Finance 201: What is the Efficient Market Hypothesis

Hi friends, 

Today, I would like to talk about this important piece of information that I have learned in the beginning portion of my finance journey - The Efficient Market Hypothesis (EMH). This piece of information has served as a cornerstone in my investment approach and why I believe in ETFs rather than Mutual Funds. And I cannot wait to share this piece of information with you guys today. 

Definition: 

The efficient market hypothesis (EMH), alternatively known as the efficient market theory, is a hypothesis that states that share prices reflect all information, and consistent alpha generation is impossible. - Investopedia

The Efficient Market Hypothesis (EMH) essentially says that all known information about investment securities, such as stocks, is already factored into the prices of those securities - The Balance

There are different forms of EMH, which will be discussed later in the post. But I would like to highlight what the abovementioned definition means. This would mean that in an efficient market, no investor is able to consistently outperform the market (outperforming the market is alpha). In this article, I will be discussing the evidence for and against EMH, the different forms of EMH, how you can utilize EMH in your portfolio, and my personal thoughts and comments. 

Evidence for EMH:
1. As was discussed in my previous look at the SPIVA papers, that shows very strong evidence for EMH. In the SPIVA paper, it has been shown that ~90% of mutual funds underperform their index/benchmark in a 15 years time horizon. Hence, we can see that in the long run (15 years), really low portion of active management approaches can outperform the market

2. Furthermore, as companies release their quarterly earnings reports, we can see that the stock prices are quick to reflect based on the report. 

Evidence against EMH:
1. Just like how 90% of mutual funds underperform the market, there are actually 10% of the mutual funds that still outperform the market in the 15 years time horizon. However, I am unable to find a comparison in performance beyond 15 years.

2. Not just mutual funds, there are active investors that have outperformed the market over long time horizons like Warren Buffett, Peter Lynch, etc.

Forms of EMH: 
1. Weak Form EMH:

This is when all past information is priced at the stock price. Hence, fundamental analysis of securities using P/E, PEG, Cashflow, Dividend growth allows for investors to produce returns above the market in the short term and there are no recurring "patterns" that an investor can take advantage of. Hence, technical analysis won't work and fundamental analysis would not work in the long run. 

2. Semi-strong Form EMH:

New public information is instantly priced into the stock price. This would mean that fundament and technical analysis would not work at all (This is where it is a bit ridiculous. As we all know that new formation is not instantly reflected in the stock price, heard of insider trading?) - This covers for private information

3. Strong Form EMH:

Both public and private information are priced into the price. Hence, no investor can outperform the market.

It is important here to say that EMH is able to explain for a majority of the market investors. However, just as all models, there are abnormalities that fall outside of this model. Hence, there will be extreme winners and extreme losers in the stock market. However, as we do not take note of the extreme losers, it can affect our perception of the market that there is a chance to outperform the market. 

How you can take advantage of the EMH:

1. Invest in super low-cost ETFs: This is such that you may take advantage of the EMH and stick to the market's performance as close as possible. (Low expense ratio) Passive investors' approach

2. Invest in inefficient markets: This is for markets that stock prices would not immediately change based on the news but it would take a few days. But with the advent of the internet, such markets are getting rarer and rarer. 


Thoughts and comments:

You are aware of it already. I am a firm supporter of the EMH. This is especially after the long-term performance of ETFs trumping on mutual funds. Furthermore, it is almost impossible to judge if a mutual fund will outperform the market in the long run (except if it is done in hindsight *cough* shady practices *cough*. 


Hence, I would always voice my support in ETFs due to their efficiencies and be disappointed as a majority of the market is still done by active investment. HOWEVER, more and more money in the market is going into passive investment. So.. I guess things are changing. And we are in the midst of this change. 

Till then,
Stay vested, stay frugal my friends.

Dionysius



Sources:
https://www.investopedia.com/terms/e/efficientmarkethypothesis.asp
https://www.thebalance.com/efficient-markets-hypothesis-emh-2466619
http://static.stevereads.com/papers_to_read/the_behavior_of_stock_market_prices.pdf
https://us.spindices.com/indexology/core/spiva-us-year-end-2019

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Finance 101: What is a portfolio?

Hi friends, 

I bet that you have heard of it before. "I have a portfolio of blah blah blah", or "How big is your portfolio?" So... What is this "portfolio" that everyone who is investing/ planning their finances is talking about? Today I shall be tackling this question:

Definition:
A portfolio is a grouping of financial assets such as stocks, bonds, commodities, currencies and cash equivalents, as well as their fund counterparts, including mutual, exchange-traded and closed funds. A portfolio can also consist of non-publicly tradable securities, like real estate, art, and private investments. - Investopedia

A portfolio refers to a collection of investments or financial assets held by an individual, investment company, financial institution or hedge fund. This grouping of financial assets can include everything from gold and property to stocks, bonds, and cash equivalents. In essence, an investment portfolio acts as a big briefcase-carrying all of these financial assets. - Capital

These are the essential points.

