Active VS Passive

Discussion in 'Share Investing Strategies, Theories & Education' started by Big A, 13th Feb, 2019.

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  1. blob2004

    blob2004 Well-Known Member

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    I couldn't resist replying to you sorry, but if you think the 5 and 10 year period proves it's not luck, I'd recommend you to listen to a few finance podcasts such as The Rational Reminder. Fama and French both explains numerous times that a 5 to 10 year period is just noise, nothing can be learnt from such a short period of time.

    Are you investing in 5 to 10 year time frames or the rest of your life?

    Also, the point is not if active beats passive during any short periods despite fees (because they can), it's that no fund in history over the long term (30+) has ever consistently done it. Most of them grow too big to be able to outperform in the end.

    I'm also sure you are aware of the data that the top quartile funds in any given year are most likely to end up in the bottom quartile the next year, and vice versa.

    Active can beat passive after fees definitely, just not for longer time frames.
     
  2. mtat

    mtat Well-Known Member

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    That's the issue isn't it. Those who outperform over a period of time are unlikely to do so going forward.

    Let's say over a 10 year period, your active picks have out-performed the standard indexes. Congratulations. However, they then go on to under-perform for 3 years - but you're still ahead over the 13 year period. What do you do? You know that they may continue to under-perform, but hey, you're still ahead overall and you believe in the manager. (also it feels good to be doing better than the rest, of course it does)

    It then turns out that over 15 years, your active picks have under-performed the market. Do you cut your losses then? But you'd be admitting that you got it wrong 15 years ago. Should have just went with index funds. You also KNOW the active funds are riskier and aren't likely to out-perform (they never were), so you can't argue that this is only temporary and going forward you'll be back ahead.

    Maybe you'll get so far ahead with the active funds early on that you'll never fall behind the market, who knows.
     
  3. mtat

    mtat Well-Known Member

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    Discussion on how to pick an active fund:



    Spoiler: don't.
     
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  4. sillydad

    sillydad Active Member

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    I could add 15 years and still say they have outperformed.

    I would roll the gains into VAS - just need to quit while ahead.

    I think when you run an active portfolio this is a risk you have to live with - and it's worth it. On a $50,000 balance - between VAS and this fund - this is a difference of $14,000 in your portfolio on 2019/2020 alone (-9% vs 16%).
     
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  5. Ross36

    Ross36 Well-Known Member

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    Screenshot_20200826-113615_Chrome.jpg

    To clarify my comment before - you have to compare to the correct index. An Australian GROWTH fund needs to be compared to an australian growth index. If you do that the Hyperion fund underperformed by a bit over 1% per year looking at those numbers. So essentially index returns minus fees.


    Screenshot_20200826-114007_Chrome.jpg

    There's nothing attrocious with these funds per se, but you also need to appreciate that most often you get index hugging but pay a lot for it. In boom times that's fine, but during bear markets those fees are a killer.

    There is really no statistical argument for active beating passive anymore. Ten years ago yes maybe because ETFs for factors didn't really exist so you had to choose these active managers for sector bets. That's not the case anymore.

    I'm not implying that your funds are no good - they're fine and have served you very well. But with all the key person risk, high fees, etc. etc. risks would you really choose them now over a low cost ETF alternative? Or is it sunk cost fallacy? I think selling out and starting again makes no sense for many tax wise, but for new investments it's worth thinking about.
     
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  6. Big A

    Big A Well-Known Member

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    If you can outperform for 10 year period on luck than you must be one hell of a lucky punter. Well if Fama and French ( who ever they are ) explain it in a podcast then it must be true. :D
    Like i said earlier, everyone can spin a story to suit there agenda. If Hyperion got lucky for the last 10 years and I have been riding that luck with them for the last 5, then that's good enough for me to stay on this ride with them. And if and when they start to consistently run out of luck then sure if I feel like that's the best move then I will dump them.

    Once they start to consistently under perform and depending by how much I would then start to consider dropping them, like I did the other 9 or so active funds that did just that. And eventually I might be just all index.
    I am happy to admit when I get something wrong. One of my strong points is the ability to see and accept my flaws rather than pretend they don't exist. I also acknowledge there's a good chance that I might be wrong now. But I am still not comfortable with the idea of 100% index just yet. So I have gone down the middle and hedged my bets. If these active players keep outperforming then I win. If the index side after 20 years proves to be the better performer than the actives I hold then I still win. Hence why I went for a 50/50 split.

