Is investing internationally using index funds generally known to be a bad idea? My inclination is to favor index funds - lower fees, less style drift. They seem more predictable.
McClung has me second guessing this perspective. I am trying to understand the portfolios suggested in Living Off Your Money. For these asset classes, he chooses actively managed funds as samples:
Intl. Large Value
Intl. Small
Intl. Small Value
Emerging Markets - Small
Emerging Markets - Value
Examining Intl. Large Value - he suggests VTRIX - 0.38 expense ratio. They just had a sub-advisor swap, which an analyst says shifts the style towards the value/blend border of the style box. I see VEA - 0.05 expense ratio. It is slightly more of a large blend style, but seems pretty comparable. I couldn't find a more similar index fund.
Examining Intl. small - he uses VINEX as one choice (0.41 expense ratio), but it has drifted to a mid-growth style. The other option he offers is indexed - VFSAX (0.16 expense) - even that has drifted to more of a mid-blend. But, the index fund is much closer to the intended asset class.
At the extreme end, for emerging markets, he doesn't pick any indexed funds. I can guess that more screening would be needed here and automating it might be prone to failure. But maybe there is a reasonable index approach? ***Edit - re-reading, I see McClung splits the emerging funds evenly - one focuses on value, the other on small. He cites the small and value factors identified by Fama and French for developing markets, as reasoning. There are emerging market index funds, but they tend towards large blend/growth.
I think people here are very knowledgeable about investing AND can avoid rehashing an active vs. passive debate. I am trying to understand if there is something special about active management for international funds. I am new to thinking about this stuff. Maybe it barely matters, maybe there is an obvious answer.
***Edited to clarify emerging markets.
Investing Internationally - Active Funds vs. Index Funds
Re: Investing Internationally - Active Funds vs. Index Funds
Imo there is, but I wouldn't trust a manager with it either.
Local expertise might be crucial when investing in high-fraud environments like China, India, etc. Political risk expertise might be crucial when dealing with places like Russia and the Middle East. In general, when it comes to intl markets, I think it's sus how e.g. with companies like BABA etc. you don't actually own shares, you own drawing rights or whatever ADRs stands for. If the CCP wakes and it's in the wrong trouser leg, you're toast. I would probably trust index funds when it comes to australia, nz, canada, japan, and the eu. south africa, maybe? but when it comes to EM, a manager with dedicated expertise might be worth their money -- IF they actually do possess and exercise said discipline, and that's a big if. As a western investor, one generally has little solid knowledge on the basis of which to evaluate claims to expertise.
Local expertise might be crucial when investing in high-fraud environments like China, India, etc. Political risk expertise might be crucial when dealing with places like Russia and the Middle East. In general, when it comes to intl markets, I think it's sus how e.g. with companies like BABA etc. you don't actually own shares, you own drawing rights or whatever ADRs stands for. If the CCP wakes and it's in the wrong trouser leg, you're toast. I would probably trust index funds when it comes to australia, nz, canada, japan, and the eu. south africa, maybe? but when it comes to EM, a manager with dedicated expertise might be worth their money -- IF they actually do possess and exercise said discipline, and that's a big if. As a western investor, one generally has little solid knowledge on the basis of which to evaluate claims to expertise.
Re: Investing Internationally - Active Funds vs. Index Funds
It seems this isn't a unique question.
The best I can gather - as you reduce market efficiency, it is more likely an active manger can offer value. Riding the efficient frontier via indexing becomes harder to do. I'm concluding at the Intl. Large Value and Intl. Small level, favoring the index fund is probably no worse. At the international small value and emerging markets level, especially given McClung's style split for emerging, the active management is probably needed.
A couple links:
https://www.morningstar.com/articles/60 ... or-passive
https://www.bogleheads.org/forum/viewtopic.php?t=252779
The best I can gather - as you reduce market efficiency, it is more likely an active manger can offer value. Riding the efficient frontier via indexing becomes harder to do. I'm concluding at the Intl. Large Value and Intl. Small level, favoring the index fund is probably no worse. At the international small value and emerging markets level, especially given McClung's style split for emerging, the active management is probably needed.
A couple links:
https://www.morningstar.com/articles/60 ... or-passive
https://www.bogleheads.org/forum/viewtopic.php?t=252779
Re: Investing Internationally - Active Funds vs. Index Funds
I've since learned:
1. In the case of McClung's emerging market and Intl. small value funds, I was confusing a passive fund following structured investment rules, with an active fund. Not the same. I made my assumption based upon higher expense ratios. I was wrong.
2. I was incorrectly grouping Wisdom Tree ETFs under the family of funds offered by Dimensional Fund Advisors (DFA). I confused myself, because one of the alternate funds I found on MorningStar, was a DFA fund. McClung wasn't pushing DFA. That's good, because I do not have access to buy DFA funds.
1. In the case of McClung's emerging market and Intl. small value funds, I was confusing a passive fund following structured investment rules, with an active fund. Not the same. I made my assumption based upon higher expense ratios. I was wrong.
2. I was incorrectly grouping Wisdom Tree ETFs under the family of funds offered by Dimensional Fund Advisors (DFA). I confused myself, because one of the alternate funds I found on MorningStar, was a DFA fund. McClung wasn't pushing DFA. That's good, because I do not have access to buy DFA funds.
Re: Investing Internationally - Active Funds vs. Index Funds
Check out Driehaus's funds. Driehaus seems extremely intelligent and they focus a lot on EM active management.
