Indexing vs Active Management

The fee structure in mutual funds has some distorted incentives, making it more profitable them to focus on growing the fund by attracting more customers rather than performing well. There are also many ways in which mutual fund companies "cheat" on their past performance figures in their public advertisements. In general, it's best to avoid the funds which derive a large portion of their customer base from advertising in mainstream business media. Akin to hedge funds, the best ones are the ones that relatively quiet and aren't easily available to the public. This is because the best managers are focused on growing their fund through capital appreciation (gains) rather than percentage of AUM management fees. These funds don't need to go out of their way to advertise because they usually spread through word-of-mouth of inside circles (and many go through periods where they are closed to outside investment completely). Investment services sold the general public are vastly sub-par.

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I think it was Brian Townsend who said that a trained monkey could beat 5/10 like 4 or 5 years ago. I'll say that an untrained monkey probably is a better advisor then the random idiot you'll get if you go to your bank and ask for investment advice.

This is because of two things:

1. Markets put reasonably reasonable prices on most stocks most of the time, so randomly picking stuff will beat the markets some fairly high % of the time.

2. The idiots your bank gives you wants to sell shit they get a commission from selling, not selling stuff you'll actually will end up being +ev owning.

Therefore: Go with the monkey, or even better try to figure some stuff out yourself.

Indeed, we live in a time where geopolitical factors and loose monetary policy have "raised the stakes" to an unprecedented level. In our current situation it's wiser for the average person to
1) protect your assets using t-bills rather than concern yourself with chasing return
2) use a shorter term horizon
3) look into asset classes that are inversely or neutrally correlated with the state of the economy

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Many mutual funds are "donkish" - they operate with artificial constraints, for example they cannot invest in junk bonds or other high-risk securities.
The fact that average manager cannot beat the market doesn't mean nobody can. Good luck trying to find a manager that can beat it though.

I think there is solid evidence that index funds outperform actively managed funds in the long run.

So my basic point is: If these fund managers who are paid millions of dollars can't beat the market consistently, why should you or me think that we can do it? Now I'm not going to stop investing in dividend growth stocks as I am confident in my overall strategy...

So which is it?
You don't think you are better than avg fund manager, yet you think your strategy of stock picking will outperform index funds (adjusted to the risk level)?

Have been skimming through your blog lately and see that you're preferring dividends-stock instead of growth stocks. Why is that exactly? As I see it, there is no difference in returns between dividends-stock and growth stocks, but you pay higher taxes on dividends than you do on growth-stocks (capital gains). Am I missing something?

vast majority of mutual fund managers blow. Look at your 401k mutual fund manager options; they have little experience running a fund.

If I could invest with places like Yale's endowment fund or Brdigewater, I'd do it in a heartbeat.

nlwolf summed it up. Institutional investors and individual investors are usually worlds apart in how they can approach using their funds. It is the reason that Peter Lynch advocated that mum and dad investors with some care could out perform most public funds.

2c0ntent half the shit you wrote doesn't make sense.

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I think 2c0intent was right about everything.

Funktion is also right that it kind of doesn't make sense but that's because the system is fucked up.

On October 17 2012 15:23 nlwolf wrote: Many mutual funds are "donkish" - they operate with artificial constraints, for example they cannot invest in junk bonds or other high-risk securities. The fact that average manager cannot beat the market doesn't mean nobody can. Good luck trying to find a manager that can beat it though. I think there is solid evidence that index funds outperform actively managed funds in the long run. Show nested quote + So my basic point is: If these fund managers who are paid millions of dollars can't beat the market consistently, why should you or me think that we can do it? Now I'm not going to stop investing in dividend growth stocks as I am confident in my overall strategy... So which is it? You don't think you are better than avg fund manager, yet you think your strategy of stock picking will outperform index funds (adjusted to the risk level)?

