beliavsky[at]aol.com wrote:
- quote -

B-
I think these are some serious limitations. The big one to me is the
changing correlations among asset classes, and the resulting instability
of the efficient frontier. I think it introduces uncertainties that call
into question the necessity of applying the concept with any precision.
I think it's a bit like the supply-demand curves in econ
101...instructive, but god forbid we try to reduce them to equations.

And my intuition says there's no good reason why, for example, REITs and
growth stocks should have a certain relationship in their pricing. I can
see buying both for diversification purposes, but setting the
allocations based on historical relationships seems a tenuous proposition.

Another flaw, to me, is the focus on volatility, which probably is not
of primary interest to the typical individual investor, at least not the
ones I've met.

I also just don't like heavily mathematical approaches to problems that
I think involve so many "soft variables" and extenal factors whose
variability cannot realistically be modeled. I'm thinking of things like
the intermittent fascination of investors with growth stocks, changing
tax policies, and cross-border macroeconomic factors. Specifically to
the three-factor model within MPT, I'm not convinced that book value and
risk are really related the way the theory says they are.

I guess I'd say that I was a quant in fluid dynamics but in the stock
market...the math to me relies on some shaky assumptions that make me
question whether it's a good application.


- quote -

Again I think it's good to take away the lessons from MPT - which
illustrates the rewards of diversification and in a sense defines what
"asset classes" are (eg they're not "technology" or "growth and
income"). That in itself is a major (and I think non-obvious) contribution.

But my preferred allocations hinge on some more subjective factors that
are rooted in my beliefs about the underlying investments, rather than
on the existence of an "efficient frontier." For example I favor value
stocks not because I buy into the risk argument or the effect on the EF,
but because I think it helps investors avoid the fluff in the market
that's being hyped by Wall Street. And I do active management with
mostly value stocks because I think there are opportunities there. But I
couldn't defend those choices on MPT terms, not by a long shot.

And factors like "buying home in two years" trump anything MPT is going
to say about how to invest the money.

-Tad

"Will Trice" <wwtrice[at]paragondynamics.com> wrote
snip forbrevity two good citations; thanks Will!
- quote -

But I do agree the trend is persuasive. It deserves emphatic mention
anytime a newby comes asking.

Elle wrote:

- quote -

Two specific cites that I got were:

Mutual Fund Performance: An Empirical Decomposition into Stock-Picking
Talent, Style, Transaction Costs, and Expenses
(http://www.smith.umd.edu/faculty/rwermers/mutuals.pdf)

and

Is Money Really “Smart”?
New Evidence on the Relation Between
Mutual Fund Flows, Manager Behavior,
and Performance Persistence
(http://www.smith.umd.edu/faculty/rwermers/persist.pdf)

Both the first paper listed above and Moody's website cite a Carhart
1997 paper: "Carhart (1997) finds that net returns are negatively
correlated with expense levels," but I have been unable to find this
paper on the net. The full cite is Carhart, Mark, 1997, On persistence
in mutual fund performance, Journal of Finance 52, 57–82.

- quote -

People can and do argue this. But another person can usually find a low
expense fund that beats the high expense fund. Still doesn't prove
anything.

-Will

"Will Trice" <wwtrice[at]paragondynamics.com> wrote
- quote -

Will, which paper from the above do you particularly favor? There are many,
and the site itself takes a long time to load on a modem connection.

- quote -

A few excerpts, which seem typical of this site to me:

----
"Companies who tend to charge under 1% [fees] seem to have generally done
better than those who charge more than 1%."

"Costs matter: (NY Times) In the first half of 2004, a majority of actively
managed equity funds underperformed the stock indexes they are supposed to
beat.

Standard & Poor's, which conducted the study, found that only 37 percent of
actively managed large-cap funds beat the Standard & Poor's 500-stock index
of large stocks through June. Fewer than 43 percent of midcap funds beat
the S.& P. 400 midcap index. And only 10 percent of small-cap funds beat
the S.& P. 600 index of small stocks."
-----

I don't like the top caption on the table at the beginning. It says "The
SEC has found that for each percentage point of increased expense level in
a fund, its annual return drops not just 1%, but 1.9%." I suspect the
authors mean "on average." It's a bit misleading.

People can bombard, but I think a shotgun approach isn't the same as a
silver bullet. A "slam dunk" would be nice, but it's just not there. A
person can easily argue, "but I'm only going to be in this high expense
ratio fund for a year, and its past five years of returns beat
such-and-such lower fee fund... "

Nonetheless, I continue to endorse low expense ratio index funds on
principle and, sure, because of some of the evidence presented to me in
this thread.

