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rmbbrave
27-09-2006, 05:34 PM
With investment, it pays to be passive

26 September 2006

The figures say active versus passive is no contest. The best way to invest is through a low-fee tracker fund. John McCrone finds that even passive investment is evolving with baffling speed.


It is the fact that the finance industry does not want to admit and investors still cannot quite believe. When it comes to funds management, you are more likely to make money without the expert help of a funds manager.

Attempts to beat the market are doomed and so you should avoid the usual active investment approach.

Instead, you should simply put all your cash into a low-cost, passively run, index tracking fund – a fund that makes no attempt to pick winners and just mindlessly buys a little of every company going.

Already you will hear the howls of anguish from fund managers, who will be waving glossy prospectuses that prove they are the exception to the rule. But study after study has shown the same thing.

Take the latest Standard & Poor's active versus passive "scorecard" results. In the first half of 2006, three out of five large-cap managed funds – those that focus on the 500 biggest US companies – failed to beat the index.

The numbers look even worse over five years, when 67 per cent of active funds failed to top the passive approach.

Fund managers often defend themselves by claiming they definitely do better in other markets away from the large, well-known firms, where their stock-picking skills can really come into play.

Yet S&P reports that so far this year, the index has beaten the experts 68 per cent of the time in the US small company market, 60 per cent of the time in the large-cap international market, and a stunning 80 per cent of the time in the emerging economies market.

So there is nary a fig leaf to spare the blushes of the managed funds industry in these results.

For index funds enthusiasts, managed funds are already the dinosaur of investing. Index investing is the approach backed by science – all those Nobel prizes in economics. And what many mum and dad investors do not realise is just how much the science has been advancing in just the past few years.

An index or tracker fund is one that buys shares in every company represented in an index in a sector of a market. The reasoning is that the sharemarkets always rise over time – averaging an annual growth rate of 10 per cent for larger companies, 12 per cent for smaller ones.

AdvertisementAdvertisementSo rather than waste time trying to beat the markets by employing exorbitantly paid fund managers, it makes more sense just to hitch a ride on the long-term rise of the markets.

An active fund can charge 2 to 3 per cent in management fees – up to a third of an investor's actual return. And many have extra hidden costs created by their frequent trading.

Passive funds cost next to nothing to run, just their administrative expenses. Fees are consequently 0.5 per cent or less.

The New Zealand Exchange has moved into index funds in a big way. It now offers five Smartshares schemes that track top and middle-sized companies in New Zealand or Australia.

Retail investors can also buy into their equivalent overseas. Giants like Vanguard and Barclays have trillions of dollars under management. Their tracker funds are now usually set up as exchange traded funds, which can themselves be freely bought and sold like shares.

A third approach is to find a financial planner who believes in the passive investment philosophy.

At least three New Zealand financial planners – Bradley Nuttall in Christchurch, Stewart Financial in Hastings, and Strategic Asset Management in Wellington, Auckland and Hamilton – have now built their services around index funds. Or, rather, around the next revolution in passive investing – asset class investment.

Andrew Nuttall of Bradley Nuttall explains that the first tracker funds were simple beasts. They bought all the shares in a standard market index like the S&P 500 or FTSE 100. But now there are funds to

Halebop
27-09-2006, 05:53 PM
It's real easy to get the wrong answer when you ask the wrong question. Just like most sharemarket listed companies are "also rans" in the outperformance stakes, most sharemarket fund managers are too. The quality of decision making is not factored into a quantititve study. So of course, it's easy for 70% of active fund managers to underperform an index - their own portfolios are not so far off the index in terms of performance but the fees are multiples of a passive fund.

