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Posts tagged index funds
Standard & Poor’s SPIVA Report – Passive beats active…as usual.
2 months ago
Just going over some data on actively managed vs. passively managed funds and wanted to post the Standard & Poor’s Indices Versus Active (SPIVA) report link:
S&P is the creator of the S&P 500 index plus a variety of other domestic and international stock and bond indices. They put out their report card each year to see how industry wide performance matches up to simple index tracking funds. As you may know if you follow the passive investing style of the Permanent Portfolio, actively managed funds do poorly. Here are some highlights:
Over the past three years, which can be characterized by volatile market conditions, 63.96% of actively managed large-cap funds were outperformed by the S&P 500, 75.07% of mid-cap funds were outperformed by the S&P MidCap 400 and 63.08% of the small-cap funds were outperformed by the S&P SmallCap 600. – SPIVA Report 2011
Over five years ending June 2008, S&P 500 outperformed 68.6% of actively managed large cap funds, S&P MidCap 400 outperformed 75.9% of mid cap funds and S&P SmallCap 600 outperformed 77.8% of small cap funds. – SPIVA Report 2008
Pretty much as expected. Actively managed funds will underperform once management costs are subtracted. With average annual expense ratios on funds around 1.3%, it means that the average fund is likely to underperform the index average by at least 1.3% a year. Index funds have the advantage because their management fees are so low. An index fund by comparison may charge only 0.20% (or even less than 0.10%) a year leaving the rest of the market returns for the investor and not the managers.
It doesn’t look good for international funds, either:
Among global equity funds, five-year results show S&P Global 1200 outperforming 70.1% of global equity funds, S&P 700 outperforming 86.5% of international equity funds, and S&P IFCI Composite outperforming 73.9% of emerging market funds. – 2008 SPIVA Report
Also Wall Street continues the tradition of merging or liquidating poor performing funds at a very high rate. Over the years the disappearance of badly performing funds from the books helps to boost the remaining funds’ performance figures:
Funds disappear at a meaningful rate. Over five years, 26.8% of U.S. equity funds, 22.5% of global equity funds and 24.7% of fixed income funds have been merged or liquidated. – 2008 SPIVA Report
The SPIVA reports only go back five years at a time, but going back further means the results just get worse for actively managed funds and better for the low cost index funds. The above is why the Permanent Portfolio only uses index funds for the stock allocation and does not try to beat the market with timing strategies, etc. Over the long run, just trying to capture the market returns is the best way to beat virtually all active money managers.
Index Funds and IPOs
3 months ago
by Craig Rowland
in Investing
A poster on the forum brought up a great question on whether index funds would be forced to buy the upcoming Facebook IPO. The worry is that the index funds will load up on the IPO and take a loss later as the IPO price comes back down to Earth.
No, this isn’t likely to happen.
IPOs are, for the uninitiated, one of the worst investments to buy. The company and investment bankers hold all the cards. They set the date for the offering, set the price, set the shares to be issued, grease the skids with brokers by allowing some early access (which they’ll dump after the price goes up), etc. Never buy IPOs no matter how tempting the media hype says they are.
So why won’t the index funds go out and load up on a big IPO like Facebook? Well, they have entry requirements for the most part. The S&P index formulation requires IPOs not only be listed for a certain period of time (6-12 months), but also have a certain number of profitable quarters before they would be added. These guys weren’t born yesterday!
From Standard and Poor’s Eligibility Requirements starting on Pg. 5
Specifically, these two points will keep most of the IPO hype at bay:
Financial Viability. Usually measured as four consecutive quarters of positive as- reported earnings. As-reported earnings are Generally Accepted Accounting Principles (GAAP) net income excluding discontinued operations and extraordinary items. For REITs, financial viability is based on both as-reported earnings and Funds From Operations (FFO). FFO is a measure commonly used in REIT analysis.
Another measure of financial viability is a company’s balance sheet leverage, which should be operationally justifiable in the context of both its industry peers and its business model.
Treatment of IPOs. Initial public offerings should be seasoned for 6 to 12 months before being considered for addition to an index.
The index funds are not going to load up on Facebook when they go public (or they shouldn’t!). This is actually another good reason to own index funds and not actively managed funds that do not have these screening rules before buying stocks. Index funds still remain the single best way to own exposure to the stock market.
Now, if you really want to own a new IPO company for your variable portfolio (for money you can afford to lose), then let it just simmer for about six months and then buy into it. By then the price normally will have settled (usually lower) and you’ll have a better chance of making a profit.
