A few days ago (June 22, 2009) The Wall Street Journal ran an article (“Active Managers Get the Cold Shoulder”) that indicated that large, institutional investors are moving away from active managers.
In a bear market, active managers are supposed to protect investors from losses. However, a growing body of data indicates that these managers have not been able to provide this shelter. The executive director of the Illinois State Board of Investment noted, “Active managers have not given us the added performance in a down market that we had hoped for.” The board recently moved $400 million from some large and small cap stock managers to index funds.
There is $2.3 trillion in public pension plans. A large and growing portion of these funds are passively managed. These funds are able to hire very bright investment talent. The movement towards passive management is a very strong indicator that active management simply fails to deliver consistent long term returns that are greater than the unmanaged market delivers.
You don’t have to be an institutional investor to invest passively. CWM offers low cost passive investment management to the retail investor. We call it “Intelligent Investing” and we encourage you to explore it.
Saturday, June 27, 2009
Thursday, June 11, 2009
Fat Tail Distributions
I received an email newsletter today from a vendor that sells financial planning software to advisory firms like Cascade Wealth. This particular company is Money Tree Software and it is located in Corvallis, Oregon. While we are not currently using their software, I have in the past.
This email caught my attention, because it mentioned Monte Carlo Analysis. You may recall from one of my prior blog postings, this is the methodology used to test the probability of outcomes. Financial Planners often use Monte Carlo simulations to determine how likely clients are to reach their financial objectives.
The recent stock market crash has caused some advisors to question the reliability of traditional Monte Carlo Analysis. The problem is that these projections rarely show major market declines. The reality, as well all know, is that dramatic market drops are not only possible, but they actually occur. We have witnessed two of these periods in the last decade alone in the tech crash in the early 2000’s and the financial sector meltdown in 2008.
Money Tree plans to enhance its software by incorporating wider distribution patterns in their Monte Carlo simulations. This means that events considered statistically very unlikely to occur will be included in their simulations. If you have ever taken a statistics class, you may remember that a normal distribution curve looks like the graph below. It displays the outcomes that occur when the pattern of distributions is symmetrical with a single, central peak at the mean (or average) of the data. Half of the outcomes fall on each side of the mean.
The spread or dispersion of the outcomes is dictated by the standard deviation. In the graph below of a normal distribution, we can expect that 68.2% of the events will fall between -1 and 1. Only 1.5% of events will fall below at -2.5 or lower.
What would this graph look like if we assumed that more outcomes occurred towards the ends of the graph and fewer near the middle or mean? The tails would become thicker. The midrange would become thinner. This is sometimes described as a “Fat Tailed” distribution.
By giving greater statistical weight to the possibility that market returns could fall outside the traditional range, Money Tree’s software will reduce the probability that a given client scenario will succeed. This should motivate the planner and the client to make more conservative assumptions.
This email caught my attention, because it mentioned Monte Carlo Analysis. You may recall from one of my prior blog postings, this is the methodology used to test the probability of outcomes. Financial Planners often use Monte Carlo simulations to determine how likely clients are to reach their financial objectives.
The recent stock market crash has caused some advisors to question the reliability of traditional Monte Carlo Analysis. The problem is that these projections rarely show major market declines. The reality, as well all know, is that dramatic market drops are not only possible, but they actually occur. We have witnessed two of these periods in the last decade alone in the tech crash in the early 2000’s and the financial sector meltdown in 2008.
Money Tree plans to enhance its software by incorporating wider distribution patterns in their Monte Carlo simulations. This means that events considered statistically very unlikely to occur will be included in their simulations. If you have ever taken a statistics class, you may remember that a normal distribution curve looks like the graph below. It displays the outcomes that occur when the pattern of distributions is symmetrical with a single, central peak at the mean (or average) of the data. Half of the outcomes fall on each side of the mean.
The spread or dispersion of the outcomes is dictated by the standard deviation. In the graph below of a normal distribution, we can expect that 68.2% of the events will fall between -1 and 1. Only 1.5% of events will fall below at -2.5 or lower.
What would this graph look like if we assumed that more outcomes occurred towards the ends of the graph and fewer near the middle or mean? The tails would become thicker. The midrange would become thinner. This is sometimes described as a “Fat Tailed” distribution.By giving greater statistical weight to the possibility that market returns could fall outside the traditional range, Money Tree’s software will reduce the probability that a given client scenario will succeed. This should motivate the planner and the client to make more conservative assumptions.
Thursday, June 4, 2009
Going Passive in Europe
If you hold a position on a subject that places you in the minority, it’s pretty nice when someone of substance enters the dialogue and supports your view. After investing hundreds of hours researching investment management, I am convinced that you, the investor, are best served by deploying your hard earned money in a low cost, passively managed portfolio. Unfortunately, the overwhelming majority of investment advisors would have you invest in an actively managed portfolio in attempt to capture returns that are greater than those of the broader markets.
This week in The Wall Street Journal, I came across an article that caught my attention, “In Europe, Are ‘Active’ Managers Worth It?” (June 3, 2009). Apparently European pension funds are questioning whether the performance they have experienced warrants the fees they pay firms to manage their assets. The Norwegian government recently dropped 16 of the 22 firms that managed its fixed income funds. Most of these firms practice active management and they all suffered substantial losses last year.
The governments of Italy, Holland, and Sweden have also shifted away from active management of their pensions. These countries are reducing fees and seeking better performance by shifting investments to passively managed funds. In the U.S., the California Public Employee Retirement System, one of the largest pensions in the world, has historically relied on passive investing in its publicly traded equity portfolio.
Those who advocate active management claim the strategy will minimize losses in a down market. However, as performance data become available, the record is showing that this did not happen during the recent stock market crash.
These massive pension funds are run by some of the smartest people in the global investment community. Their decisions to move away from active management serve to validate passive management.
If your portfolio is not currently passively managed, perhaps it’s time consider a change.
This week in The Wall Street Journal, I came across an article that caught my attention, “In Europe, Are ‘Active’ Managers Worth It?” (June 3, 2009). Apparently European pension funds are questioning whether the performance they have experienced warrants the fees they pay firms to manage their assets. The Norwegian government recently dropped 16 of the 22 firms that managed its fixed income funds. Most of these firms practice active management and they all suffered substantial losses last year.
The governments of Italy, Holland, and Sweden have also shifted away from active management of their pensions. These countries are reducing fees and seeking better performance by shifting investments to passively managed funds. In the U.S., the California Public Employee Retirement System, one of the largest pensions in the world, has historically relied on passive investing in its publicly traded equity portfolio.
Those who advocate active management claim the strategy will minimize losses in a down market. However, as performance data become available, the record is showing that this did not happen during the recent stock market crash.
These massive pension funds are run by some of the smartest people in the global investment community. Their decisions to move away from active management serve to validate passive management.
If your portfolio is not currently passively managed, perhaps it’s time consider a change.
Subscribe to:
Posts (Atom)
