Monday 17 September 2012

Index tracking strategy a good one?

Question
I am a great admirer of your website and independent opinions.

In todays volatile markets many people (like myself) are struggling to maintain the value of their investments and provide some sort of investment income/capital growth. Obviously cash deposits now loose money in real terms. There are many theories of how to do this through investments. The problem is sorting out the pressurised sales literature fiction from actual facts. I have narrowed down three areas of interest and would value any opinion on them:-

1. www.saltydoginvester.com. This is a subscription service which provides weekly online updates on performance of unit trusts, all divided up into different segments related to risk which extends backwards historically. There are a lot of figures! They also run their own portfolio which is reviewed and explained weekly and in a monthly newsletter. Their portfolio seems to have been successful in avoiding downward dips, where they have transfered into a money fund. The idea is that you can follow emerging trends by using a platform provider like Hargreaves Lansdown and make sales and purchases at very little cost or effort on line. The basis of the scheme's theory appears to mirror the Jesse Livermore investment rules of momentum trading, which means you only ever buy on a rising market, you do not implement any investments/segmented ideas until the market has confirmed by going up. etc, etc. You have to act decisively once you have spotted a trend!
Although this man Livermore was a legendary and incredibly successful investor over 30 years, his wealth se-sawed up and down and he eventually committed suicide, which is a little worrying.........
The other fly in the ointment is the forthcoming changes in investment commissions and 'trail' commissions.

2. www.monkeywithapin.com This is a website written and hosted by Peter Comley who has a degree in psychology. It is free. It contains an interesting and seemingly academic book 'Monkey with a pin' (which you can dowload and print) This book draws attention to some uncomfortable opinions/conclusions regarding investment managers and how the costs are hidden and the returns magnified by using doubtful stats. and selected time periods. He also draws attention to experiments that suggest that a monkey with a pin can probably outperform star investment managers! 'Buy and hold'' is no longer a good policy due to extreme volatility. He also says that humans are not 'hard wired' to make investment decisions successfully due to their inability to sell at a loss, etc etc.

If the best investment managers are so prone to making mistakes eventually and monkeys can out-perform them, what about tracker funds:-

3. Vanguard Investments and in particular their FTSE Equity Income range, which contain a selection of equity income shares of companies that are yielding a handsome dividend income because they are stolid and huge, like utility companies, etc and also some companies who seemingly yield a good dividend income simply because the market believes they are either boring, non growth or in trouble and have consequently marked their share price down (investing there goes against the Jesse Livermore rules though!)
They have quite a big range of other trackers.
Vanguard Group have commissioned a paper summarising the findings into active investment managers results compared to passive investment which is available on their website.
Of course - need I say - the passive strategy comes out as best and this seems to be confirmed when you compare active fund managers performance and they say that investing is a 'zero sum' game with equal losers and winners. Are these funds real shares or derivatives?
There is a 0.5% purchase fee as well as charges from Hargreaves.Answer
Thanks for a very interesting question.

I've recently written an article including a look at Saltydog Investor here. It's certainly worth a look if you believe in momentum investing and have the time/inclination to make frequent fund switches within your portfolio. But it doesn't particularly suit income seeking investors and you'll probably want to use a fund platform that doesn't charge dealing/switching for funds, else the costs of frequent switching could soon pile up.

The Monkeywithapin website/book makes some valid points. The main conclusion isn't surprising - the majority of active fund managers are simply not very good. I include a random stock pickers (i.e. monkeys) versus active managers comparison on our tracker fund page. And yes, the monkeys tend to fare well.

While the monkeys comparison is a good advert for tracker funds, we mustn't forget tracker funds charges, which pretty much guarantees they'll fail to beat the index (unless their tracking error is consistently positive). So it's important to consider low cost trackers that accurately mirror the chosen index.

It's also important to consider underlying assets when having the tracker versus active manager debate. Some assets just doesn't lend themselves to tracking, for example physical commercial property - there's no practical way to artificially track a portfolio of office blocks and retail parks. It is possible to track indices of property companies (e.g. REITs), but these tend to be more correlated to stock markets losing some of the diversification benefits of property.

Vanguard offers a low cost range of tracker funds (which buy shares, not 'artificial' derivatives), but rather shoots itself in the foot with a £100,000 minimum investment if you want to buy direct. The funds are currently available via four fund platforms, Alliance Trust Savings, Bestinvest, Hargreaves Lansdown and Sippdeal - but each route incurs extra platform fees of some sorts.

In my view (echoed by my portfolio) a mix of trackers and actively managed funds is a sensible approach, using trackers for mainstream assets/markets and active managers for more specialist areas. It still backfires sometimes, but on the whole it works well.

Read this Q and A at http://www.candidmoney.com/questions/question708.aspx

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