EDIT: The Finance Buff asked about other indices like Russell 3000 and Wilshire 5000. These indices are more lax than S&P and will reformulate and bring in IPOs sooner. However they still have a lag time and it is not likely they will be going out and immediately bring in Facebook IPO based on their formulation criteria which I list below:
Russell Index Formulation and Methodology
Russell lists out the specifics on how IPOs are added beginning on Pg. 8.
Wilshire has their methodology here. They will do monthly, but it doesn’t look like the Facebook IPO is going to be snapped up immediately either:
In the past when someone asked what Small Cap value fund to use of Russell 2000 vs. S&P 600 for instance I would steer them towards the S&P versions because of their more sane screening process to weed out IPOs. I think S&P’s handling of IPOs is a smarter way to do it vs. their competitors.
Trading Against Pros
4 months ago
by Craig Rowland
in Investing
Doing some research recently I’ve found that almost 9 out of 10 of the trades on any given day on Wall Street are between professionals, not individuals. Think about that for a second. When you go to make a trade, 9 out of 10 times you are doing it against someone that does it for a living. And not just a living, but paid really big bucks to do it and has a tremendous amount of resources behind them. This includes mutual funds, pension funds, hedge funds, professional speculators, investment banks, etc.
But it gets even better. If 9 out of 10 trades are between professionals that means that most of the trades pros do are between each other. Now that’s interesting to consider. That means the average you see in the investing products on Wall Street represents the best that the pros on Wall Street can do in any single year.
Often I read about an investing strategy or trading method that claims to beat the broad market indices. That’s a pretty bold claim. I have to wonder if the sellers of these ideas are aware of the reality of trading on Wall Street. To think that you’re going to teach an individual investor to go up against a highly skilled pro and win. It’s kind of like telling an amateur golfer they are going to turn into Tiger Woods if they just buy the right golf club. It’s a fun thing to think about, but just not very realistic.
Even much vaunted hedge funds, the supposed masters of secret Wall Street strategies, often bomb. If they can’t do it, what chance does an individual have?
THERE’S yet more evidence that it makes sense to invest in simple, plain-vanilla index funds, whose low fees often lead to better net returns than hedge funds and actively managed mutual funds with more impressive performance numbers.
Basic stock market index funds generally aspire to nothing more than matching the returns of a market benchmark. So in a miserable year for stocks, index funds may not look very appealing. But it turns out that, after fees and taxes, it is the extremely rare actively managed fund or hedge fund that does better than a simple index fund.
That, at least, is the finding of a new study by Mark Kritzman, president and chief executive of Windham Capital Management of Boston. He presented his results in the Feb. 1 issue of Economics & Portfolio Strategy, a newsletter for institutional investors published by Peter L. Bernstein Inc.
The Index Fund Wins Again, Mark Hulbert February 21, 2009
http://www.nytimes.com/2009/02/22/your-money/stocks-and-bonds/22stra.html
I’ve been to financial firms on Wall St. in the past and had a chance to see some of their trading operations. These firms are trying everything possible to make a buck off each other. They are highly competitive and highly compensated if they manage to do it. Many use cutting edge hardware, algorithms and trading techniques trying to sniff out every last penny of advantage. There are actually magazines for the field (http://www.automatedtrader.net) discussing advanced applications in areas of High Frequency Trading and other esoteric topics.
These firms are looking for every possible edge to gain. And the harder they look, the more efficient the markets become. It is almost impossible to get an information edge, and therefore consistent excess profits, over anyone else at those levels. This is why, despite their best efforts, many funds cannot beat the market average once you subtract the costs from what they do.
You cannot compete against Wall Street with a home computer and technical analysis charts. The NSA would have a hard time competing against some of the computing power these firms have.
Sitting back and letting these people slice each other to pieces on trading is the best strategy. A Permanent Portfolio using a simple stock index fund let’s you do just that. You cannot compete against Wall Street with a home computer and technical analysis charts. The NSA would have a hard time competing against some of the computing power these firms have. This is why trading against the pros is a losing proposition on all fronts. Not only are you not likely to beat them, but they can’t even beat the simple market average themselves.
Conclusion?
Just own index funds where appropriate for your Permanent Portfolio. Don’t waste time and money trying to compete against those that aren’t even competitive against market averages.
Reminder: You can sign up for the announcement list for the upcoming Permanent Portfolio Book here.