I don't think I'm better than the average fund manager, but I think I just can't help myself but try a strategy that I'm interested in (honest answer). And time spent researching is time spent learning about the market/companies which is fun. I feel like indexing will provide the same-ish or better return as my strategy tbh, and I am protecting myself from some unexpected headwinds that might affect dividend growth stocks specifically. For instance, when/if the dividend tax rate goes up to match normal income taxes, people may sell out of a lot of companies from fear. Although that will provide an opportunity, etc it is still a headwind that dividend growth investors face in the near-term.

On October 17 2012 19:01 HotChip wrote: Have been skimming through your blog lately and see that you're preferring dividends-stock instead of growth stocks. Why is that exactly? As I see it, there is no difference in returns between dividends-stock and growth stocks, but you pay higher taxes on dividends than you do on growth-stocks (capital gains). Am I missing something?

Well one of the key differences is that I am trying to invest in dividend growth stocks, not just high-paying dividend stocks. So I am trying to find companies who have the resources/potential to increase their dividend over time. Also, capital gains tax is only lower if you are in the lower tax brackets. As you climb to the 25% bracket, capital gains tax for long term gains climbs to 15%, and, for short term capital gains, upwards of 25%. Also, with dividend growth stocks you really only have to worry about entry point/price and then monitoring the fundamentals of the company. If you use a growth stock strategy, you have to depend on stock price appreciation which means someone out there has to be willing to buy what you are holding at a higher price than you paid for it. Not only that, but you have to figure out WHEN to sell as well. It's just a lot more variables to consider so more mistakes you can make. I feel like Dividend Growth Stocks give you the best of both dividends and stock appreciation with less hassle.

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On October 18 2012 14:55 2c0ntent wrote: Dividend growth is an interesting combination of characteristics. Most companies that are growing need to use the cash resources that they have to continue expanding their operations, whilst paying a dividend is to expel cash from the company. How is does this balance out in dividend growth companies?

Well, most of the companies that I consider to invest in are companies with large economic moats, that have shown years of sustained increasing dividends, and earnings per share that support future dividend increases. These companies that focus on increasing their dividend payouts every year, therefore, must continue to grow their earnings per share in order to continue to pay increasing dividends to shareholders. So they do this by either increasing their margins, or expanding to new markets/optimally saturating locally. Companies to consider are large established companies like McDonald's, Wal-Mart, Lowe's, Pepsico, and Coke, who have continued to grow and expand in emerging markets, as well as companies like 3M and Medtronic, which require cutting-edge research and development but still grow their sustainable dividends.

On October 17 2012 22:20 2c0ntent wrote: rly? I'd like to know what specifically didn't make sense

Hopefully it didn't come off as I was having a go. I just don't understand what you are saying in half your sentences.

For example

diversification is an excellent way to completely neutralize your profitability because losses tend to come bigger and harder than gains.

Diversification also lowers your risk. I don't know what you mean by losses come bigger and harder than gains.

i would be very careful about investing indiscriminately into equity when so many of those equities are propped up by absurdly high systemic debt at impossible to maintain low interest rates

Who is investing indiscriminately? It seems wh00sel is picking very carefully in fact. Not really sure how or what you mean by systemic debt in relation to companies.

ie financial sector blows up again (which will happen since they are doing the same shit type of over leveraged shit they always have + they have the precedent of enormous government stimulus), a lot of non-finance related companies you have money in through the index who are benefiting from artificially depressed interest rates, will have their ability to get credit at reasonable rates destroyed, which will seriously harm their business operations and stock price.

Brushing aside the issue of whether a significant amount of companies are over leveraged you definitely can't predict with any certainty if the financial sector will "blow up" again.

The conclusion is basically that you would be most wise to invest 90% of your savings in the absolute SAFEST possible way (ie. T-bills -- cuz if t-bills fail, everything else has failed at least as badly)

If T-bills fail I absolutely guarantee you that the least of your worries will be money, start hoarding food and water.