Still, for proponants of passive investing, why not ask the question of going passive yourself rather than through both a fund manager and financial intermediary, none of whom come free even with a passive fund? The onus is still on paying fees for what will ultimately be within 1 standard deviation of average performance. Instead, I want to know the secrets, skills and failings of those who operate outside 1 standard deviation. What analysis was placed on those active managers who have a long term record of handily outperforming indices even after their fat fees?

rmbbrave
17-10-2006, 06:48 PM
Try to find surprises and beware the random
17 October 2006

By DAVID McEWEN
Everyone has heard the story about putting an immense number of monkeys in front of typewriters. "There is a certainty that one of them (will) come out with an exact version of The Iliad," writes Nassim Nicholas Taleb in his new book Fooled by Randomness.


How many investors, however, would be prepared to bet their life savings that the same monkey would write The Odyssey next? Surprisingly, investors are prepared to take exactly that sort of bet when backing financial "experts", many of whom simply have been lucky.

Taleb points out that the brain tends to look for patterns, even in random events. "We tend to think that traders are successful because they are good," Taleb writes. He adds it is just as likely, however, that they have made money because the assets they have purchased have risen for unpredictable reasons.

The concept of "survivorship bias" also can be a trap. For example, managed funds seem to offer reasonable returns on average because those that lose money consistently tend to get wound up. Only those funds that are still around report their results. Those funds that have risen the most are often thought to have the best managers, but it is possible luck rather than skill played its part.

US commentator James Glassman has drawn these lessons from Taleb's book:

If you're doing well in the market, don't get carried away by hubris.

Don't be reluctant to invest purely by instinct, because fundamental analysis is not all it is cracked up to be.

Pay little attention to the day-to-day movements of stocks and news about companies.

Don't expect mutual funds to outperform their peers simply because they have done well in the recent past.

Put money in low-cost index funds or broadly diversified portfolios.

And beware of black swans.

This term is based on a finding by Scottish philosopher David Hume that: "No amount of observations of white swans can allow the inference that all swans are white, but the observation of a single black swan is sufficient to refute that conclusion."

In other words, surprises happen.

One of the key elements of Taleb's book is that investors can make money by looking for black swans. One can profit by backing something unpredictable to happen when the market expects existing conditions to continue.

Take two companies that traditionally improve their earnings by 15 per cent a year. One trades at 30 times earnings because everyone expects earnings to go up by 50 per cent in the next few years. The other has had an earnings slump and is on a price-earnings ratio of 9 because everyone expects only 5 per cent growth.

The popular company will be hard-pressed to deliver faster than expected growth, but the unpopular company is unlikely to do worse than expected. Smart investors will invest in the unpopular company.

http://www.stuff.co.nz/stuff/0,2106,3831547a1865,00.html

patsy
19-10-2006, 05:15 PM
quote:Originally posted by rmbbrave

With investment, it pays to be passive

The figures say active versus passive is no contest. The best way to invest is through a low-fee tracker fund. John McCrone finds that even passive investment is evolving with baffling speed.



Plenty of statistical analysis supports that conclusion. However, I think that the reason for an index performing better than a fund manager is that the index could be likened to a "buy and hold" approach, whereas the fund manager's frequent trading erodes results.

The interesting thing is that if we look at the results of the Sharetrader's stockpicking contest over these past years, the majority of us managed to beat the NZX indeces. Part of the reason is that the contest assumes a "buy and hold" strategy over the year rather than the high turnover that a fund has.

rmbbrave
05-01-2007, 12:22 PM
The Undercover Economist: Why the stock market is a wild, unpredictable beast

By Tim Harford


In Tim Harford's book The Undercover Economist, he explains why share prices move the way they do.


One of the most famous dotcoms was the internet bookshop Amazon.com.

Amazon started selling books on the internet in 1995, and in 2003 it sold more than $5 billion worth of merchandise. Amazon's rapid growth and its fight to become profitable is remarkable, but not as remarkable as the price of its shares. In 1997 Amazon shares were first sold to the public at a starting price of $18.

In 1999, Amazon shares soared to more than $100 despite multiple stock-splits designed to increase the number of shares. At the time it was said that Amazon.com was valued at more than all the regular bookshops in the world.

