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Letters to the Editor

Letters

A thoughtful discussion on whether actively managed mutual funds can outperform passive index funds over the long term.

by AAII Staff | September 2015

Featured Tickers:

Feedback on ETF Guide

Comments posted to “The Individual Investor’s Guide to Exchange-Traded Funds 2015,” by AAII staff, in the August 2015 AAII Journal.

Thanks for the intense list of information on ETFs.
—Robert Reichert from Arizona

The article was very helpful. It would be nice to have some type of historical data on tracking error between indexed ETFs and their index.
—Matthew from Pennsylvania

Long-Term Returns of Index vs. Active Funds

Comment on “Is Outperforming the Market Alpha or Beta?,” by Larry Swedroe and Andrew Berkin, in the July 2015 AAII Journal.

I don’t understand why we investors, for years, have been given the advice from so many financial experts to only invest in index funds and ETFs on the grounds that fund managers cannot beat the market consistently over time. Larry Swedroe and Andrew Berkin repeat this recommendation in their article when they tell us to only invest in passively managed investments.

If we apply some of the contrarian thinking advocated by Ken Fisher to the same issue, and look at actual results, one can see that this advice just doesn’t stand up. After all, the 15-year average return of the S&P 500 is only 4.4% (as of July 24, 2015, and based on Morningstar data). This return is so low that it would be difficult to find any actively managed fund, of any kind, that did not perform better.

Rather than investing only in index funds or ETFs, any investor can create a diversified portfolio that exceeds the returns of the overall market for long periods of time, and with less risk and volatility. One example would be making equal investments in Vanguard Health Care (VGHCX), Vanguard Wellesley Income (VWINX), Homestead Small Company Stock (HSCSX) and Metropolitan West Total Return Bond (MWTRX) funds.
— Murray Manus from Chicago, Illinois

Editor Charles Rotblut, CFA, responds:

With hindsight, it is easy to find actively managed funds that have outperformed the S&P 500 over a given period of time. The challenge is identifying the funds that will beat their respective indexes in the future after factoring in expenses.

Our mutual fund guide (in the February 2015 AAII Journal) includes 285 large-cap funds with at least 10 years of return history. Within this group, just 41% outperformed the Vanguard 500 Index fund (VFINX) over the past 10 years. The “beat” rate is inflated by survivorship bias—it excludes all of the funds that have either been closed or folded into other funds. The number also excludes funds whose performance has caused a large outflow of investment dollars or was never good enough to attract significant interest on the part of investors.

There have been and will be some active managers who will defy the odds and outperform the major indexes in the future. A key common trait they will have, beyond targeting the right asset class or the right sector at the right time, is following a differentiated approach. Such fund managers are out there, but finding them requires effort. Plus, an investor has to have the willingness to stick with the funds when market conditions cause their specific asset classes or strategies to fall out of favor for periods of time.

Corrections to ETF Guide

The first paragraph in “The Individual Investor’s Guide to Exchange-Traded Funds 2015” (August 2015 AAII Journal) incorrectly stated that the ETF industry crossed the $2 billion mark for assets under management. It should have said $2 trillion.

ValueShares was left off the initial listing of ETF fund families on AAII.com. The company’s website is
www.alphaarchitect.com/funds.

Discussion

Jim Cullinan from AZ posted over 10 years ago:

I am interested in AAII thought's on the recent mispricing of ETF's that occurred on 8/24/15. Do investors have any remedies available ?


Charles Rotblut from IL posted over 10 years ago:

Hi Jim, We're not attorneys, so I can't give any legal guidance. Part of the problem with the pricing of ETFs and some stocks was an imbalance of sell orders relative to buy orders. The best way to protect oneself against such occurrences is to not place market orders, especially to be executed at the open of trading, and to avoid using stop orders. The latter will be triggered the moment a stock falls below the specified price, even if just momentarily. We'll have a new article about how trades are executed and how various groups (market makers, high frequency traders, etc.) impact trading in a forthcoming issue of the Journal. -Charles


Ronaldo Jenkins from MD posted over 10 years ago:

Mr. Rotblut, You recently posted an update discussing how an investor can chase higher yield resulting in greater risk and loss of capital to the portfolio. I am interested in identifying metrics or conditions which might indicate dividend cuts by a REIT and dividend paying stock. Do you know of a historical database of firms that have cut their dividends? Obviously, reduced sales and/or earnings can lead to a dividend cut but I hope to study these dividend cutters for common traits. I would appreciate any assistance you can provide on this matter. Thanks for a good article on the dangers of overreaching for a high yield.


Charles Rotblut from IL posted over 10 years ago:

Hi Ronaldo, I have not seen a database or a list of companies that have cut their dividends. This isn't to say that such a database does not exist, only that I'm not aware of its existence. One big risk factor is cash flow. If cash flow from operations and/or free cash flow is negative, the dividend will be at risk of being cut or eliminated. For example, in 2011, JC Penny had free cash flow of -$5.13. In 2012, the company had cash from operations of -$10.0 million and free cash flow per share of -$11.09. The annual dividend went from $0.80 inn 2011 to $0.00 in 2013. I hope this helps, Charles


Doug from NY posted over 10 years ago:

Ronaldo, It ought to be straightforward to catch dividend cuts/reductions via AAII's Stock Investor Pro. As Mr. Rotblut suggests, cash flow declines (which you can also track with SIP) might be a leading indicator for this. I would also think that the prevailing interest rate environment would affect this (when interest rates go down, companies could lower their dividend yields and still be "competitive").


Jane Sink from CA posted over 10 years ago:

I, too, would be very interested in seeing a database of ETFs and/or Index funds results stacked up against the benchmark they are mirroring. Any thoughts?


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