Elle wrote:
- quote -

Hey Elle,

I made the same assertion as you back in December and was bombarded by
citations. You may want to check out these webstites:

http://www.smith.umd.edu/faculty/rwermers
http://www.efmoody.com/investments/fundexpenses.html

-Will

I note that until March 1, 2005, a short 5 days ago, Fidelity charged the
same $10.00 fee. You may wish to note that the Vanguard fee is waived if
total assets exceed $50,000 regardless of any individual fund holding. This
applies not to just an individual's holdings, but to those of a household.

Elizabeth Richardson


"Elle" <elle_navorski[at]nospamearthlink.net> wrote in message
news:eflWd.1492$oO4.657[at]newsread3.news.pas.earthlink.net...
- quote -

For example, for VFINX, the Vanguard S&P 500 index fund, an "account
maintenance fee of $2.50 a quarter is charged if the VFINX balance falls
below $10,000. For a $5000 investment in VFINX, this may be said to raise
the expense ratio from 0.18% to 0.38%. Now I know Fidelity, for one, has
something similar. OTOH, Fidelity has permanently lowered its ER to 0.1% .

At misc.invest.mutual-funds, examples such as VGHCX are raised. A 1%
"early" redemption fee is applied if shares are sold before five years.

Also, just for another quick example, go to Vanguard and look up VGHCX, and
note their various "IRA Custodial fees."

Vanguard has much to offer, and I do recommend it to many people, but it is
not to me the hands down winner for low cost mutual funds any longer. It
depends on the specific consumer's needs.

"Elizabeth Richardson" <erichktn[at]worldnet.att.net> wrote
- quote -

You snipped the part where I wrote that www.ifa.com (via Dimensional
investments) offers a small cap EM index fund.

Re international bond funds, which Vanguard appears not to have: I think
we'd have to identify specific ones to discuss this intelligently.

My point is that while Vanguard may have everything _you_ want, this may
not be so for others.

<beliavsky[at]aol.com> wrote
snip
- quote -

snip
- quote -

Just curious: Are you aware of the claimed accuracy of the results of
algorithms that use the principles you indicate below?

I know software is available or can be easily designed that
follows the tenets of the latest Markowitz or Harvey "theorem." It should
spew out suggested portfolio allocations, factoring in the investor's years
to retirement and maybe some other particulars. The results might be
something like 40% S&P 500, 20% long-term high grade bonds, etc.

Given the historical variation in returns of each asset class, surely there
is a margin of error of some kind associated with each suggested
percentage. On about what order would this be? E.g. is the S&P 500
allocation more accurately given as 40% +/- about 10%?

One of the reasons I haven't spent time reading the minutiae of Markowitz,
Modern Portfolio Theorists, etc. is because the underlying assumptions seem
to me to be so enormous. The only practical value their work may have is in
providing very general guidelines.

<beliavsky[at]aol.com> wrote
re the work of Markowitz and Modern Portfolio Theory
- quote -

"Elle" <elle_navorski[at]nospamearthlink.net> wrote in message
news:AS5Wd.1043$oO4.21[at]newsread3.news.pas.earthlink.net...
- quote -

I have a few Vanguard accounts, and I have never been charged any extra
fees. To what could you be referring?

Elizabeth Richardson

Elle wrote:
- quote -


I don't know if a small cap emerging market index fund is feasible -- I
never heard of an index that tracks them, although it may exist.
Remember the study I cited on the substantial rebalancing costs of
Russell 2000 index funds -- the rebalancing costs of small cap emerging
market funds could be even higher.

- quote -

In general I think indexing makes a bit less sense for bonds than
stocks. Do you want your biggest bond positions to be in the most
indebted companies or countries? Today, Argentina, which used to have
one of the biggest government bond markets, announced it was
"restructuring" debt for about 34 cents on the dollar.

Tad Borek wrote:

- quote -

To a quant, this is blasphemy . The key formula for the variance of a
portfolio given asset weights and the covariance matrix is correct,
assuming returns have a multivariate normal (MVN) distribution. The
assumption of MVN returns may be invalid because
(1) some assets have negatively skewed and fat-tailed (kurtotic)
returns
(2) return volatilities change over time
(3) correlations between some assets can rise in falling markets

but the Markowitz mean-variance portfolio theory is the foundation upon
which more realistic theories are built. Markowitz is a smart man who
realized he was making certain simplifying assumptions, both to make
the math analytically tractable and to enable implementation on
computers that were primitive by today's standards. A good book on his
work is "Mean-Variance Analysis in Portfolio Choice and Capital
Markets" (1990), by Markowitz, Todd, and Sharpe. Although the book is
heavily mathematical, it is accompanied by VBA code implementing the
algorithms that can be used in an Excel spreadsheet.