Total return of Driehaus EM growth vs. iShares Emeging Markets
https://stockcharts.com/freecharts/perf.php?DREGX,EEM
Total return of Driehaus EM small cap vs. iShares EM Small Cap
https://stockcharts.com/freecharts/perf.php?DRESX,EEMS
Caveats:
-Past performance is no guarantee of future results
-Though the charts show total returns (with dividends reinvested), I'm not 100% sure if they are showing gains after fees (I think they are)
-After this bull run, I would expect the Driehaus drawdown to be equal to or greater than the iShares drawdowns
-Like any other fund, you're going to be highly correlated with the index no matter what. A fund would have to have a very small AUM or employing an unconventional trading strategy to have a chart that looks very different than the index.
Total return of Driehaus EM growth vs. iShares Emeging Markets
https://stockcharts.com/freecharts/perf.php?DREGX,EEM
Total return of Driehaus EM small cap vs. iShares EM Small Cap
https://stockcharts.com/freecharts/perf.php?DRESX,EEMS
Caveats:
-Past performance is no guarantee of future results
-Though the charts show total returns (with dividends reinvested), I'm not 100% sure if they are showing gains after fees (I think they are)
-After this bull run, I would expect the Driehaus drawdown to be equal to or greater than the iShares drawdowns
-Like any other fund, you're going to be highly correlated with the index no matter what. A fund would have to have a very small AUM or employing an unconventional trading strategy to have a chart that looks very different than the index.
Re: Investing Internationally - Active Funds vs. Index Funds
I appreciate the suggestions.
The portfolio I am trying to implement is built around a small and value tilt. These funds fall in the mid-large growth style boxes. Revealing my passive bias, the expense ratios and turnover also put me off. I'm not ready for the total 180 yet
.Re: Investing Internationally - Active Funds vs. Index Funds
Active funds get generally outperformed by passive investing (index funds, etfs, buying yourself a large amount of stocks and having passive management, etc).
AND the active funds that for a few years are able to outperfom the passive ones are generally unable to replicate that performance.
So not only the majority underperform for any given year, but those who are able to outperform cannot consistently do so.
This has been empirically verified.
Thus yeah i think you should stick with more passive approaches.
I myself hold a globally diversified passive etf.
AND the active funds that for a few years are able to outperfom the passive ones are generally unable to replicate that performance.
So not only the majority underperform for any given year, but those who are able to outperform cannot consistently do so.
This has been empirically verified.
Thus yeah i think you should stick with more passive approaches.
I myself hold a globally diversified passive etf.
Re: Investing Internationally - Active Funds vs. Index Funds
There is some evidence that as you point out there is a preferential advantage of smaller trades spaces for active adding more - bonds, EM etc. My concern though would be trust and style drift. If a new manager took over if they decide to now do x chasing whatever the latest x is to increase AUM etc.
Will this be in tax advantages space or taxable accounts? In other words consider how locked in you might become.
The other point that is above my knowledge level is that the best chance of beating the market might be in truly lightly traded areas if you wanted to ever be completely DIY. But EM requires very specialized knowledge of government markets etc So YMMV
Will this be in tax advantages space or taxable accounts? In other words consider how locked in you might become.
The other point that is above my knowledge level is that the best chance of beating the market might be in truly lightly traded areas if you wanted to ever be completely DIY. But EM requires very specialized knowledge of government markets etc So YMMV
Re: Investing Internationally - Active Funds vs. Index Funds
My problem was viewing active and passive management as polar opposites, rather than recognizing they exist on a spectrum. There's a zone between "I trust this guy completely" and "buy all the things". A fund can have structured investment rules, implemented by the fund manager, that are not as simple as "buy the index". They could have a small or value tilt, filter out penny stocks, etc.
Taking WisdomTree's Emerging Markets SmallCap Dividend Index as an example:
The WisdomTree Emerging Markets SmallCap Dividend Index is a fundamentally weighted index that measures the performance of primarily small cap stocks selected from the WisdomTree Emerging Markets Dividend Index. Companies included in the Index fall within the bottom 10% of total market capitalization of the WisdomTree Emerging Markets Dividend Index as of the annual index measurement date. Companies are weighted in the Index based on annual cash dividends paid.
So as an investor, I am picking a passive fund that introduces assets with the factors I desire (emerging, value, small) into my portfolio. I might do that because I believe emerging has lower correlation with my other holdings. Or maybe I believe there is a risk premium available on small and value, allowing me to reduce the weight of equities in my portfolio, for the same expected return.
Is this actively investing? Or just reasonable portfolio construction? I dunno. Somewhere on a continuum, definitely closer to passive than active. Totally different than "I like the stock" or "Buffet always wins". I've seen some sources refer to it as factor investing.
Taking WisdomTree's Emerging Markets SmallCap Dividend Index as an example:
The WisdomTree Emerging Markets SmallCap Dividend Index is a fundamentally weighted index that measures the performance of primarily small cap stocks selected from the WisdomTree Emerging Markets Dividend Index. Companies included in the Index fall within the bottom 10% of total market capitalization of the WisdomTree Emerging Markets Dividend Index as of the annual index measurement date. Companies are weighted in the Index based on annual cash dividends paid.
So as an investor, I am picking a passive fund that introduces assets with the factors I desire (emerging, value, small) into my portfolio. I might do that because I believe emerging has lower correlation with my other holdings. Or maybe I believe there is a risk premium available on small and value, allowing me to reduce the weight of equities in my portfolio, for the same expected return.
Is this actively investing? Or just reasonable portfolio construction? I dunno. Somewhere on a continuum, definitely closer to passive than active. Totally different than "I like the stock" or "Buffet always wins". I've seen some sources refer to it as factor investing.