1. Group of financial assets (Financial instruments that can be anything that we discussed and more, like real estates, arts, whiskey, etc)

2. Held by an individual, company, funds. 

For today, we will be talking about your individual portfolio. As per the definition, your portfolio is a combination of the different financial instruments that you are holding. A portfolio is also something that you should build based on your preferences. It should be in line with your investment beliefs and your risk appetite

Here are some of the things you should consider before setting off to build your portfolio:

1. What is your risk tolerance? 

How much gain/loss are you able to tolerate? Are you ok with a portfolio that can give you large returns and losses?

2. What is your time horizon?

A longer time horizon would mean that you can create a portfolio that has a higher potential for appreciations. 

3. What assets are you comfortable/ familiar with?

If you are competent and have a lot of experience with a particular financial instrument, you can consider having more of your portfolio allocation to the instrument that you are familiar with. 

Here are some of the financial instruments that you can have in your portfolio. We have actually gone through the majority of them in the other Finance 101 articles:

1. Stocks, etfs, mutual funds, index funds, Reits 

2. Bonds, bond funds

3. Gold, precious metals

4. Crypto (Bitcoin, ethereum)

5. Real estates 

6. Other financial instruments like alcohol, art, etc

7. Commodities like copper, steel, oil

8. Insurance

As we are talking about the personal portfolio, in which I would assume that you do not have the need to invest in commodities, alcohol, art etc. We will focus on 1,2,3,4,5,8 I will analyse it from the POV of a) Aggressive investors (with a long time horizon) b) Conservative investor (with a shorter time horizon) c) Investor who is looking to pass intergenerational wealth d) ultra-aggressive investor

Do note that the allocations are just for example. You should do your own research. 

a) Aggressive Investor (For those who wants :

1. Stocks (85% in etf, individual stocks)

2. Bonds (0%)

3. Precious metals (4% in gold)

4. Crypto (1%, treat it as a gamble)
5. Real Estates (5%)

8. Insurance (5%, to protect against sudden events)

b) Conservative Investor (For those who wants to have some returns but cannot take too many losses)

1. Stocks (20% in etfs, and reits etfs)

2. bonds (60% in bond funds)

3. Precious metals (5% in gold)

4. Crypto (0%)

5. Real Estates (5%)

8. Insurance (10%)

c) Generational Wealth Investors (For those who wishes to pass to their offsprings without incurring taxes)

We do not have inheritance tax in Singapore. But do know that if you pass on properties, your offsprings might need to pay property taxes on it, or pay for the maintenance fees. 

Hence, you might want to consider holding on to stocks and bonds. 

d) Ultra-aggressive Investors (me, with about 30-40 years of investing)

1. Stocks (95% in etf, individual stocks/ reits)

2. Bonds (0%)

3. Precious metals (0%)

4. Crypto (0%)
5. Real Estates (0%)

8. Insurance (5%, to protect against sudden events)

I will reiterate this again. Your portfolio would be reflective of your investment beliefs. Your portfolio should be tailored to your needs. Of course, with a portfolio, you should always look at it every now and then to rebalance it. The rebalancing would allow your portfolio realigned with your chosen allocations. This rebalancing should be around once per 3 months. 

As always, do take note that the allocations are just examples, you should always do your own research before making any financial decisions. 

Also, now that we have settled a majority of the financial instruments, I will be moving on to the most famous financial portfolios that are held by famous investors like Warren Buffett, Ray Dalios, etc. It will be named "Finance 201". I am an Engineer for goodness sake. How creative do you think I am :')  Don't worry. Finance 101 series will still run on, just keep sending in request so that I know to explain some of the basic terms that I have used in my posts

With that, 

I end today's topic

Stay vested, Stay frugal my friends,

Dionysius

Sources:
https://capital.com/portfolio-definition
https://www.investopedia.com/terms/p/portfolio.asp

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My thoughts and comments on the ETFs vs UTs Webinar

Hi friends,

I have recently attended this webinar through an invitation from one of my friend who is a financial advisor. This webinar was held on the 30th of April 2020, from 8pm to 9.30pm. I have screenshot quite a number of slides from the session.

It was interesting to hear from the opposite side, with people trying to say the reasons why they support unit trusts.

Let me give the TL;DR  to my TL;DR version of this webinar:

TL;DR (Level 2)
Expected:
Fair, transparent, open conversations of ETFs vs mutual funds

Reality:
Speaker threw shades on ETFs and Robo-advisors using articles/ inadequate studies. He was not transparent about the costs of mutual funds and gave anecdotal examples of mutual funds outperforming ETFs based on hindsight rather than a full statistical picture for the audience.

