Performance of active funds vs ETFs

Discussion in 'Share Investing Strategies, Theories & Education' started by Omnidragon, 9th Apr, 2020.

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  1. APINDEX

    APINDEX Well-Known Member

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    Let me preface this by saying I am not against active management as have considered adding a couple of small satellite active managers and also I have picked a few stocks myself... I like to think I am aware of the risks/chance of underperformance hence the reason they are satellite positions.

    Think we can all agree 5-7 years probably not going to give you the confidence an investor wants to predict future performance.. not sure anything will?

    Couple managers I have followed QVE/IML and also Forager have outperformed for a number of years before underperforming over the last 5-7 what does that mean for future performance? I have no idea!

    I have to ask how you found yourself in a thread called ETF's? there are numerous property investing threads here (given the site is called Propertychat!) that I ignore simply because I have no interest in property as an investment vehicle (outside of PPOR), I'm fairly confident the users in those threads are not longing for my thoughts around why I don't like it...

    This is not meant as a criticism but a bit like the ETF v LIC, property v shares, holden v ford (maybe last one not a good example) the futility of it all is ultimately pointless I can see why investors invest in active,ETF's LICS and even property (groan) but I can see why so many people on here advocate ETF's/LICS etc and given the results they have achieved isn't that the most important thing after all that's what we are all here for... I think the most important thing is people taking ownership for their decisions and I am 100% comfortable investing in ETF's & LICS and if I fail to reach my goals because of those decisions it's 100% my fault.

    I'll get off my soapbox now.
     
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  2. Omnidragon

    Omnidragon Well-Known Member

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    I've been on this forum for a long time and browse around all the time. Invest in both shares and properties so all these products register on my radar to an extent. Whatever misgivings some others may have about me or my style, maybe I'll learn a thing or too, or see a different view, even if I (sometimes strongly) already have a different opinion.
     
  3. The Falcon

    The Falcon Well-Known Member

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    Ok right you are. But you are being a bit crafty again, we were comparing JAN 2013 - MAR 2020. I calculate at circa 6.8% pa (38,352-62,838) over 7.25 years. I've used 4 JAN 2013 as I cant locate 2-3 JAN 2013.

    If we move the dates just a week 28 DEC 2013 - 1 APR 2020 its c. 7.4% pa over 7.25 years. Start and end dates matter of cours.

    It was not my intention to mislead re. 8%, was working off mobile and back off envelope. Mea Culpa. I've got some more comments in due course.

    PS. Can we get this re-titled to Active vs. Index as ETF is only a vehicle for any number of strategies.
     
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  4. The Falcon

    The Falcon Well-Known Member

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    This false. 6 years you say (lets use the date of your post) Total return from 10 APR 2014 - 9 APR 2020 around 5.55% p.a. Hardly underwater? (47,800 to 66,682 pts).

    Source.
    S&P/ASX 200 Franking Credit Adjusted Annual Total Return Index (Tax-Exempt) - S&P Dow Jones Indices

    There is no argument that many other strategies have done better.
     
  5. Omnidragon

    Omnidragon Well-Known Member

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    Yes agreed, 6.8% is probably the most accurate comparison. It's hard to use the 1 Apr date because the other funds you'd compare to would probably have benefited from the market's rise of 3.5% that day too (to the extent they were net long). Nor do we have data for it. No problems re mea cupla - I figured you read the next row when you said 65000.
     
  6. Omnidragon

    Omnidragon Well-Known Member

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    Point taken... wasn't looking at accumulated post credits. The big win (during that period) seems to have been that first year also, hence the returns decline after. Pattern not too dissimilar on this side, which would be logical, as you'd think a lot of these other funds would have a significant element of beta in them anyway.
     
  7. Perthguy

    Perthguy Well-Known Member

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    Did anyone ever get the maths right to "prove" ETFs are such a bad investment because I am still not convinced.

