Re-balance Cycle Reminder All MyPlanIQ’s newsletters are archived here.

For regular SAA and TAA portfolios, the next re-balance will be on Monday, October 24, 2016. You can also find the re-balance calendar for 2016 on ‘Dashboard‘ page once you log in.

As a reminder to expert users: advanced portfolios are still re-balanced based on their original re-balance schedules and they are not the same as those used in Strategic and Tactical Asset Allocation (SAA and TAA) portfolios of a plan.

Please note that we now list the next re-balance date on every portfolio page.

Stock Investing: Actively Managed Funds vs. Index Funds

In previous newsletter August 8, 2016: Portfolio Construction Using Stock ETFs And Bond Mutual Funds, we advocate a mixed ETF and mutual fund investment portfolio that uses low cost index ETFs for stock (equity) assets and uses actively managed total return bond funds for fixed income (bond) asset. It drew some questions from several readers. In this newsletter and a follow up one, we will discuss the rationale behind choosing index funds or active funds for stocks and bonds. 

For stock asset classes including US stocks, international stocks, emerging market stocks and REITs, in principle, we prefer using low cost index funds (ETFs or mutual funds). 

Active stock funds rarely outperform index funds consistently

Though it’s been a popular and hotly debated topic on the value of active stock funds, the very first common sense and experience tell us that there have been way too many great stock funds that suffered from sudden downward performance. SEQUX (Sequoia) is one of the recent examples. The following table shows some of recent ‘disgraceful’ funds: 

Performance of some well known actively managed value funds (as of 9/16):
Fund Name YTD
1Yr AR 3Yr AR 5Yr AR 10Yr AR 10Yr Sharpe
SEQUX (Sequoia) -10.8% -26.3% -0.8% 8.1% 5.9% 0.29
LMVTX (Legg Mason Cap Mgmt Value C) 4.1% 6.1% 7.1% 12.9% 1.7% 0.05
FAIRX (Fairholme) -1.0% -12.2% -3.7% 6.9% 4.7% 0.18
LLPFX (Longleaf Partners) 15.3% 11.6% 2.4% 8.6% 3.8% 0.14
TAVFX (Third Avenue Value Instl) 5.8% 4.9% 1.7% 7.3% 2.1% 0.07
DODGX (Dodge & Cox Stock) 7.4% 6.8% 8.1% 14.9% 5.5% 0.22
VFINX (Vanguard 500 Index Investor) 5.8% 9.0% 10.0% 14.1% 7.1% 0.31

See detailed year by year comparison >>

The first two funds are well reported. Fairholme’s Bruce Berkowitz was named as the manager of the year by Morningstar. He was a rising value investing star before 2008. The next three funds are all managed by well known value investors and have been recognized for a long period of time. Not only these funds underperformed Vanguard S&P 500 (VFINX), they underperformed by a big margin: as high as 5.4% difference!

We also took a task to look at the performance of the domestic (US) stock funds whose managers won at least once the covet Morningstar’s manager of the year award. The following table shows the funds whose managers won the award before year 2000. 

Performance Comparison of Funds That Won Morningstar’s Manager of The Year (as of 9/16/2016):
Fund Name YTD
1Yr AR 3Yr AR 5Yr AR 10Yr AR 10Yr Sharpe
FKACX (Franklin Growth Opportunities C) -1.7% -3.4% 7.2% 10.8% 7.7% 0.3
VIGRX (Vanguard Growth Index Inv) 4.7% 6.4% 10.7% 14.0% 8.6% 0.39
FMAGX (Fidelity Magellan) 1.6% 4.3% 10.0% 13.5% 5.6% 0.22
TAVFX (Third Avenue Value Instl) 5.8% 4.9% 1.7% 7.3% 2.1% 0.07
PRNHX (T. Rowe Price New Horizons) 7.6% 5.8% 9.4% 16.7% 11.4% 0.47
FPPTX (FPA Capital) 8.4% -0.1% -2.1% 3.7% 5.0% 0.21
SKSEX (Skyline Special Equities) 4.3% -0.7% 5.3% 15.3% 7.4% 0.27
NAESX (Vanguard Small Cap Index Inv) 9.0% 5.7% 7.3% 13.6% 8.0% 0.3
NYVTX (Davis NY Venture A) 4.3% 5.7% 7.7% 12.2% 5.3% 0.21
GABAX (Gabelli Asset AAA) 6.5% 4.9% 4.7% 10.8% 7.2% 0.32
YACKX (Yacktman Svc) 6.8% 10.8% 5.7% 10.7% 9.6% 0.5
CFIMX (Clipper) 6.2% 9.6% 10.0% 13.3% 5.2% 0.21
VFINX (Vanguard 500 Index Investor) 5.8% 9.0% 10.0% 14.1% 7.1% 0.31