TL;DR (Level 1)

Expectations:
I expected to hear an objective and research-driven argument on why unit trusts/ mutual funds should be preferred over ETFs (and Robo-advisors). So I have expected the speaker to be completely transparent about the financial instruments, their costs, their advantages, and disadvantage.

Reality:
I received a presentation that tried to throw shades at other financial instruments (while contradicting himself in the midst of it) by questioning their research methodologies and the credibility of the studies. Ok, I understand that you should be critical in the studies that you read. But the speaker was not specific in the impact on the research methodologies and the counter-argument paper he has presented was inadequate in the scope that the other paper has looked at.

After throwing shades at the other financial instruments, the speaker was also not completely transparent about mutual funds. Especially the cost, where he has skipped over quite a bit of the cost like front-end loads, yearly management fees, and my favourite; advisory charge, etc. (You know? The things that will eat into your returns.)He has also done something that triggered me really badly. In order to prove his points that mutual funds do outperform the benchmark, he chose a fund that has outperformed the benchmark after accounting for all fees.

For those of you who do not understand, he has essentially filtered for a fund that outperformed the benchmark and just selected it based on that (and used a five-year time horizon to prove his point). You do know that hindsight is 20/20 right? What are the odds of you choosing a fund right now and 10 years later, perform higher than the benchmark?

Actual post:

It started off quite balanced. With this slide:

Alpha would mean outperforming the market. But even at this point, there are some parts where I actually disagree already. I would say that it is a spectrum rather than a binary option. Like how I am a passive investor, but I do some active maneuvers like timing my entry and exit into and from the market and keeping track of the stock market every day. 


But I guess he was trying to contrast between a unit trust and ETFs investment approaches. 

Sadly, that will be the only glimpse of an objective view I got for the presentation...

Point A - Throwing shades at other financial instruments

Part 1: Questioning the methodologies of research papers but not being specific about the impacts brought by the inadequacy of the methodologies:


The speaker was saying that SPIVA's yearly research paper of active vs passive investment was limited in its approach. This is as they used the wrong index to measure against that particular mutual fund (Example, what he is saying is that: A large-cap US-focused mutual fund was not measured against its benchmark, but aginst the S&P 500 instead. Do you see why I'm confused? SPIVA has actually classified the funds based on their biggest holdings - Check out my SPIVA blog post for that) 

He was also saying that SPIVA's credibility is also limited as they sell ETFs and warn us not to fall for what marketers are saying. ERM, the SPIVA scorecard is transparent in its approach. They have shown their methodology and their data at different time horizons. At least try to show us evidence of inconsistency if you decide to question their credibility. 

An article by Schroders was also used by the speaker. Schroder is also an active fund house, so I guess you can guess about the credibility using his logic. Furthermore, SPIVA's paper is 37 pages long, with several time horizons, while the Schroders' article (emphasis on the word ARTICLE) was only 13 pages long, while focused on the 5 years time horizon, with no mention on the US market. URGH. They are so different in their scope that they shouldn't be compared. 

Furthermore, the speaker has said that the mutual fund should be measured to the ETFs for comparison, that is a fair view. It is something that I agree on the limitations of the SPIVA studies. However, even so, the speaker did not speak about the implications of this limitation with data to back it up. 

Part 2: Throwing shades at ETFs and Robo-advisors and contradicting himself

During the presentation, the speaker has also questions on the age of ETFs and how its young age, compared to mutual funds, would not be fully representative of its impact in an investor's portfolio. I would not have a problem with this statement if I did not know how long ETFs have existed. This is as the speaker has phrased it in such a way to make it seem that ETFs magically appeared out of nowhere when actually it has started in the 1970s. That would be 50 years of existence.




He then attempted to throw shades at ETFs, saying that it is illiquid, that ETFs would affect the fundamental values of stocks as people are just buying all the companies in the index. But he then contradicted himself by showing that ETFs are not even the majority portion of the market (just 6% btw).

Regarding the illiquidity issues; the speaker was saying about how if there is a crash, everyone would be selling and no one would be buying. This would further the crash and you would not be able to cash out, this would lead to the illiquidity issues. The price of the financial instrument is determined by the price of the previous transaction. Hence, it does not affect liquidity. 

Regarding the throwing shades on Robo-advisor, the speaker talked about the recent shut-down of one of the more prominent robo-advisors recently - Smartly. He then talked about the young age of Robo-advisor does not mean that it could give a proven track record on investors' return and if it closes down, we would be forced to cash-out at a time that we do not want to. 

Yes, I agree that the young age of robo-advisors does not have a proven record of helping investors to achieve their returns. But investors using robo-advisors should already be aware before going into them in the first place. Furthermore, yes. robo-advisors can close down. But so can mutual funds and etfs. And the speaker did not bring out a fair argument. 

In 2016, almost an equal number of mutual funds left the market. A total of 426 mutual funds liquidated, which is an increase from just 290 the year before. - Creditdonkey

Point B: Not transparent about the cost of Mutual funds




When I saw these two slides, I knew that something was wrong. The fees for mutual funds/ unit trusts were too low. As I am not a financial consultant; I asked my consultant friends on the fees on an ILP. 

