2017 has started out as a pretty decent year in the markets, with the S&P 500 gaining about 5.5% and the Tech heavy Nasdaq up 9.8%. Bonds were up less than 1% for the quarter and Small Cap stocks were up a mere 2.24%. International markets were the stars of the first quarter with the EAFE index up 7.9% and Emerging markets up 11.59%. Small Caps were the best performing last year and so far the worst this year. Which leads up to our real topic for the quarter, and one I’m sure we’ll discuss again. In fact, there is so much here, this will only be the first part of the discussion.
There has been much discussion on the topic of passive investing versus active investing. What’s our opinion? If you watch or listen to any financial programs you will likely hear a variation of this statistic, “Most mutual funds don’t beat their benchmark.” Usually the number is somewhere around 75% - 80%. So, the conclusion is don’t spend the extra money on an active manager when they likely won’t beat their index. The commentators will usually take it a step further and say, just buy the S&P 500 and forget about it. I’m going to tackle that last part next quarter. For now, let’s stick with passive versus active.
Our view on this is pretty simple: If an actively managed funds looks, feels, and acts like their index, we agree, don’t pay extra for that and just buy that index. Further, if the fund consistently does not beat its benchmark, then why own the fund? But we also flip the numbers around and say that if 75% to 80% don’t beat their benchmark, that must mean that 20% to 25% do beat their benchmark. Simple math, right? So, doesn’t it make sense to try and find those 20%-25% of managers that beat their benchmarks over time? We think it does and we spend a fair bit of time on your behalf trying to find good managers that have a proven process and a discipline to stick to that process. Does that mean they outperform every year? Of course not. That’s like a .300 hitter in baseball, they don’t hit .300 every year, but over the course of their career they do. Same thing is true in the world of finance. On June 25th, 1889 (Jeff was around to hear this speech) Carroll D Wright, a statistician, speaking at a Convention of Commissioners of Bureaus of Statistics of Labor said:
The old saying is that “figures will not lie,” but a new saying is “liars will figure.” It is our duty, as practical statisticians, to prevent the liar from figuring; in other words, to prevent him from perverting the truth, in the interest of some theory he wishes to establish. We can only do this by being absolutely fair ourselves.
What he meant by that is you can make just about any statistic prove or disprove your argument based on the sample that you use or the time frame the you’re using, when in fact we should endeavor not to distort the facts with statistics. The commentators on the financial networks don’t break their figures down, they just give you a headline and if you don’t know any better or don’t have the time or interest to fact check, you just assume that it’s the truth (I will say that I am amused by the financial shows talking about buy the index and forget it, then they immediately discuss why you should own one stock versus another).
To wrap this up, we believe in having our tool box completely full of every tool that we can think of. If the only tool you have is a hammer, every problem looks like a nail. We prefer to have the right tool for the right job. Does that mean that we get things right 100% of the time, no. But, because we have a proven process and the discipline to stick to our process, we (meaning you) will be successful over the long run, even though from time to time we will underperform (not hit .300 in a particular year).
As always, we encourage you to call or email if you wish to have a longer discussion surrounding these or any topics – and certainly we look forward to speaking with you. If you have friends or family that you would like to pass this along to, please do.