Both times I've read these posts I've been up all night writing so it might be I just can't read this stuff properly and get what your saying.

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>mfw investing

/DX got's some going up to do. /6A got's some going down to do.

On October 18 2012 21:36 2c0ntent wrote: I misinterpreted what I originally was going off as my source for this. It turned out to be applicable as a general rule in a more specific situation than we're discussing. I come equipped with an intuitive argument, however. Basically, earnings are taxed and losses are not. When you capture a wide, non-selectively chosen group of companies and invest your money in the averaging out of their results, assuming companies of equal starting value, any company which losses 100% of its intrinsic value becomes a 0 in your data while any company which increases its intrinsic value by 100% (ie double its return) had to earn a profit of [(100% more profits) / (1 - tax rate)] rather than simply lose or gain 100% of what gives it value (profits)

It is difficult to determine the intrinsic value of a company. For example how can you put a price on a reputation besides having an educated guess? Following that the underlying intrinsic value of a company may be reflected in the share price, it may not. What was the intrinsic value of many of the dot.com companies that went bust but prior had huge market caps?

Purchasing an index qualifies as purchasing company equities indiscriminately. I should have specifically referred to indices again. BTW definition just in case

I didn't think you were referring to indices and were saying he was just picking random stocks, misunderstanding. As for supplying the definition, good to see info being supplied to save readers the effort of googling etc.

I'm quite comfortable predicting that we will continue to have huge blows ups in our financial system. There is too much change in the world for their not to be.. Oh plus the finance companies are so highly leveraged and interconnected that its like we're asking for it. I never predicted when it'll blow up.. That is a very arcane matter, more fit for those who read tea leaves and such.

Huge blow ups to me seems vague. When is kind of important, this is like me saying I think the sun will burn out. If I'm asked to make predictions, some sort of timeline is usually given and past a certain time frame any prediction is pretty much bogus and pure speculation.

Yes I agree. That's why its totally safe to put 90% of your assets into t-bills.

While default risk is pretty much non existent (for the US anyway) there is still some interest rate risk. I mean they are regarded as the risk free rate for a reason (along with some other money market instruments) but nothing is "totally safe".

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What did I tell ya? /DX had some going up, /6A had some going down. Fucking wish I could've shorted /ES which a real account instead of demo.

I'm in drunk asshole mood.

whoosel,

In 100 words or less:

Why should we believe you have any idea what you are doing in the stock market?

On October 19 2012 12:09 2c0ntent wrote: huge blow ups since 1987, USA-centric list Great crash of 1987 90's tech bubble burst 08/09 banking system collapse These three were 90% driven by the policies of our financial giants. And they're now further emboldened by the government's demonstrated willingness to bail them out on a massive scale for plain old irresponsible practices. The world's economies and finances are more interconnected than ever before and that is NOT diversification of our economic risk, it is expansion of it. For instance, a revolution in china which shut down a lot of their manufacturers would shit on our economy in a big way. That wasn't a risk 20 years ago. I don't think a prediction without a timeline is bogus. Statistics like, "10% of these vehicles spontaneously explode while being driven, killing the occupants" are still useful in decision making.

It is well known that globalisation was a contributing factor to the GFC. People/companies/governments who were diversified across continents found out they weren't to the extent they thought. Which is why in modern text books you will read about the contagion effect. The point is that you can't diversify against this risk hence why it is called systematic risk (if you want any sort of growth anyway).

But that wasn't in dispute and hadn't been brought up until now anyway. The prediction of a blow up was the topic. As you have shown blow ups happen and will continue to happen, it's the boom/bust cycle. But as far as I can see it is of limited value if you don't know when. Is the strategy to just stay in T-bills forever? What if you hold T-bills only for 5 years and nothing happens and you think fuck it maybe I was wrong, you let your bills expire and buy stocks and then BAM melt down. If you could of predicted the dot.com bust then you could of got out and put your money in other stocks. If you had predicted the Asian currency crisis you could have offloaded any of those currencies and positions. But how can it help an investor to know a blow up is coming if you don't know how wide spread it is or when?