But throughout 2000, Amazon shares slid back toward $18 and beyond. In the summer of 2001 Amazon shares were trading around $8. In 2002, the company was getting good write-ups in the financial press, but shares were still down more than 80 per cent from the peak. Yet since then they have recovered to $40 a share. Which price was the mistake: $100 or $8? Or both?

The answer would be useful, not least because Amazon's rollercoaster performance is common. So can the Undercover Economist say anything about why share prices acted the way they did, and how they might behave in the future?

Economists face a serious problem in trying to say anything sensible about stock prices. Economists work by studying rational behaviour, but the more rational the behaviour of stock market investors, the more erratic the behaviour of the stock market becomes. Here's why. Rational people would buy shares today if it was obvious that they would go up tomorrow, and sell them if it was obvious that they would fall. But this means that any forecast that shares will obviously rise tomorrow will be wrong: shares will rise today instead because people will buy them, and keep buying them until they are no longer so cheap that they will obviously rise tomorrow.

In fact, rational investors should be able to second-guess any predictable movements in the stock market or in the price of any particular share - if it's predictable then, given the money at stake, they will predict it.

But that means that if investors really are rational, there won't be any predictable share movements at all.

All the predictability should be sucked out of the stock market very quickly because all trends will be anticipated. The only thing that is left is unpredictable news. As a result of the fact that only random news moves share prices, those prices, and the indices measuring the stock market as a whole, should fluctuate completely at random. Mathematicians call the behaviour "a random walk" - equally likely on any day to rise as to fall.

More correctly, the stock market should exhibit a "random walk with a trend", meaning that it should on average edge up as the months go past, so that it is competitive compared with other potential investments such as money in a savings account, or property.

If it was expected to edge up by more than that trend, it would already have done so, and similarly if it was expected to edge up by less, or to fall, it would already have underperformed. This is the reason people hold shares at all.

The trend doesn't alter the basic analysis, though, and on any given day the trend is dwarfed by random movements.

This theory should hold even if not every investor is rational.

The ones who are should be enough to force the market into a random walk, providing they are throwing plenty of money into good shares and out of bad ones. Throwing money around shouldn't be too difficult, since presumably the smarter investors make more money.

Should we believe the "random walk" theory? We certainly shouldn't expect it to be absolutely true. If it was, that would be a paradox: perfectly informed investors produce a random market, but a random market doesn't reward anybody for becoming perfectly informed. It wouldn't b

Steve
06-01-2007, 04:56 PM
I have been following the Undercover Economist series in the NZ Herald - a very interesting read. We could almost start a thread on each topic!

Deev8
07-01-2007, 01:35 PM
quote:Originally posted by Steve

I have been following the Undercover Economist series in the NZ Herald - a very interesting read.

It's worth getting hold of a copy of the book ("The Undercover Economist") - it's all very interesting.

I've also seen a series that Harford did for BBC TV in the UK ("Trust Me I'm an Economist"). That made a pleasant change from most of the rubbish that we see on the box.

Steve
07-01-2007, 01:52 PM
I have had a quick look for it at the local bookshops (whitcoulls & paper plus)with no luck, so I intend to try the university bookshop to see if they can get it in for me

stephen
18-01-2007, 08:26 PM
Interesting take from Brian Gaynor http://www.nzherald.co.nz/category/story.cfm?c_id=71&objectid=10418897"

"Why do some commentators argue in favour of passive funds when there is clear evidence that they have underperformed active funds despite having a huge tax advantage?

The only conclusion is that they are using overseas data and arguments and applying these incorrectly to New Zealand."

Love to read what Mary Holm has to say about this :)

zyreon
19-01-2007, 07:17 AM
index funds have their place, and not just for the faint hearted - they can be used in stock index arbitrage, every security in the market has a use. You can also use leverage e.g. margin lending or index futures or index CFDs.

I think the NZX funds have their merits, the savings plan is a good idea. If you dont have enough time to do your analysis and get educated then index funds could be a key element in your portfolio.

Though I guess it would be good to compile some historical data for the NZ markets to see how well such a strategy actually works...