    ETFs are not good or bad, they are just tools. If you use the right tool for the job then you have made the right choice.

    I don't mind if people have a different viewpoint but if they try to prove their point using made up numbers then I don't find them convincing.
     
  8. Omnidragon

    Omnidragon Well-Known Member

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    Since you’re so concerned about the maths, have you ever worked out your cost of equity when you make these investments?

    If I ran an NPV on your investment using your cost of equity, I suspect you wouldn’t have made any money.
     
  9. PKFFW

    PKFFW Well-Known Member

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    Another case of a data point without verification. This time at least it is because you can't verify it rather than all the others where you simply couldn't be bothered.
     
  10. Omnidragon

    Omnidragon Well-Known Member

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    Why can’t I verify if? His cost of equity should be the same as mine for the same investment. It’s a neutral data point - person agnostic.

    My question was, does he (or you) know what it is when you make the investment, not whether I knew what I was.
     
  11. Pleep

    Pleep Well-Known Member

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    Ok. What is your cost of equity? Provide calculation pls.
     
  12. Omnidragon

    Omnidragon Well-Known Member

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    Well we established the long term market return was 6.5% earlier (someone else ran a 97-20 return). An index ETF would have a beta of 1, naturally. The current risk free rate is 2.5% based on Aust 10 year Govt bond. So your RE in this investment is 2.5% + 1 x (6.5-2.5%) = 6.5%.
     
  13. PKFFW

    PKFFW Well-Known Member

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    The answer is in your statement.

    I'll give you a hint....."Same investment". Do you know if you both have the same investment(s)?
    Actually, you asked a question.

    Then you made a statement in which you "suspect" something which you have no way of verifying.
     
  14. Omnidragon

    Omnidragon Well-Known Member

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    Right..... We have been using VAS as the example all along, or broadly talking about index funds (as per Falcon's above post)
     
    Last edited: 15th Apr, 2020
  15. Perthguy

    Perthguy Well-Known Member

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    Never. I have no interest in doing so, just as I have no interest in calculating the Internal Rate of Return for any investment that I purchase.

    You are right at NPV. I have 2 particular residential property investments that would be negative NPV right now.

    If I sold now then I would lose money. This doesn't concern me because I have no interest in selling now. Both investments are putting money in the bank. I am not concerned with their NPV.
     
  16. Pleep

    Pleep Well-Known Member

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    Thanks
    Still dependent on start and end dates. What if this argument was being had in Jan 2020?
    In current circumstances 6.5% nothing to be sniffed at. Where would you put your money with as much confidence of outperforming that?

    (dangerous question I know)
     
  17. Omnidragon

    Omnidragon Well-Known Member

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    If you did the same calc in Jan 20, your hurdle rate would just be higher at 2.5% + 1x (7.7%-2.5%), that's all, which means over an identical period you'll be mathematically deemed to have made even less money on a time-value and risk-adjusted basis. See post #30.

    The problem is not really how you calculate the long-term market risk premia, but the co-variance of a broad-based index fund. As you're just mirroring the index with no internal leverage, naturally your beta is going to be 1. So in the long run if you funded the investment with your own cash, your expected return would be the cost of equity, which would make any investment NPV-neutral (and that's before the fund's fees). With the benefit of hindsight we could say that in a short-term horizon, such as the last 5 years, the investment was NPV-negative as the IRR over that period was below the required rate of return (see post #55).

    Where would you put your money? Thinking about it this way, you'd want to put it on something that is value accretive on a risk-adjusted basis. If I had a product with beta of 0.5, my hurdle rate would be 4.5% using the Feb end date. If I expected the share price to appreciate 5% in 12 months (maybe because of a combination of EPS growth, good relative trading metrics etc), then that investment is NPV-positive at this point. It's just about what risk-adjusted returns you're getting and an index fund by definition is value-neutral pre-fees once risk-adjusted opportunity cost (as opposed to inflation which is irrelevant, as your returns and discount rate are either both in nominal terms or real terms) is accounted for.
     