As for that statistic it's not that helpful if it was from 10 years and the cars no longer do that. I find vague predictions really annoying from media analysts, "gold will go up", ok not that helpful if you trade it daily. Without qualifiers everyone is trying to look like a genius but it's useless information to act on. "Gold will go up...oh I meant within 20 years". There are plenty of good predictions and statistics (obviously) but they need context.

On October 19 2012 18:08 RiKD wrote: I'm in drunk asshole mood. whoosel, In 100 words or less: Why should we believe you have any idea what you are doing in the stock market?

This question goes out to anybody:

How does anyone expect to beat inflation+taxes+costs+fees+bots+pros in today's stock market unless you are a pro?

On October 20 2012 09:17 RiKD wrote: Show nested quote + On October 19 2012 18:08 RiKD wrote: I'm in drunk asshole mood. whoosel, In 100 words or less: Why should we believe you have any idea what you are doing in the stock market? This question goes out to anybody: How does anyone expect to beat inflation+taxes+costs+fees+bots+pros in today's stock market unless you are a pro?

Well, you don't! You have to be a pro, but what defines a pro? Is it a hedge fund manager, the farmer who buys contracts and negates his losses, a central bank chairman, or a "retail" trader who makes a living?

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On October 19 2012 18:08 RiKD wrote: I'm in drunk asshole mood. whoosel, In 100 words or less: Why should we believe you have any idea what you are doing in the stock market?

You shouldn't. You should investigate on your own and invest your money accordingly. Just telling you what I'm up to and why I'm doing it. I like when I have to re-eval what I'm doing because of a comment that questions/pokes holes in my though process.

night which of taleb's books would you recommend starting with if you had to choose one? (sry for semi-offtopic)

On October 20 2012 13:03 2c0ntent wrote: Show nested quote + On October 20 2012 00:58 Funktion wrote:   On October 19 2012 12:09 2c0ntent wrote: huge blow ups since 1987, USA-centric list Great crash of 1987 90's tech bubble burst 08/09 banking system collapse These three were 90% driven by the policies of our financial giants. And they're now further emboldened by the government's demonstrated willingness to bail them out on a massive scale for plain old irresponsible practices. The world's economies and finances are more interconnected than ever before and that is NOT diversification of our economic risk, it is expansion of it. For instance, a revolution in china which shut down a lot of their manufacturers would shit on our economy in a big way. That wasn't a risk 20 years ago. I don't think a prediction without a timeline is bogus. Statistics like, "10% of these vehicles spontaneously explode while being driven, killing the occupants" are still useful in decision making. It is well known that globalisation was a contributing factor to the GFC. People/companies/governments who were diversified across continents found out they weren't to the extent they thought. Which is why in modern text books you will read about the contagion effect. The point is that you can't diversify against this risk hence why it is called systematic risk (if you want any sort of growth anyway). But that wasn't in dispute and hadn't been brought up until now anyway. The prediction of a blow up was the topic. As you have shown blow ups happen and will continue to happen, it's the boom/bust cycle. But as far as I can see it is of limited value if you don't know when. Is the strategy to just stay in T-bills forever? What if you hold T-bills only for 5 years and nothing happens and you think fuck it maybe I was wrong, you let your bills expire and buy stocks and then BAM melt down. If you could of predicted the dot.com bust then you could of got out and put your money in other stocks. If you had predicted the Asian currency crisis you could have offloaded any of those currencies and positions. But . Hm.. what. I was giving context for why I suggested that there is still huge and growing blow up risks in our economy. Stay in t-bills and don't leave them, while investing the rest of your non-nestegg / essential money in aggressive positions. The point of doing so is to avoid exposure to the risk of your life savings being blasted off at any time, ever. You can invest based on a prediction without a definite timeline for the prediction. There are many tools for this activity.. I am still learning but here: Forward contracts, future contracts, a bunch of options strategies (ie buying way out of the money puts if you expect a meltdown but don't know when)   how can it help an investor to know a blow up is coming if you don't know how wide spread it is or when? As for that statistic it's not that helpful if it was from 10 years and the cars no longer do that. I find vague predictions really annoying from media analysts, "gold will go up", ok not that helpful if you trade it daily. Without qualifiers everyone is trying to look like a genius but it's useless information to act on. "Gold will go up...oh I meant within 20 years". There are plenty of good predictions and statistics (obviously) but they need context I outlined 3 major crashes that were all the result of mismanagement and manipulation of the financial market and accounting policies, ie the two major systems of rules that humans have developed for keeping track of and supporting economic activity. Then I pointed out that these risks have further grown because not only is there still plenty of bad policy in the way we run economies, but every national economy is exposed to risks from outside of their borders in ways that they never were previously. Presentation of the imaginary statistic, "10% of these vehicles spontaneously explode while being driven, killing the occupants" was meant to show that even if there is NO TIMELINE attached to the prediction, you can make exposure decisions based upon it. Please take a moment to digest my words before you argue because I had to repeat myself a lot here, otherwise I'm glad to continue.. I've learned some things and clarified my own thoughts along the way thanks to our exchange but yeesh. Maybe I'm just not communicating well the first time.. I'll try to improve