Snoopy
22-01-2007, 01:23 PM
quote:Originally posted by stephen

Interesting take from Brian Gaynor http://www.nzherald.co.nz/category/story.cfm?c_id=71&objectid=10418897"

"Why do some commentators argue in favour of passive funds when there is clear evidence that they have underperformed active funds despite having a huge tax advantage?

The only conclusion is that they are using overseas data and arguments and applying these incorrectly to New Zealand."


That is an interesting observation by Gaynor who is a market commentator/investor I have a lot of time for. However, I would draw a quite different conclusion from Gaynor's 'only conclusion'.

NZ is in a unique position of having its top ten, and indeed the whole market, dominated by Telecom. At one stage Telecom made up as much as 30% of the whole market. In the recent past that has shrunk to around 20%. But that 'one stock domination' is well above what you would find on any comparable overseas market.

TEL's place in the market means that the rise and fall in the share price of Telecom has a disproportioonal effect on the index, be that the NZX10, NZX50 or NZXAll. An individual share price is always going to be more volatile than an index. My interpretation of the relative underperformance of 'NZ market index funds' is that the sharp decline in Telecom share price over the last ten years has introduced a disproportionate random element into the index. In no other comparable index worldwide would the decline in price of a single share have such a dramatic effect. I would bet that if you instead looked at the performance of the NZX49 (excluding Telecom), that fund managers would have a much lower chance of beating it. In more recent years Telecom has not done as badly as you might believe, because the measuring stick, the NZX50, includes the cumulative effects of dividends which are paid out. These very high dividends are not measured, in the case of Telecom.

I think my NZX49 would have stacked up well against the results of NZ's active fund managers over the last ten years . However, I'm not planning to start up an NZX49 for people to invest in. That's because the same skewness that Telecom has exerted on the NZX50 to bad effect in the last ten years could easily be reversed in the next ten years. Indeed from a value investor's perspective TEL looks like the only obvious 'buy' in the NZX10. That isn't to say there are not better companies in the NZX10 than Telecom. The problem is these 'better companies' have had their investment attractiveness arbitraged away by higher share prices.

Oh and one last point. I think Gaynor should have declared the self interest in his own conclusion by pointing out that he is an active fund manager in his own right.

SNOOPY

CJ
23-01-2007, 10:58 PM
Snoopy (aka Mary Homle)

Your answer is exactly what she said. The TENZ fund is dominated by telecom. FNZ (top 50) has telecom in it but all stocks are limited to 5% so not so bad. Midz I cant remember but excludes the top ten at least. These last two funds beat the index.

Disc: Holder of FNZ and happy with last years return.

Halebop
23-01-2007, 11:43 PM
Snoopy the Telecom factor doesn't address Gaynor's argument. Active Managers could "actively" avoid TELECOM because of their active mandate. On the flip side, they can actively buy TELECOM if prospects appear satisfactory.

The real truth is markets were strong and only a total pilchard could have lost money. Passive funds will also lose money in a falling market. But a falling market is what is needed to indentify the truly skilled active investors.

rmbbrave
30-01-2007, 12:08 AM
New words, same message - diversify
The Dominion Post | Tuesday, 23 January 2007

By MARY HOLM

New data confirms the same old messages about share investing: hang in there, and diversify.

An analysis of the last 30 years by SuperLife shows that if a share market is performing badly, stick with it and it is likely to get better pretty fast.

The New Zealand market, represented by the NZX40 index, delivered positive returns in 81 of the 120 quarter-years – about two-thirds of the time.

Let's look harder at the 39 negative quarters. Eighteen of those were one-offs. The market went down in one three-month period but recovered in the next one. Another 18 were double bangers. The market fell for two consecutive quarters nine times. Nevertheless, it recovered after each of those dismal six months. Only once in the past 30 years did the New Zealand market fall for more than two quarters in a row. It fell for three quarters – starting July 1, 2002 – but recovered after that.

The numbers overseas are similar. Share returns – as measured by the MSCI unhedged international share index – were positive in 87 of the 120 quarters. Of the 33 negative quarters, 20 were one-offs and eight were double bangers.