*: NOT annualized

**YTD: Year to Date

See detailed year by year comparison >>

Notice that some funds have different styles and should be compared with their respective benchmarks (highlighted). For example, PRNHX (T. Rowe Price New Horizons) is a small cap stock fund and it should be compared with Vanguard Small Cap Index (NAESX). 

These funds are the who’s who in mutual fund industry in the last 20 to 30 years, long enough for a generation of investors to have patience in them. However, the majority of them have vanquished or underperformed significantly. 

Again, this table shows it’s hard to maintain consistent outperformance. 

Larry Swedroe has written a series of articles on the persistence of outperformance of actively managed stock funds by looking at many well known funds’ performance. Interested readers can read his latest one Are the Returns of Jeremy Siegel’s “Superstar” Funds Likely to Persist?

Risk (stock) funds are heavily influenced by sectors and styles

The other problem with active stock funds is so called ‘disappearing alpha’: their performance is mostly influenced by their so called factor weights instead of individual stock picking ability. In academic study, Fama and French’s 4 factor model is the most famous. Basically, it states that the performance of a stock fund can be mostly explained (or decided) by the following factors: 

  • Beta or market exposure: how much correlated with a broadbase market index (such as S&P 500)
  • Size: large capitalization or mid cap or small cap of a stock
  • Value: how expensive a stock is (value stocks vs. growth stocks)
  • Momentum: the recent price performance 
A famous example is CGMFX (CGM Focus). The fund had a fantastic run before 2008, averaging 23.5% annually since its inception in 1997. It outperformed S&P 500 by a large margin (see the following picture). At times, investors were attracted by the fund’s stock picking ability. But a more elaborate analysis reveals that the outperformance was mostly due to its timely and outsized bets on various sectors. To some extent, it was more a sector rotation fund. 

Unfortunately, just like other popular stock funds, this fund has lagged seriously since then: 

Performance Comparison (as of 8/31/2016):
Ticker/Portfolio Name YTD
1Yr AR 3Yr AR 5Yr AR 10Yr AR 10Yr Sharpe
CGMFX (CGM Focus) -7.8% -12.1% 1.3% 5.1% 2.4% 0.05
VFINX (Vanguard 500 Index Investor) 7.7% 13.7% 12.0% 14.6% 7.4% 0.33


Though it’s not totally impossible, it’s a very tough task to pick a long term active stock fund winner. Furthermore, based on the above discussion, even if one wants to actively pick a near or intermediate term winner, it might be better off to work on a list of style or sector index funds and rotate among them, instead of picking from actively managed stock funds. For style/sector fund rotation, interested readers are referred to July 27, 2015: Performance Dispersion Among Momentum Based Portfolios. This is MyPlanIQ’s guiding principle when constructing an investment plan. 

Market Overview

As we have warned many times, stocks and bonds retreated meaningfully in the last two weeks. Investors seem to adopt a wait and see attitude. Near term, markets are very much hinged on this Wednesday’s Federal Reserve decision on interest rate. However, in the current high valuation and weak fundamental environment, market loss can be triggered by many other factors. We will just have to react accordingly by following our chosen strategies. Again, this is not a time to be aggressive. 

For more detailed asset trend scores, please refer to 360° Market Overview

We would like to remind our readers that since the financial crisis in 2008-2009, we have not seen substantial structural change in the U.S., European and emerging market economies. Economies have heavily relied on low interest debts. Capital might be misallocated to unproductive investments and consumption. U.S. stock valuation is at a historically high level. It is thus not a good time to take excessive risk. However, we remain optimistic on U.S. economy in the long term and believe much better investment opportunities will arise in the future. 

We again would like to stress for any new investor and new money, the best way to step into this kind of markets is through dollar cost average (DCA), i.e. invest and/or follow a model portfolio in several phases (such as 2 or 3 months) instead of the whole sum at one shot. 

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