I had a response written out but it doesn't matter. Anyway I've read your posts and given considered responses. For what it's worth I'm RG 146 compliant and a few months from completing my degree in Applied Finance. So I hope I know a little bit about this stuff (for example what forwards, futures and options are).

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thx, been meaning to check out those books forever

Just reading through a paper and thought this might be interesting considering the OP content:

32. Is it true that very few Spanish mutual funds outperform their benchmark? Isn’t it strange?

A32. Yes. During the period 1998-2007, only 30 of the 935 mutual funds with over 10 years of history obtained a higher return than the benchmark used; and just two of them obtained a higher return than the Overall Index of the Madrid Stock exchange. During 1998-2007 and 1992-2007, the average returns on mutual funds were lower than the returns on state bonds (at any term considered). During the past 10 years, the average return of the funds was lower than inflation. Despite these results, at 31st December 2007, 8,264,240 shareholders had €238.7 billion invested in the 2,907 existing investment funds.

Can get the paper from:
http://ideas.repec.org/p/ebg/iesewp/d-0817.html

when people measure the performance of mutual funds in that way, is the management fee taken into account? Would be pretty rofl if so many mutual funds are failing to beat the indices before fees..

Certain fees get deducted from assets, so are factored into the returns.

Should of posted the original paper instead of the 100 questions one, it's here: http://ideas.repec.org/p/ebg/iesewp/d-0746.html if you just want the main findings just read the conclusion.

Some snippets:
For funds that have existed 10 years - The information provided in Figure 4 is similar to the one in Figure 3 but it is expressed in Euros: it shows how much 1 Euro invested in December 1997 in each of the 935 funds was worth by December 2007. One Euro became €5.95 in the case of the most profitable fund and €0.19 in the least profitable.

Consequently, we can conclude that, from the €180.027 billion mutual funds that could have appreciated following the benchmarks we employed, the shareholders only got €80.184 billion. Using the poor historical information offered by CNMV on fees charged by mutual funds, we can calculate the total of fees and charges (explicit commissions) in 1992-2006 at €34 billion. The other €66 billion (100-34) is due to hidden commissions and investment decisions.

A surprising fact is that in the case of many mutual funds, the sales rep’s salary is higher than the manager’s.

Here is a paper on US/UK mutual funds: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=955807

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/dx still going up
/6a still going down

/6A went up, quite unsure of it at this point. Just letting it do it's thing.