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  18. Perthguy

    Perthguy Well-Known Member

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    Why?

    What if I'm not looking for an investment that is value accretive on a risk-adjusted basis? Is that "wrong"?

    You seem to imply that there is only one way to select investments, using some kind of IRR and NPV/cost of capital analysis and not using these criteria is somehow "wrong". It might work for you but it is certainly not going to work for everyone.

    My needs are a lot more basic, along the lines of:

    To invest well, you need to find investments that fit your financial goals, investing time frame and risk tolerance.

    Choose your investments - Moneysmart.gov.au

    I have selected an investment that fits my financial goals, investing timeframe and risk tolerance, that you have outright stated is a money losing investment. I know I could get a higher return but:
    a) I don't "need" a higher return
    b) I intentionally sacrifice some return for simplicity (because I have no interest in chasing a higher return) and security (sleep at night factor).

    Could I select an investment with a higher return? Undoubtedly.

    Do I "need" to select an investment with a higher return? Definitely not.

    Am I in any way interested in spending time researching to hopefully select an investment with a higher return? Absolutely not.

    Back to the topic of the thread... do actively managed funds outperform an index ETF over the long term? Maybe, maybe not. It depends.

    I have read all of your posts in this thread and the ETF thread and I am still lost as to what your point is. Is it that there are better investments than an index ETF? Because if it is, I already know that.

    What you might learn one day is that some investors will settle for a lower return if an investment fits their financial goals, investing timeframe and risk tolerance. Some investors don't need to chase the highest return and have no interest in doing so. I guess that is what you are struggling to understand.
     
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  19. PKFFW

    PKFFW Well-Known Member

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    The only think I'd add @Perthguy is the fact that there really is no higher return without an associated higher risk. Comparing an ETF to individual stock picking or even to picking individual fund managers without acknowledging the higher risk is kind of pointless to begin with.
     
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  20. dunno

    dunno Well-Known Member

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    Why did I look?

    Investment word bingo at its best. Who are you trying to fool?

    2.5% + 1x (7.7%-2.5%) WTF? add & subtract the same number and multiply by 1??????? The index is the definition of a beta of 1 so this calc can always be simplified to just the Index return unless for some reason you want to make it seem complicated.

    Then your masterpiece of waffle says if you use the Index return from one time frame as your cost of equity in another time frame with a lower return you will get a negative Net Present Value. Well of course. You are just making circular arguments.

    Companies have a cost of equity (cost to raise equity funding) but individuals don’t actually have a cost of equity, they have savings for which they may have a desired return or opportunity cost arising from alternative uses but not a cost of equity. Market return over ‘X’ period is no better than any other number an investor might pluck out their arse and try and impose on the market. Some sort of long run equity risk premium seems like a reasonable expectation to me if you really want a hurdle rate, but you are always going to get time variances. A passive index investor is much more likely to be of the mentality to dispense with forcing a comparison with a number they make up. Underperformance or outperformance of the “market” is not a function of the market – it’s a function of your unrealistic guess as to what the market would return.

    Getting yourself into a circular knot that says your cost of equity is the market return for a given period and that a market tracking ETF is a poor investment when it returns less in a different period than the period you picked is madness.

    As for risk adjusted mumbo jumbo in the last paragraph. All you are really saying in that dribble is if you plug in a higher return number than the market is pricing in you will ‘project’ a positive outcome. The tricky bit is you must guess beforehand better than the market. Not a game everybody who understands potential reward and corresponding risk wants to play not matter how good you say you are at it or how easy you say it is or how many bingo words you use to fake competence in the absence of substance.

    Oh why did I look and why can't I let it be? Off to the sin bin to question my lack of acceptance and tolerance. Maybe Frank from marketing and fake it till you make types are legitimate forms of communication these says and I’m just a relic from pre online days.
     
    Last edited by a moderator: 17th Apr, 2020