Evaluating Managed Funds

[buffett]

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by the time you have enough years of data to see they are truly skilled and not just lucky, they'll be retired. And if you are trying to find those managers before they have all of the necessary data, you could be wrong and underperorm the benchmark.

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I respectfully disagree. I think it's possible to find good managers early on in their careers, the way Whitney Tilson describes, and I think Ed has done a good job in identifying Fairholme. Lowenstein/Goldfarb have their list of 10, and some of those are plenty young enough to be around for a good while.

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is there still positive alpha after evaluating on the 3-factor model?

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I honestly don't know what you're asking. Could you simplify this for those who may be playing along at home?

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Didn't W. Buffett say that most investors would be better off in index funds during a shareholder letter in the 90s?

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Yes (though I think it was done verbally at an annual meeting or two), and he's absolutely right. I recommend most of my friends and family (that don't have enough assets to hire me) to just go with Vanguard stuff. For the enterprising ones who have a mild-but-not-rabid interest in investing, I suggest Fairholme as the best among many Superinvestor choices.

[Evan]

Ed, I don't know a whole lot about specific funds so I can't give any useful opinions on which are best. As far as sectors though, investing in non-dollar denominated assets is a very good idea imo.

The USD will decline further. There is an attrocious imbalance of trade in America and it cannot go on forever. Furthermore, there is a very, very high probability that the US will default on a portion of it's debt in the near future (read before you retire). The reason for this is the chronic imbalance of trade I talked (that is one that is not going away) about before. The net difference between importans and exports between the US and China is ~$150B annually, and it's not any better with other nations. Basically what this means is that Chinese people work all day to produce goods, export them to America, and get nothing in return but paper; China's economy is starving its own citizens so that we can buy Lexuses, BMW's and more [censored] from Wal Mart. This has been referred to as "the greatest foreign aid scheme of all time," by many economists.

Kent Smetters, former secretary of treasury under Clinton, projected roughly a $44T shortfall on PV of government revenue-government sepending in perpetuity. To put that number in context, that's about 4x the current GDP (also about 3x the market cap of NYSE, AMEX and NASDAQ combined). If we wanted to even this out right now, imagine not eating or comsuming in any way for the next four years. The IMF estimated this number at $60T.

The US government is selling treasuries today with interest it can't afford to pay back, and that problem is only going to get worse in the future. Martin Woolf (who should be a more distinguished economist than myself), in the Financial Times, estimated that the USD will depreciate 40% agains the Yuan. That is an extraordianry figure that's almost impossible to believe.

The results that are being predicted are really just so catastophic that people can hardly believe them. They are so staggering that peopl hardly know what to do. How do you react to a 90% chance that the US will default on its debt? If the numbers weren't as bad I think there'd be a more severe public reaction because people would feel like they could approach it somehow. Right now it seems unmanagable.

I have to run out now, but I'll try to come back later and add more to this.



Edit to note that I didn't have time to read this and it may be a little rough.

[BadBoyBenny]

Ed,

I didn't read the prospectus on Fairholme but my guess is that they try to beat the S&P buying undervalued mid to large caps. If you believe in these guys and this is the case, then I wouldn't worry too much about owning an S&P index, you are essentially trusting these guys to pick the best of the S&P. Kind of reiterating what you just said.

I like the thinking in your last allocation. I put 40% of my 401K contributions into VGTSX. However, I think they are allocated something like 60% into VEURX so by buying them both you may be getting too much of Europe and not enough of the rest of the world.

[jively]

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is there still positive alpha after evaluating on the 3-factor model?

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I honestly don't know what you're asking. Could you simplify this for those who may be playing along at home?

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Ok, I knew that this was jargon and probably too much for a forum like this... Here's a good explantion:

http://www.moneychimp.com/articles/risk/multifactor.htm

-Tom
Edited: added the link

[jively]

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The USD will decline further. There is an attrocious imbalance of trade in America and it cannot go on forever. Furthermore, there is a very, very high probability that the US will default on a portion of it's debt in the near future [...]
The US government is selling treasuries today with interest it can't afford to pay back, and that problem is only going to get worse in the future. [...]
How do you react to a 90% chance that the US will default on its debt?

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Whoa, this is a real doomsday prediction. There have always been "perma-bears" that think things like this, and I suppose there always will be. Y2K had an 80% chance of causing a recession, according to some. Some people moved all their money to gold and moved out in the woods with years supply of food and ammunition!

