there are other MPT practicioners besides Malkiel, Ferri, Swedroe, and Bernstein. I never suggested that they were the first to develop MPT. They do, however, use index funds to implement MPT.

 

3) More disagreement on data with international indexing. We'll have to disagree on that one, too.

 

4) I am most impressed that you do explain the advantages of using index funds to implement MPT with your clients. That puts you way, way, way ahead of the advisors of whom I am aware. You are to be commended for this. Do most of your clients opt for this, or do they opt for actively managed funds? Just curious.

 

I am not focused on costs or performance. My objective is try and help my client reach their goals. Paying attention to those issues is important in helping the client reach their goal but it is not the goal. Generally, they will chose the course I suggest. I use both without bias.

 

Lastly:

 

1) How can actively managed funds overcome the cost advantages of index funds?

 

They can't, by definition.

 

2) With so much information so widely available to the public, how is it possible for actively managed funds to market inefficiencies?

 

I am not qualified to address this issue as a market theoritician. I can only say that there is a broad diversity of opinion in the investment community about this issue. I would say this: many academics hold to theories such as what you suggest, but they are only theories. That is, they describe what we observe. But these kinds of ideas are wonderful in the abstract, something else in practice. We know that economists have been trying to describe the US economy for years. I think we would all agree that this kind of exercise is an evolving process, not static. It's a hard concept for many to accept (including me) that all information is known and there are no inefficiencies anywhere.

 

I am sincerely interested in your responses to these last two questions. You have (falsely) accused me of paying attention to only one side of these issues. Hey, I was an active investor for years. I read everything I could get my hands on to try and outperform the markets. I finally came to the conclusion that it was not possible (for me, anyway), but it wasn't for lack of information on the point of view that you are espousing. That does not mean that I am unaware of the other side. I just disagree with it. I am open to hearing more, and that is why I am asking these questions.

 

My concern is that some people on the passive investing bandwagon have taken the position to an extreme. I personally don't know of any practitioners that would suggest that active management is always superior to passive management. When I hear anyone take a position like that on any investment approach or product my radar goes up. I want to know what ax they have to grind. I think both approaches have merit in helping clients achieve their goals and therefore should not be treated with disdain.

 

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Guest Sierra

This is utterly amazing and demoralizing to say the least. Not one participant in the NJ DCP wants to contribute his or her two cents to my original post. And they wonder why they are treated with such contempt and utter disrespect by their employer, the State of New Jersey.

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