    That's the hope. And so far on track.

    @Ross36 you make some good points in your last post. Especially that Hyperion look to be performing inline with the high growth index minus fees. I guess my only argument against that which is wrong if they are continuing to under perform that index during these volatile times is this. My expectation is that a fund manager can move part of the portfolio into cash and back to in order to outperform during volatile periods assuming they get it right. Magellan moved something like 15% into cash in the global fund and they appear to have had a better result than there respective index during this downturn. They did the same thing during the late 2018 down turn. Should we look at there holdings and maybe say that the VGS is not a fair comparison to Magellan global because Magellan hold more tech stocks so we should compare it to a tech index of sorts. I don't know whats going to perform well from here. Is it tech, financials , mining , tulips? So how would I be able to pick which index I should invest in other than going a whole market index like VAS or VGS. I will leave the picking of the next boom segments to the active managers that I pay the 1% fee to do that for me.
     
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  7. Sticky

    Sticky Well-Known Member

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    The problem comparing to an index, is you can't invest in an index. You invest in an ETF which tracks an index. Are there any lower cost ETF options that track that specific Growth index? There may be, but often with niche ETF funds, the fees are just as high as an active alternative.
     
  8. blob2004

    blob2004 Well-Known Member

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    If you don't know who Fama and French are...I'd really recommend you looking into them if you're interested in economics and finance in general. They're well known academics who have won a nobel prize for their research.

    You can be lucky for 10 years if the growth factor has outperformed the value factor for 10 years (which it has), and if you have a growth fund then obviously you should outperform a market weight portfolio. However, you would have been absolutely hammered holding a growth fund when value outperformed in the prior decade.

    Most active management outperformance could be explained by factors and that is where all the smart beta hype has been coming from these days. @Ross36 is correct that you have to be comparing the right fund to the right index. You have to ask yourself, is it truly a skilled based outperformance or are you really just lucky that you chose the right factor for your active management?

    Anyway, I do welcome active management and as long as they continue to set an efficient market us indexers will be enjoying the free ride ;)
     
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  9. sillydad

    sillydad Active Member

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    For my Australian investments - I have always found VAS as the relevant benchmark - if I wasn't investing in Hyperion Growth Fund I would be more likely be investing in VAS. So when I look at how the active managers have performed I compare these to VAS. Reading the PDS the benchmark 'S&P/ASX 300 Accumulation Index' appears to be VAS?

    Curious if you would have this view if you held an active portfolio that has outperformed the index, within your relevant time frame? I don't think this is a binary choice.

    From a purely academic point of view, and in the long run, the additional fees/transaction costs of active investing means passive will always be ahead - for reasons explained by posters above.

    However, not every investor is holding onto their portfolio forever. Taking my personal situation into account - a section of my portfolio will be needed 6 - 10 years - so its a balance between additional risk via active management (or direct stock picking) vs passive investing. I am not too concerned with fees as long as you can get above market returns, net of fees. Looking at the active return - the difference between what my portfolio would be if there was no active risk, and if I had a purely passive portfolio - for me its been worthwhile.
     
    Last edited: 26th Aug, 2020
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  10. rizzle

    rizzle Well-Known Member

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    Isn't the caveat here that that "its been worthwhile based on the fund I selected and the time frame of my investments (delivering overall superior returns to the benchmark index)"?

    So are you actually trying to say that it's been worthwhile taking on the increased risk of poorer returns, because you got the fund selection and timing right? Would you say the same if your returns were below the benchmark?

    What I'm getting at is that it is unknowable which active funds will outperform in the future, and from an academic standpoint, buying the low cost index provides the best risk adjusted returns over the long term. For those with greater risk appetite, and less concern with doing well over longer term horizons then yeah sure active might make sense.