The bond market is pretty efficient. The bond traders really do analyze a company and sell the bonds that have a high probability of defaulting. GM bonds are rated at BB or somewhere around there, and are not investment grade anymore... GM has some probability of defaulting on some of their bonds. But US treasury bonds still trade at AAA. If there was a 90% chance of default, they would probably be rated in the C's.

Do you know there is a huge trade deficit between New Jersey and Texas? (I actually forget which way though! Doesn't really matter.) The consumers in New Jersey are importing an enormous amount of goods from Texas. It really can't continue!

If the goods are cheaper to make and import from China, that's best for the world economy. It's best for us because we get lower prices. Capitalism works.

The US economy is really, really strong and resilient. It is possible it won't be the strongest economy in the world in 50 years, but bankruptcy is not probable.

-Tom

[rockrock]

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This line would also argue that no one can beat a sportsbook over the longterm. After all, someone is always taking the other side of your bet.

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Terrible analogy.

How many people win at sports betting?

I know several prominent bookmakers offshore and they tell me there are around 10 or so "originators" in all the major sports that are capable of moving the line when they bet (causing the screen to go "black").

The rest of the bettors lose or are followers of the originators (bet slow books that don't move their line when the originators move the market).

The percentage of people that win betting their own opinion is so tiny its pratically non existent. I am referring to sports with plenty of volume like the big 6, soccer, etc.

[rockrock]

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a CFA is worth the money and then some....You don't need a CFA for this...

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I think you mean CFP.
-Aaron, CFA

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No, I meant Chartered Financial Analyst. CFA because it's the most prestigious and therefore most expensive type of advisor. What I said applies to CFPs as well. It can be worth it in some instances.

I'd think books by guys like William Bernstein (Effecient Frontier), Jack Vogle, Swensen from Yale and others would put you guys out of business.

Its clear (to me at least) that the secret is out and out-outperforming once taxes and fees are taken into account is nearly impossible over an extended period of time for mutual funds and "advisors".

[rockrock]

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Ed, my allocation looks a lot like yours, but I am heavier in Foreign markets (35-40%).

This is something to consider as it is a hedge against a major drop in the dollar.

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I haven't read this whole thread, but I suspect this is the best post in it.

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Ok, that's a fair point... my worry when I first constructed it was that I was too heavily invested in US stocks. So how would you change it exactly? How about?

Fairholme - 30%
Vanguard 500 Index Fund Investor Shares (VFINX) - 15%
Vanguard Small-Cap Index Fund Investor Shares (NAESX) - 20%
Vanguard European Stock Index Fund Investor Shares (VEURX) - 20%
Vanguard Total International Stock Index Fund (VGTSX) - 15%

I don't like skimping on Fairholme, though... I think it's quite likely to beat the market less fees (the fees and turnover are modest). Maybe just take out the 500 fund altogether, just letting Fairholme represent the big stuff:

Fairholme - 40%
Vanguard Small-Cap Index Fund Investor Shares (NAESX) - 20%
Vanguard European Stock Index Fund Investor Shares (VEURX) - 20%
Vanguard Total International Stock Index Fund (VGTSX) - 20%

BTW, this is more of a learning exercise than anything else. The actual amount of money in my Microsoft 401k is small (by small, I mean 10% is about the smallest allocation I can make into any fund).

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you need international small cap (VINEX and others) and commodities (PCRIX) because these are low to non correlated, different asset classes than what u have listed.

[rockrock]

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Yes (though I think it was done verbally at an annual meeting or two), and he's absolutely right. I recommend most of my friends and family (that don't have enough assets to hire me) to just go with Vanguard stuff. For the enterprising ones who have a mild-but-not-rabid interest in investing, I suggest Fairholme as the best among many Superinvestor choices.

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What is so super about FAIRX? Run it against IJJ for any time period and tell me why I should be convinced.

I own this fund and wish I didn't but don't want to take cap gains hit by selling. Give me tax advantaged ETFs any day where I don't have to worry about the manager retiring or upping fees or dying.

Its not even close.

[DesertCat]

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is there still positive alpha after evaluating on the 3-factor model?

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The idea that Buffett and the rest of the SuperInvestors are crushing the markets solely because of their higher exposure to small caps and value stocks is kind of silly. You might get an extra 1-2% of annual outperformance that way, not 10-15%.

The key characteristics that these investors have are great judgment and patience. A secondary characteristic is that most eschew running mutual funds, which are structured to sap performance. Those who do run mutual funds usually do so intelligently, i.e. they close before they get too big, which eliminates some of the handicaps.