These are the fees in an ILP:
1. Front-end load (Plan distribution charge charged by the insurance company, in the first two years, only like 30% of your premiums paid is paid to buy units of a mutual fund)
2. Advisory fees (1-4%, might be 0 in some cases, charged annually by your agent on the total sum of your money)
3. Annual administration charges (Charged by the mutual funds)
4. Management expense ratio (sum of management fees and annual operating expenses of the mutual fund 1-2% of your money under management)
5. Bid offer spread (This can be charged by the insurance company or the mutual fund or both, some ILPs have no bid-offer spread)

Such fees are confusing due to a lack of standardization between the insurers and different fund houses, I was confused even though I had the help of 2 financial consultants and I am still a bit confused. Yet, the speaker did not speak about these fees. Oh. guess what, front-end loads are not included in the returns calculations when you are shown the fund fact-sheet. There isn't an ILP fees calculation formula that I can find on the internet as well. 

Meanwhile, ETFs and Robo-advisors' costs are transparent and easy to calculate. 

For ETFs:
3 components 
1. Bid-offer spread (when you buy/sell)
2. Commission-cost (when you buy/sell)
3. Expense ratio (annual charge ~ 0.04% for S&P 500)

Example (Using FSMone):
ETF - NikkoAM-STC Asia REIT (REITs ETF)
Bid - 1.07
Ask - 1.078
Comms - Min 10.88 or 0.08% of your transaction
Expense ratio - 0.6%
Platform fees of ETF - 0%

Can you see why I prefer ETFs? The cost of investment is definitely lower. 

Robo-advisors (Using StashAway): 
1. Bid-offer spread (when you buy/sell)
2. Commission-cost (when you buy/sell)
3. Expense ratio (annual charge ~ 0.04% for S&P 500)
4. Annual fee rate (0.8% for the first $25,000)
5. Currency conversion fees (0.08%) 

My fees are ~0.75%. This is not inclusive if you use my referral code to get 6 months of free management by them: https://www.stashaway.sg/referrals/dionysiazdky

So. Yes. His calculations are wrong. If you use an ETF with a really low expense ratio, like 0.04%, your cost of investment would not be anywhere near what he has calculated

Point C: Using a mutual fund that has outperformed the benchmark to show that mutual funds do outperform ETFs

 This really triggered me. As the speaker has just pulled out this ONE example and gave an impression that NAH, SEE, MUTUAL FUNDS CAN OUTPERFORM ETFs. 

This trigged me as:
1. This is just ONE example
2. The example used was in an inefficient market (China)
3. This example used a 5-year time horizon, even the since-launch option does not tell us the long-term performance
4. This example is in hindsight.

If you want to show that mutual funds can outperform ETFs, show us broad statistics, with super long time horizons, of it, don't just show us one example of it. 

Show us a way to select a mutual fund that will outperform the ETFs on the spot instead of choosing it by filtering based on its past performance. Show me your portfolio that chose a mutual fund that has consistently outperformed the index net-of-fees. Don't show me something that you pulled out from a database of mutual funds. 

In conclusion:
While there are some legitimate points being brought out in the session, they are not elaborated properly with no data to support it. The parts where he showed his calculations are also inadequate as they do not show the true cost of the ETFs, mutual funds, and Robo-advisors. He also used hindsight to support his point rather than telling us how to choose a proper mutual fund.

It is in my belief that if something is really good, there is no need to hide any information, and there will be a demand for it. I am not sure if the speaker was intentionally hiding such information, but yes. Certain information was not shown to its audience and if they do not know about the financial instruments, they would definitely be misguided. 

If you really want to understand finance, read yourself, or read my blog. Read from somewhere that does not have a vested interest to sell you a product. It's your money, learn to manage it, never learn it from a salesman. 

With that, 
I end today's topic. 

Stay vested, Stay frugal my friends,
Dionysius

Sources
https://www.investopedia.com/articles/mutualfund/09/mutual-fund-liquidation.asp
https://www.creditdonkey.com/average-mutual-fund-return.html
https://finance.yahoo.com/news/calculate-total-cost-etf-200030478.html
https://secure.fundsupermart.com/fsm/new-to-fsm/pricing-structure
https://www.stashaway.sg/pricing

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Finance 101: What is a Mutual Fund/ Unit Trust?

Hi friends, 

Today, I will be talking about Mutual Funds (MFs)/ Unit Trusts (UTs). It is effectively own a pool of stock managed by a fund manager. 