    I feel like the debate can be summarised best as follows:
    • If you want the highest chance of the best long term performance then select low cost index hugging passive funds (i.e. what Malkiel, Buffet et al say the average investor should do)
    • If you have a shorter term horizon, have more appetite for risk and are not interested in optimising your risk adjusted returns, then active could be an option to explore.
     
  11. mtat

    mtat Well-Known Member

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    I hate the term "average investor". No one thinks they are average, so they won't take advice for the average person - "Yes, the average person should invest in index funds. But I think I know better than the average, I know I can pick a good active fund."

    The "average" in this case refers to 99.9999% of the population.
     
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  12. sillydad

    sillydad Active Member

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    Correct - fund manager determines the returns.

    I would accept my risk didn't work, learn and move on. I used to have a conviction fund that wasn't performing too well, and charging 2.67%. Sold out and invested in IOO, and direct holdings in AAPL and AMZN direct - my views aren't set in stone.

    Correct but what if you have short term investment horizon?

    Except Buffet does the opposite and runs a very concentrated active portfolio, and very successful at it.

    Hope I don't get into trouble for saying this - but there is a bit of intellectual dishonesty in this debate - the biggest advocates of index investing have been very successful in very active strategies over decades (and successful at it) - with a lot of wealth and capital passive investing is okay. For a young person starting out a bit of risk is important - I think young people shouldn't be brainwashed into passive investing. You make mistakes and learn.

    This.
     
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  13. rizzle

    rizzle Well-Known Member

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    This is the only point I wouldn't agree with. These guys say one thing and do another because they have a unique advantage that they can leverage consistently over time to make more money than the index. But they understand that 99.99% of the average population don't have a unique advantage (per @mtat comment), so the best advice for most people is low cost index investing.

    Huge money to be made from those with the right skill set (which I'm sure there are a couple on this forum). But dunning-kruger shows us that wayyyyyy too many people overestimate their abilities in stock picking (or active management firm picking, which is a similar crap shoot).
     
  14. dunno

    dunno Well-Known Member

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    So, you will sell these funds once they underperform?


    You seem to be looking at only the mark to market return on the survivors in your portfolio. How much of that maximum excursion is likely to be wiped by the time you believe you are seeing enough underperformance to sell?


    When analysing ‘your’ active results don’t forget to control for survivorship. You wouldn’t want to be making a rooky amateur error of ignoring closed trades in your assessment, now would you.


    I checked out the two Aus funds that you still hold, seems sticking with the performers has led to a high growth factor concentration.

    upload_2020-8-26_18-42-6.png
    Hyperion Australian Growth

    upload_2020-8-26_18-42-56.png
    Bennelong ex-20 Australian Equities


    The trend is your friend until the bend at the end.
     
  15. Big A

    Big A Well-Known Member

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    Don't get me wrong. I am not advocating active over passive. I have one foot in each camp, so I am split down the middle.

    So i understand this right. We are saying that the hyperion fund is performing well because it has been buying growth stocks and not value stocks. Growth is having its time in the sun and that could end. Can hyperion then not possibly recognize when the turn has come and value makes a come back and move to holding more value stocks? Have they got some sort of mandate that says they must only hold growth stocks even if they under perform the general market?

    I know there are some active funds that call themselves value investors and have been under performing as they only invest in value stocks. Are they not allowed to recognize that growth has been the winner for a while now and add some growth stocks to there fund?

    Can we say that Hyperion for the last 10 years has recognized that Growth stocks are the way to go so have been smart enough to tilt towards growth and could possibly be smart enough to adjust back the other way if and when value becomes hot again? Does hyperions fund currently not hold any stocks that would be considered value stocks?

    I have a basic understanding of the meanings of value and growth stocks but is there a clear way of measuring every stock and giving it a growth or value title?
     
  16. blob2004

    blob2004 Well-Known Member

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    Buffet has definitely outperformed the index for many decades, but if you look at his track record you will notice the outperformance shrinking year by year, and also underperforming the index in recent years.

    It may have been easier to outsmart the market in the 70’s and 80’s because there are not as many skilled professional investors out there competing for a piece of the pie. You also have to factor in lack of transparency and regulation of companies and even insider trading in those periods. Moreover, Buffet does not just “buy and sell stocks”, he actually buys in a large enough stake in a lot of businesses and becomes a part owner - participating in a lot of business decisions. He has openly stated when he passes away he wants his inheritance to be invested in 90% SP500 and 10% bonds for his wife.

