Investing by the Numbers The Active vs Passive Approach?

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Investing by the NumbersThe Active vs Passive
Approach?
Mark Hebner Index Funds Advisors, Inc.19200 Von
Karman Suite 500Irvine, CA 92612888-643-3133 www
.ifa.com Reference sources can be found at
www.ifa.com and the Index Funds The 12-Step
Program
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0

• Zero the number of active equity managers left
  in the Philip Morris 12.4 billion domestic
  equity pension fund.
• Zero the number of active equity managers left
  in the 36.9 billion Washington State Investment
  Board.
• Zero The mathematical expectation of the
  speculator is zero. Louis Bachelier, The Theory
  of Speculation, 1900

Source Pension and Investments, Aug 9, 1999 May
2001
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1

• 1 out of 28 professionally managed major pension
  funds beat a simple index fund allocation of 60
  SP 500 Equity Index and 40 Lehman Bond Index
  (1987-1993.)

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1

• Dimensional Fund Advisors (DFA) ranks 1 of all
  mutual fund companies, with strong ties to Univ.
  of Chicago academics.
• Eugene Fama ranks 1 out of 44,492 authors of
  academic economic research. He is a Univ. of
  Chicago Economist, CRSP Director, and DFA
  Director of Research. If you dont understand
  his work, someone who does will be taking your
  money.
• Univ. of Chicago ranks 1 in the world for Nobel
  Prizes in Economics (9.)
• Over 1 trillion dollars of index funds are now
  invested in pension plans.

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2

• Only 2 out of 71 (3) mutual fund managers
  outperformed the SP 500 index over 10 yrs in
  taxable accounts.

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3

• 3 risk factors captured in DFA funds explain 95
  of stock market returns, going all the way back
  to 1928.
• 1. Your exposure to the market. Premium 8
• 2. Your exposure to small cap stocks. Premium
  3
• 3. Your exposure to value stocks. Premium 4.5

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4

• Over 10 years, 88 of the return of the SP 500
  was contained in an average of 4 days per year.

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5

• 5 year track records of investment managers offer
  no useful information for investors. You need 20
  years.

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12

• Over the last 74 years, a Small Cap Value index
  had a total return of 12 times the SP 500.
  (27.3 million vs 2.25 million on a 1,000
  investment in 1927.)

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12

• 12-Step Program to Index Funds, the treatment of
  choice for active investors.
• The number of steps used to treat over 31
  different addictions.

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12

• Of the original 500 stocks in the SP 500 in
  1957, 426 were taken off the index and only 12 of
  74 remaining ended up with an index beating
  return. Leaving a 2 chance of picking the stocks
  in advance that beat the average return.

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17

• Over the last 17 years, the SP 500 had a total
  return of about 17 times the average equity
  investor, after inflation. IFA estimates that
  after inflation, taxes, and all related expenses
  the average equity investors actually loses
  money over 17 years.the mathematical
  expectation of the speculator is zero before
  costs.

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19

• The famous Janus and Magellan funds both claim
  SP 500 beating returns. Since about 19 of their
  return went to taxes, they both underperformed
  the index by about 0.5 per year over 15 years,
  in taxable accounts.

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22

• Morningstar says you need 20 years of risk and
  return data to draw statistically meaningful
  conclusions about mutual funds. Of their 11,000
  mutual funds in their database, only 22 managers
  have 20 years tenure. Only 2 have a risk-adjusted
  returns in excess of the SP 500 over the last 10
  years. None beat a global index fund portfolio.

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28

• Since 1961, 28 of mutual funds became dead
  mutual funds. From 1970 to 2000, 41 died.
  Survivorship Bias upwardly skews the results of
  active management by about 1.5 per year.

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30

• The first index fund was created 30 years ago, in
  1971, at Wells Fargo Bank for the 6 million
  Samonsite Luggage Pension Fund.
• US pension and public institutions currently
  index 30 of their US equities.

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35

• Out of 1,466 large cap mutual funds, only 35 beat
  the SP 500 over the last 10 years. A mere 2.4.
  How could anyone identify those funds 10 years
  ago?

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37

• The average investor recently scored 37 correct
  answers on 20 basic investment questions.

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40

• There are 40 books in the ifa library that
  support the passive indexed strategy of capturing
  risk factors and their related returns in the
  most efficient low cost manner.

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50

• A diversified equity portfolio of DFA index
  funds has earned about 17/year for the last 25
  years or growth of 1 to 50.
• SP 500 was up 15.3 over the same period, or
  growth of 1 to 35.

Past performance does not guarantee future
performance. See disclaimer and backtested data
at www.ifa.com
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53

• Over a 15 year period, 53 of the total return of
  actively managed funds go to your silent
  partners. It is only 13 for a total market
  index fund.

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60

• If I have noticed anything over these 60 years
  on Wall Street, it is that people do not succeed
  in forecasting whats going to happen to the
  stock market.
• - Graham, Benjamin, Legendary investor and author

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95

• 95 of market timing newsletters went out of
  business over a 12.5 year period.

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96

• Of the dead mutual funds, the Harwick Fund had
  the worst record. They had a total loss of 96.5.

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99

• "99 of fund managers demonstrate no evidence of
  skill whatsoever."
• - William Bernstein, The Intelligent Asset
  Allocator

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100

• Recent research concluded that stock selection
  and market timing contributed nothing to long
  term returns. 100 of returns are explained by
  asset allocation to appropriate benchmarks using
  index funds.
• 100 of 68 comparable bond funds were
  outperformed by the Salomon World Government Bond
  Fund Index.

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102

• 102 years ago, Louis Bachelier wrote the The
  Theory of Speculation.
• 52 years ago, Harry Markowitz wrote Portfolio
  Selection.
• 39 years ago, Bill Sharpe wrote Capital Asset
  Prices A Theory of Market Equilibrium Under
  Conditions of Risk.
• 12 years ago, Fama/French wrote The Cross-Section
  of Expected Stock Returns.
• These 4 papers explain how the stock market
  really works. Only a very small percentage of
  investors understand them.

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250

• There are 250 academic research papers listed in
  the article database in the library of ifa.com.
  They support the passive indexed strategy of
  capturing risk factors and their related returns
  in the most efficient low cost manner.

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Q and A

• Investing

1. How do I make a return on my capital? Expose
it to risk (engage in capitalism) 2. What is
risk? The possibility of loss. The degree of
probability of such loss is usually specified. 4.
Where do I find risk? The most risk and return
has been found in small and low priced stocks.
(selling close to book value)
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Q and A

• Investing

5. How do I get the highest return for a
specified level of risk? Diversify and passively
hold risk factors captured within multiple index
funds. 6. How much risk exposure should I have?
Measure your risk capacity with the Risk Capacity
Survey.
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Why Index Funds?

• Why invest in a portfolio of index funds?

Because you get Because you avoid
Lower portfolio turnover, taxes, fees and expenses Higher portfolio turnover and the high costs of silent partners in your returns.
Increased Diversification, reduced risk, higher and more reliable returns Low diversification, un-rewarded and higher risk, and lower and less reliable returns.
28 yrs simulated risk and return data on risk factors captured by many of the indexes. Stocks, times, managers and style picking. Highly suspect risk and return data, with very high std error of the mean.
Style Purity, Asset Allocation and risk consistency Style Drift, Asset Allocation and risk drift
Relaxation Stress
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