By definition:
A mutual fund is a type of financial vehicle made up of a pool of money collected from many investors to invest in securities like stocks, bonds, money market instruments, and other assets. Mutual funds are operated by professional money managers, who allocate the fund's assets and attempt to produce capital gains or income for the fund's investors - Investopedia

A unit trust (or “mutual fund”, as the wacky Americans call it) is a fund where multiple investors pool their money. A fund manager takes that pool and channels it into a whole bunch of different investments. -Money Smart

Here are the keywords:
1. A pool of money - UTs get their capital from a pool of investors
2. Invest in securities (Stocks, bonds, money market instruments, and other assets) - buying assets to generate returns
3. Operated by managers - The assets are selected by professionals, they would decide when the purchase will take place, the portfolio allocations and how long to hold it for. 

So... What is a Mutual Fund?
Essentially, imagine you and a bunch of other investors invest a sum of money. Through that, a manager of the fund would decide what stocks to buy, how much to buy, how long to hold. The manager's aim is to beat the market and generate returns for you. It may be in his interest to beat the market, as his salary may be pegged to how much he can outperform the market. This is unlike ETFs, where you are buying the market. 

Now that we know what are Mutual funds, allow me to elaborate on their advantages and disadvantages:

Advantages:
1. Quick Diversification - You buy into all the stocks under that fund. 
2. Professional Management - By paying the fees, you can have a professional team of managers/ analyst that is working to maximise your profits. 
3. Reinvested Dividends - Some funds allow for your dividends to be reinvested and purchase it at a lower price. This would further increase the units that you are holding. 
4. Low barrier to entry - Similar to ETFs, mutual funds are relatively cheaper to invest. You can even do a $100 investment every month. 
5. Potential to beat the market - As mutual funds would steer away from the market index, this would give them the potential to do better than the market. 

Disadvantages:
1. High expense ratios and Sales charges - Research has shown that a high expense ratio would negatively impact your returns. The picture below shows the correlation, not including the sales charges. 
2. Bad fund Management - Some fund managers may use techniques to make their funds appear to be doing better than it is.
3. Limited trade execution - As you can only buy and sell units of a mutual fund at the end of the trading day. You might not be able to execute buy and sell orders immediately. 
4. Potential to do worse than the market - As mutual funds would steer away from the market index, this would also give them the potential to do worse than the market. 

How to determine a good mutual fund?
This would be tough to write about. There is a module in my university that talks about this. Students that went through that have to research and find 3 mutual funds based on criteria and present what mutual funds they think will perform well. 

Thankfully, I didn't have to take that module. But here are things that I found from my research:

1. The mutual fund's investment style:
If your focus is on receiving dividends, you shouldn't be looking at growth mutual funds. Likewise, if you are seeking capital appreciation, you should not be looking at income mutual funds. If you have a long time horizon and the mutual fund seeks to make returns in a short time, that would be a conflict in the investing approach. You should choose one that suits your style. 

2. Size of the fund:
Warren Buffett has famously said that if he only had a mere $1 million to invest, he could guarantee 50% annual returns. He then explained that having a large fund size would hinder the purchasing process. This is as your investment would make a substantial impact on the company's market cap - Imagine you have $1 billion, you want to find 5 companies to invest in. You would be limited to companies whose values are more than $200 million. Hence, even if there are good stocks that are under $200 million, you would not be able to buy them. 

Hence, a mutual fund needs to be small enough to be flexible in taking advantage of smaller companies. aka. Flexibility.

3. History of the fund manager and his trading frequency:
A fund manager that has been managing the fund for a long time may indicate that he knows the values of the assets that he is managing. A lower trading frequency would indicate that he is adopting the buying and holding approach to investing and that he is confident in the stocks that he chose.

4. The number of holdings:
A larger number of holdings would indicate diversification, this would generate a more consistent return in the long run. This is important as this is one of the advantages of mutual funds - quick diversification

5. Fees and Expense ratio:
You would want the fees and expense ratio to be as low as possible. As we can see the correlation between fee, expense ratio and the return that you receive from your mutual funds. 

6. Outlook on the market/sector that fund is investing in:
If you believe that the market/sector that the fund is investing in has the potential to do well in the future (ahem, China, India, Indonesia, etc), you can invest in those markets. Emerging markets are generally less efficient and mutual funds usually perform better under those conditions.

Thoughts and opinion:
As we have discussed in the SPIVA scorecard, mutual funds are unable to outperform the market in the long run. Fees and expense ratios are one of the reasons that contribute to this observation. Furthermore, I am a believer of the Efficient Market Hypothesis, especially in the efficient US market, no investor can consistently take advantage of the market. Plus, the success of a fund in one year does not translate to the next year (from the SPIVA scorecard), which means it is extremely hard for you to choose a fund that will earn you higher than market returns.

Yes, there are fund managers that consistently do well and deliver higher-than-market returns to their investors. They are Peter Lynch (who wrote a book on how to perform better than fund managers) and...... 

Sorry, I only know one mutual fund manager that was really successful and popular. 