Again, there was just one time when the market fell for more than two quarters. This time, though, it was seriously bad news. The international market fell for five quarters in a row, starting on January 1, 2002.

Keep in mind, though, that this happened only once in 30 years. And the market has largely recovered since then. Over the long haul, shares in both markets have grown strongly.

On average, New Zealand shares have grown 16 per cent a year, including dividends, over the past 30 years, while international shares have grown 13.3 per cent a year.

The data also showed how the New Zealand and international share markets interact. Returns were positive for both markets in 66 of the 120 quarter-years.

What about the other, more worrying 54 quarters? In 36 of them a fall in one market was at least partly offset by a rise in the other. Both markets fell in only 18 of the 120 quarters.

What can we learn from all this? Share markets are volatile. If you invest in shares or a share fund, expect the value of your investment to fall often.

It is rare, however, for the market to keep falling. Hang in there, and things will usually come right fast. Even when it takes a while, it comes right in the end.

This volatility is why experts recommend that you don't invest in shares if you need the money in the next few years, in case you end up having to sell when the market is down. Many say you should have at least 10 years in hand.

SuperLife adds: "This is one reason why an investor, near retirement, should have a mix of cash for immediate expenditure, bonds for medium-term expenditure and shares for longer-term expenditure."

Investing in both the New Zealand and international markets considerably reduces your risk. When one market does badly, there is a good chance the other will do well.

Of course, the future might not be like the past.

But when you look at share data over a period as long as 30 years you can generally draw more accurate conclusions than from shorter periods.

As SuperLife puts it: "We see few reasons why positive and negative returns will not occur with the same sort of frequency in the future."

Halebop
30-01-2007, 07:37 AM
Hmmm. The "data" also shows I would not yet have recovered my capital if I was unlucky enough to take a portfolio approach in New Zealand circa 1986. This is a period of "just" 21 years so perhaps Mary doesn't consider it statistically valid. Some of those consecutive down quarters saw real people left in real ruin - and the more passive they were, the more damage there was.

Snoopy
30-01-2007, 09:52 AM
quote:Originally posted by Halebop

Snoopy the Telecom factor doesn't address Gaynor's argument. Active Managers could "actively" avoid TELECOM because of their active mandate. On the flip side, they can actively buy TELECOM if prospects appear satisfactory.


I agree with what you say Halebop. But I don't think Gaynor's comments on active vs passive were that specific as to *why* active had beaten passive in the NZ market. Perhaps the conclusion that you made was the conclusion that Gaynor wanted you to draw. But Gaynor didn't actually say he would actively avoid Telecom shares. Indeed, on the subject of big cap underperformers, Gaynor is on record as a long term holder of Carter Holt shares. In recent years CHH had been the number 2 share in our market and a long term market underperformer. Based on that I'd be willing to bet that Gaynor has indeed held Telecom shares, at least until 2006, in his own name on a long term basis.

I think the point that Gaynor carefully doesn't mention is that even if you are a long term Telecom bull (like myself) the holding that TENZ had in TEL was way out of proportion to any guideline you care to name that balanced risk with diversification through owning a wide basket of shares. I regard myself as 'overweight' in Telecom. Yet my holding in Telecom in proportion is nowhere near the 20%-30% of all NZ shares that an index investor would get, just by buying TENZ alone.


quote:
The real truth is markets were strong and only a total pilchard could have lost money. Passive funds will also lose money in a falling market.


Gaynor didn't say index investors lost money. An investor in TENZ would not have lost money. They just wouldn't have made as much as the average actively managed NZ market fund (with the benefit of hindsight)


quote:
But a falling market is what is needed to indentify the truly skilled active investors.


A falling market coupled with an eventual market recovery with a caveat that those skilled investors were not forced to sell out at the bottom by panicing retail investors wanting to pull their money out of 'the skillfully controlled fund' at just the wrong time.