    Another example is David Swensen who has beaten the index for many years, but he advocates index investing for most people as he understands very few people have the ability to access private equity, venture capital and hedge fund deals like him in the Yale endowment. For the record, most other university endowments that tried to imitate him has failed and lagged the index. For a good understanding of Swensen’s thinking I recommend reading “the unconventional success”.

    I think active investing and risk taking is fine and people have the right to do what they want. Many will win, but most in the long run will lose. However I think understanding market theory and history is extremely important for all investors. I certainly wouldn’t call academic research “brainwashing”.
     
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  17. blob2004

    blob2004 Well-Known Member

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    Most funds have a mandate what they invest in - they don’t usually jump in and out of different styles as that would not be what the investor asked for when they first put their money in. A quick browse of the hyperion growth funds states that they invest in growth orientated companies. I sincerely doubt they would change that mandate if growth happens to suddenly underperform because:
    1: How long of an underperformance will they be willing to take in order to change styles? What if they change styles and growth takes off again?
    2. Would investors be happy if the managers have no conviction in their holdings and changed their styles completely?

    One final note I’m curious is how much of a tax drag was your active investments? I have often seen people say the tax drag of holding active funds compared to indexing can be up to 0.5%-1% per year.
     
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  18. mtat

    mtat Well-Known Member

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    I think most of the dishonesty comes from the active side. You know, all those fund managers leeching off clueless investors without providing any extra value, and making absolutely false claims like active is better during downturns.

    If a young person wants to take on more risk, there's plenty of ways to do that without taking on uncompensated risk involved with active funds. Leverage could be a good strategy for a young investor willing to take on more risk.
     
  19. Ross36

    Ross36 Well-Known Member

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    That's quite common for active managers - use a benchmark that is in your ballpark but might make you look good. If you are a growth fund and know you likely won't beat the growth index you'd be silly to use it as your reference. By using the asx300 they are essentially taking a bet that growth outperforms value by a wide enough margin which will make them look good.

    Interesting you say that as my own direct shares have outperformed by quite a lot over the last 15ish years. BUT - it was pure luck. I had no idea what I was doing, but somehow managed to DCA the majority of my money into macquarie bank in the years prior to the gfc. Everything else I bought was crap, but were for tiny amounts. So I lived through the gfc seeing the value get destroyed, then the monster bull market for macquarie since then. But it could have just as easily been alco finance group or one of the other companies that went bust. I'll never sell my holding - I like the company but would never go direct again. Every time they change CEO etc. I need to read about it, whenever there's a controversy I need to look into it etc.

    The same goes for active. If I had an active fund I'd need to be looking into who the new manager is everytime they change (happens a lot for many funds), looking at their strategy everytime they divert, figuring out tax issues in the likely event they dissolve the fund etc. etc. I don't want all that hassle for the likely outcome being they underperform the index anyway.

    Personally I see no reason FOR ME to use an active manager. For others having an expert looking over their investments and switching to cash when the tea leaves tell them to helps them sleep at night. I say funds like the hyperion one look pretty good for those people. If the total fee is under 1% and there's no performance fee that's a small price to pay for a good sleep.
     
  20. Ross36

    Ross36 Well-Known Member

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    Sites like Morningstar or marketindex have lists of ETFs. I don't know if there is an aussie growth etf as personally I don't know if it would be all that successful, because growth vs value is really sector vs sector.

    In Australia a bet on growth is a bet against sectors like banks and many industrials I'd imagine. So you'd likely lose a lot of the franking credits advantages of the aussie market, which are really the main reason to overweight australian equities. If you look at the asx sector performance it is banks and REITs that have been the drag in recent years. Something like MVW would probably tilt more into growth given their equal weighting.

    Personally I've made the decision to not tilt value or growth. I'll hold both in my broad indexes. I will however tilt things like US mid-caps to add diversification. That technically is active investing, and you could argue has active management with ijh as their index has certain "quality" parameters that companies must meet to be in it.

    Again - each to their own.
     

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