If you're thinking of Ray Dalio and Warren Buffett, no. They are not mutual fund managers. they are hedge fund managers. This is a topic for a different day. 

Personal Portfolio:
As you can see from the way that I wrote, I sincerely do not believe in the value of mutual funds. It is my belief that mutual funds still exist as a lot of money is paid in the advertisement and marketing to sell to the public. As we become more financially savvy, we should see a decline in mutual funds. Just like in the US. 

With that, 
I end today's topic. 

Stay vested, Stay frugal my friends,
Dionysius



Taken from the morningstar white paper titled "study on investing expense ratio"

Sources:
https://blog.moneysmart.sg/invest/unit-trust-singapore-invest-guide/
https://www.dbs.com.sg/personal/investments/unit-trusts/get-to-know-unit-trusts
https://www.valuechampion.sg/introduction-funds-singapore-what-are-unit-trusts-and-etfs
https://www.moneysense.gov.sg/articles/2018/10/unit-trusts-guide-to-pricing-and-fees
https://www.investopedia.com/terms/m/mutualfund.asp
https://www.sec.gov/reportspubs/investor-publications/investorpubsinwsmfhtm.html#Common
http://oreillywa.com/wp-content/uploads/2017/08/morningstar-study-on-investing-expense-ratios-2016.pdf
https://www.thebalance.com/how-to-choose-the-best-mutual-funds-2466456
https://www.investopedia.com/investing/how-pick-best-mutual-fund/

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Active management allows for better performance in market downturns?

Hi friends,

One of the counter-arguments brought-forth by active management believers would be that they can utilise some other instruments (bonds, derivatives, or even cash) in a market downturn to achieve better performance in a market downturn (like the one that we are having now). Thus, I will be examining if this saying holds up when we look like historical data:

Links:
1. https://www.onedayinjuly.com/active-vs-passive-in-down-markets
2. https://advisors.vanguard.com/iwe/pdf/FASAPMSM.pdf
3. https://advisors.vanguard.com/iwe/pdf/FASAPCM.pdf
4. https://www.morningstar.com/articles/852864/will-active-stock-funds-save-your-bacon-in-a-downturn
5. https://us.spindices.com/documents/spiva/persistence-scorecard-december-2019.pdf?force_download=true

From the POV of active investment:
Passive investments would rely on the market index (index funds/ etfs) for their investments. As the market goes into a downturn, active investment would shine as they would often own stocks that are outside of the index. This would mean that they have the potential of performing better than the market index when it goes down. A skilled manager would only pick the good stocks in the stock market and hence, it should perform a lot better than just buying all the stocks in the market using index funds.



Looking at the figure above, we can see there in a bear market, active managers do perform better than compared to a bull market. Hence, from a short-term perspective, active managements can be considered as a way of investment (Provided that we can choose the ones capable of choosing the right stocks)


However, when we attempt to look at things from a long-term perspective (i think of around 10 years?). The graph above actually shows that for the top 20% actively-managed funds in one crisis, only 23% would remain in the top 20% for the next crisis.

Effectively, only 4.6% of actively-managed funds would remain in the top 20% in their performance for a period of 2 crisis. The issue of how we want to select this 4.6% is beyond me, as I believe that it is more likely due to luck that they actually remained in the top 20%. Evidently from the 77% that actually slide below the quintile.

The same also applies if we look at the US small-cap funds and emerging market fund. Please look at link number 1 for that.

Also, looking at the SPIVA scorecard, which includes 12 equity buckets spread across Large-Cap, Mid-Cap, Small-Cap, and Multi-Cap. Each of those four broad categories is further divided into Core, Growth and Value sub-categories. The 13th category is Real Estate funds. The SPIVA score card has data started in 2001. 

Looking at the 2001 dot com bubble burst and the 2008 financial crisis, only 4 out of 13 of the categories has more than half of the active funds beating their respective index in 2001. In 2008, only 2 our of 13 of the categories has more than half of the active funds beating their respective indexes.  

Hence, even in a market down turn, we are unable to see substantial evidence that active management would perform better than their respective indexes. This is especially evident in the previous paragraph, where only 4/13 of the categories of active funds out perform their indexes in 2001, only 2/13 of the categories of index funds out perform their indexes in 2008. 

In conclusion: when we look at the short-term perspective, there are indeed a substantial proportion of active funds that will outperform the market (50%, so if you would want to choose a fund, you can choose to flip a coin), However, in a long-term perspective, there is no substantial evidence that active management would consistently perform better than passive-investments. Between one crisis to another, there is no consistency in which fund will always do well in the crisis. 