SNOOPY

ratkin
30-01-2007, 05:00 PM
quote:Hmmm. The "data" also shows I would not yet have recovered my capital if I was unlucky enough to take a portfolio approach in New Zealand circa 1986. This is a period of "just" 21 years so perhaps Mary doesn't consider it statistically valid. Some of those consecutive down quarters saw real people left in real ruin - and the more passive they were, the more damage there was.

Mainly those who were greedy borrowing to buy shares, or maxing out so they had no spare capital.

Any sensible passive investor would commit a fixed sum to shares each month , gradually building up holdings , they would also invest in more than one passive fund.
Anybody adopting this approach would have done very well no matter what time they started their contributions

rmbbrave
05-02-2007, 12:36 PM
Nest egg growth slows for pros

February 05, 2007
By Simon Hendery

Mere mortals who have failed to reap substantial share market returns recently can take heart.

Some of the country's most high-profile investors have missed out on cashing in as well as they might on the NZX's recent stellar run.

While the benchmark NZSX Top 10 index climbed 15 per cent in the past three months, a group of elite "smart money" share investors - with a collective portfolio of $670 million - only managed to increase the value of their holdings by 9.1 per cent.

Investment Research Group director David McEwen has been tracking the market fortunes of the eight individuals and family investors since 1999.

Over that time, McEwen's "smart money index" (SMI), which tracks the group's collective NZX investment fortunes, has risen 143 per cent while the Top 10 index has gained only 54 per cent.

But, in the latest issue of his weekly tip-sheet, McEwen's Investment Report, he says the SMI's relatively mediocre performance in the three months to February 1 shows it is hard to outperform a sharemarket caught in the grips of a rampant bull run.


"In those circumstances, you might as well invest in an index fund and capture total market growth," he says.

"But when the going gets tough, that's when smart investors can really use skills and a contrarian approach [buying when others are selling] to stay well ahead of the market performance, and to produce positive returns when the market is falling."

The portfolios McEwen monitors belong to Hugh Green, Craig Heatley, Michael Friedlander, Peter Masfen, Sir Selwyn Cushing and his son David, Eric Watson, Phil Briggs and the Todd family.

Taking the biggest hit over the past quarter was retired property developer Green, whose portfolio fell $14.9 million as a result of a slump in the share price of investment group Hellaby.

McEwen says, however, that Green has still made a significant gain from his investment in Hellaby "which he picked up when it was virtually a penny stock".

While a recent profit warning may have shaved 20 per cent off the company's share price and the paper value of Green's holding, "a quarter is an irrelevant period for an investor like Green, whose horizons seem to stretch to decades".

Masfen holds the most diverse portfolio among the smart money investors and gained $28 million during the past three months thanks to jumps in the share prices of Fletcher Building, Contact Energy and SkyCity.

During the quarter he sold 2.4 million Telecom shares as the stock bounced off the lows it plunged to in the wake of the Government's decision to unbundle the local loop.

McEwen says Heatley made a significant purchase of 3.2 million Infratil shares during the quarter.

"Infratil shares are not cheap, and have never looked cheap," says McEwen. "But its strategy of focusing on long-term growth sectors like energy and airport assets is proving a good one as these are highly sought after sectors and, when managed well, highly profitable."

Former market polariser Watson remains on McEwen's watchlist despite bowing out of almost all activity in the local market over the past few years.

The "Watson factor" has been a huge market influence in the past, with small investors either flocking to, or shunning, companies such as Advantage (now Provenco) and Pacific Retail when he appeared on the register.

During the past quarter Watson sold a $3 million investment in Abano and now only holds a small stake in gold exploration company Glass Earth.

"This [Glass Earth investment] shows the gambling streak in Watson's investment style," McEwen says.

Sharebroker and investment adviser Briggs upped his stake in Cynotech to more than 13 million shares during the quarter.

"Cynotech is starting to trade itself out of difficulty and the share has doubled its price over the quarter, to 20c, handing Briggs a good profit," says McEwen.

The Todd family, which has the most valuable portfolio in the SMI, bought 22 million shares in eftpos company Provenco