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Conclusion of the study on funds and their indexes for 15 years (IV)

Hi friends,

Thank you for reading so far into my 4 part series. The objective of this part is to give you the key takeaways from the paper. This is especially important for those of you that cannot look at the data presented in the previous posts and just want the main point. Here I go:

1. Majority of funds would not perform as well as the market index as the time horizon increases.
2. Bigger fund sizes would perform better than smaller fund sizes. (But still less worse than their indexes)
3. Growth stocks generally perform better than value stocks.
4. A higher proportion of international funds perform better than their respective indexes, especially prevalent in small cap markets. This would mean that if you’re looking to invest actively, you would do better if you aim at the international small-cap market (22% chance of out-performing the market in a 15 years time horizon)

With that, I conclude this min-series. Next I will be writing about the performance of actively-managed funds in a bear market (As there has been counterarguments that active-management would fare better compared to their indexes in the bear market.)

I will also be talking about some basis of investing; what are bonds, stocks, ETFs, funds etc. So that we can be on the same page. Also, I will talk about the ideals that drives my financial journey.

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Comparison of funds and their indexes in international/global market across different caps for 15 years (III)

Hi friends,

I would like to thank you for still reading through this dry and technical series. I hope that you have learnt a lot from my second post. This is the third post and we shall look at the performance of the International and Global market. Do note that in the paper, global funds/indexes would include US stocks and international funds/indexes would not include US stocks. The paper can also be found at https://us.spindices.com/documents/spiva/spiva-us-year-end-2017.pdf - you should always check the sources of everything you read on the internet.

Without further ado, let me jump straight into the content:

Table of International, Global, Emerging Market funds and their respective index

Fund Category	Comparison Index	Percent of funds outperformed by index over 15-Years (%)
Global Funds	S&P Global 1200	82.47
International Funds	S&P International 700	91.63
International Small-Cap Funds	S&P Developed Ex-U.S Small Cap	78.13
Emerging Market Funds	S&P/IFCI Composite	94.83

Comparing this table compared to the U.S stock funds/index performance, we can see a slightly higher proportion of active-managed funds does better compared to the index. But majority of funds are still outperformed by their indexes. Which is important to note: How do you know if a fund would consistently outperform the index? Moving onto the Asset-weighted and Equal-weighted category, here we hope to see if the saying that "bigger funds would perform better" holds up in the international, global, emerging markets.

Average International equity funds 15-Years performance Equal-Weighted and Asset-Weighted

Fund Category	15-Year (Equal-Weighted) (%)	15-Year (Asset-Weighted) (%)
Global Funds	8.24	9.35
S&P Global 1200	9.52	9.52
International funds	7.19	8.38
S&P International 700	9.21	9.21
Emerging Markets Funds	10.8	11.89
S&P/IFCI Composite	13.41	13.41

I guess that the assumption does hold up. The bigger fund size would perform better compared to smaller fund size. But funds generally do not out perform their respective indexes

Next, we will be looking at the variance of the international, global and emerging market funds return

Spread of International, global and Emerging Market funds and index 15 year performance

Fund Category	25th Percentile (%)	75th Percentile (%)	Index Performance (%)	Difference (%)
Global Funds	8.27	10.22	9.52	1.95
International Funds	6.79	8.92	9.21	2.13
Emerging Market Funds	10.19	12.49	13.41	2.30

From the table above, we can see that the emerging market funds have the largest variance. This can be an indication that the emerging market is not as efficient. This shows in the bigger disparity of the 25th to 75th percentile. Furthermore, we can also conclude that more than 75% of funds would underperform their index in a 15 years time horizon for international and emerging market segments. 

This would prove that it would be difficult in trying to determine if a fund would outperform the market. You would have a better return if you just stick to the index.

 With that, I conclude my 3 part series. I will be writing another post as a summary to the points that I have listed out in the past 3 posts. I will also be writing another multi-part series based on another set of papers. With that, I hope that you have enjoyed it.

Till then,
Stay vested, stay frugal my friends.

Dionysius

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Comparison of funds and their indexes in the US market across different caps for 15 years (II)

Hi friends,

This is the second part of my four-part series on presenting to you the results of active-managed funds and passive funds. I will also be telling you what these data would mean in your personal finance.

However, there is still a need to explain some of the terms in the paper such that you may fully understand the significance of the results. So these are the things that you need to take note of:

1. Funds refer to the actively-managed funds and index refers to the market index that the funds are grouped against.
2. Funds assigned to the groups are judged based on the composition of their funds, having more than 75% weighting of large-cap stocks over a 3 year period would mean that the fund will be compared against the large-cap market index. The funds that have less than 75% weighting would be classified as multi-asset.
3. In each capitalization range, there would be growth, value and core. These are ways by which the weighting of the stocks are decided for the funds or the market. A growth fund/index would allocate a higher weighting to stocks of the capitalization range that are deemed to have higher growth potential (like ... uber? I'm not sure about that)
4. The 25th and 75th percentile returns of the different funds in their respective capitalization range would be used as gauge of variance for their return.
5. Fund performances are also categorized into asset-weighted, equal-weighted. As an example, asset-weighted calculated returns are calculated using the returns of the different funds of the capitalization range while taking into consideration the size of their respective managed asset. (Equal-weighted returns are calculated by taking the average return of the different funds of the capitalization range)
6. Global funds refers to funds that invest in stocks all around the world. International funds refers to funds that invest in stocks all over the world except US stocks
7. Returns of the funds are net of fees, excluding loads (Important)
8. The data are taken from SPIVA U.S. Scorecard 2017

Now that we are on the same picture, I shall now present to you the facts. Do take note that I will only look at the 15 years returns for funds and index. This is as I believe in the value of long-term investment.

Table of Large-cap, mid-cap, small-cap, multi-cap funds and their respective index

Fund Category	Comparison Index	Percent of funds outperformed by index over 15-Years (%)
Large-cap growth funds	S&P 500 growth	93.94
Large-cap core funds	S&P 500	94.67
Large-cap core funds	S&P 500 value	85.71
Mid-cap growth funds	S&P MidCap 400 growth	95.32
Mid-cap core funds	S&P MidCap 400	96.51
Mid-cap value funds	S&P MidCap 400 value	89.89
Multi-Cap growth funds	S&P Composite 1500 growth	86.21
Multi-Cap Core funds	S&P Composite 1500	90.82
Multi-Cap value funds	S&P Composite 1500 value	86.96

From this table, it can be observed that for a time horizon of 15 years, sticking to the index would be the wise choice. This is as majority of funds are unable to beat the market. The study has also included 1 year, 3 years, 5 years and 10 years data too. However, due to the limitations of my HTML skills, I didn't include it in. Do check out the information yourself. But from the paper, we can see that over a longer period of time, lesser portion of funds would outperform the market. (Using Large-Cap funds, 1 year was 63.06%, 5 years was 84.23%, 10 years was 89.51%) This would mean that over a longer period, funds has a lesser tendency of outperforming the market. Do note that I am not saying that all actively-managed funds will underperform the market. What I am saying is that if you are not sure on the approach of selecting a competent fund, you will perform better by sticking to the market index.

Moving onto the next topic, where we will look at performance of funds against the index (Equal-weighted and asset-weighted). However, we will only look for the large-cap funds performance (Because I need to enter all these data into blogspot, it is really hard). There are arguments that the largest funds should return a larger return due to their scale and there must be a reason why so much money is managed by them right? Hence, we should expect that asset-weighted performance should fair a bit better than equal-weighted (look to the top where I defined how the asset-weight performance is derived.)

Average US funds and index 15-Years performance Equal-Weighted and Asset-Weighted

Fund Category	15-Year (Equal-Weighted) (%)	15-Year (Asset-Weighted) (%)
Large-cap growth funds	8.99	9.55
S&P 500 Growth	10.30	10.30
Large-cap core funds	8.09	8.45
S&P 500	9.92	9.92
Large-cap value funds	8.19	8.80
S&P 500 value	9.38	9.38

From this table, comparing between the equal-weighted return and the asset-weighted returns, it can be observed that asset-weighted outperformed equal weighted return. So maybe there is some truth in saying a bigger fund might perform better compared to smaller funds. However, even asset-weighted still underperformed compared to the market. So, from this, we can see that there is a possible correlation between fund sizes and their performance compared to the market. Also, growth stocks have been favored by the market as compared to value stocks. (I have no idea what are the implications, I am presenting the facts.)

Next, we will be looking at the variance by calculating between the 25th and 75th percentile of the large-cap, mid-cap and small-cap funds. The variance should allow us to understand the spread of the funds in that capitalization range.

Spread of US funds and index 15 year performance

Fund Category	25th Percentile (%)	75th Percentile (%)	Index Performance (%)	Difference (%)
Large-cap growth funds	8.82	10.29	10.30	1.47
Large-cap core funds	8.20	9.63	9.92	1.43
Large-cap value funds	8.10	9.60	9.38	1.50
Mid-cap growth funds	9.49	11.39	11.97	1.90
Mid-cap core funds	9.38	10.81	12.00	1.43
Mid-cap value funds	9.15	11.34	11.90	2.19
Small-cap growth funds	10.22	11.61	12.64	1.39
Small-cap core funds	10.00	11.45	12.27	1.45
Small-cap value funds	9.94	11.59	10.17	1.65

From the table above, it can be observed that value funds have the biggest variance when compared to core and growth funds. This is applicable to all capitalization range. Also, at least 75% of funds would underperform the market (Except for large-cap and small-cap value funds).

So, we have looked at the long term performance of funds and their index, possibility of a correlation between size of funds and their performance and the variance of performance of funds in the US market in this post. I hope that it was informative to you as it was tough trying to sort through and make sense of all these data. I realised that this post is limited as I only looked at the US market (Efficient) and hence, there is a need to look at whether these scenarios are applicable to less-efficient market. I will be doing a similar thing to the global, international market (part 3) and emerging markets (part 4).

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