One recent paper on portfolio optimization of assets with non-normal
returns is
"Portfolio Selection With Higher Moments" by Harvey, Liechty, Liechty
and Mueller , available from
http://www.fuquaworld.duke.edu/www/fsc/frp2.jsp?pid=123 .

What method for derivng an asset allocation does Tad Borek propose
instead?

<beliavsky[at]aol.com> wrote
- quote -

I had in mind recommendations re diversifying that typically include
putting money in a variety of flavors of international bond and
international stock mutual fund vehicles, in particular with a single
mutual fund company. Vanguard has no small cap emerging market index funds.
I'm not sure Vanguard has any international bond fund, index or otherwise,
either. Index Fund Advisors (IFA.com) has this sort of stuff, but of course
I'm sure Vanguard can trump IFA in other areas.

You seem very sold on Vanguard, perhaps especially because of its funds'
low expense ratios. But Vanguard does tack on many extra fees here and
there. In some (all?) cases, these really add on to the "low" expense
ratio.

ETF share prices do not necessarily reflect the underlying value of their
holdings. Also, ETFs are untested in conditions of, for example, Black
Monday, October, 1987. (Though I grant that "controls" have been installed
to preclude something exactly like that day.)

<beliavsky[at]aol.com> wrote
About exchange traded funds:
- quote -

Elle wrote:

- quote -

The ETF tracking the S&P 500, symbol SPY, was introduced in early 1993.
I don't know of any significant problems caused by the ETF format since
their inception. Do you have a specific worry?

Vanguard, the leader in open-end index funds, also manages ETFs. In
general they avoid "untested vehicles" and fads.

"Tad Borek" <borekfm[at]pacbell.net> wrote
- quote -

DIA's yield is 2% according to yahoo and 2.6% according to marketwatch.com
...

Also, it is an exchange traded fund, which so far I feel are somewhat
untested vehicles.

- quote -

WDOWX's yield is 1.7%, according to marketwatch.com and finance.yahoo.com .
I can get this with FSMKX, Fidelity's S&P 500 index fund.

- quote -

I can't tell if you're saying you're rejecting MPT or not.

Elle wrote:

- quote -

I think the only mutual fund for U.S. stocks that a staunch indexer
needs is one tracking the Wilshire 5000, which tracks essentially all
U.S. stocks http://www.wilshire.com/Indexes/Broad/ . Both Fidelity and
Vanguard have such funds.

Only an investor who wants growth/value or large-cap/small-cap
weightings that differ from the Wilshire (perhaps because he expects
value to outperform growth over the long run) needs more specialized
index funds.

If you own 6 funds, (small/midcap/large) * (value/growth), periodically
some of your funds will be buying stocks that other funds are selling,
due to index rebalancing, resulting in needless transaction costs and
perhaps even capital gains taxes. Vanguard does offer index funds in
all categories and may be able to internalize some trades, but if the
assets of their value index fund greatly exceed those of their growth
fund, this will limit opportunities for crossing (growth fund buying
what the value fund is selling). The Wilshire 5000 index owns all
stocks by capitalization weight and largely avoids such costs.

"Tom B." <tbridgeport56[at]gmail.com> wrote
snip good support for small expense ratio/passively managed/index funds

Thanks, Tom.

- quote -

I think it might be a packaging problem.

Two of the tables in the 2005 Malkiel paper that Beliavsky cited should
give a person a bit of pause. The "problem" is he/she can still rebut the
financial planner with "but what if Fund X is in that 20% (or whatever) of
funds that beat the S&P 500"?

One has to get people to focus on the odds: But 80% (or whatever) did
worse!

I suppose. It's a hard sell at misc.invest.mutual-funds. They're not all
sold on index funds over there.

- quote -

Yes, I agree that's likely part of the problem.

- quote -

This would be consistent with Tad Borek's recollection, too. (Too lazy to
google. I think you fellows are right.)

"Rich Carreiro" <rlcarr[at]animato.arlington.ma.us> wrote
snip interesting sound bite for MPT (or SMP, depending on one's
perspective)
- quote -

I think I would have added a bit more that would explicitly emphasize the
diversity aspect and its mathematical advantages. But your sound bite is
cool, afaic.

What you say about why it took so long has occurred to me, also. Markowitz
presented his seminal work c. 1950s, right? Over the decades it has evolved
and garnished increasingly more attention from the masses. I figure the
absence of computers, the dearth of ordinary people interested in
investing, and the fact that pension plans IIRC were just gaining in
popularity, precluded any serious, large-scale interest in optimal ways to
invest until starting around the 1950s.

Elle wrote:
- quote -

I think you can cover the map pretty well with Vanguard. There are a
couple missing pieces - international comes to mind - but it's a good
one-stop shop. In a brokerage account, iShares also cover the map well.
I use DFA funds almost exclusively in some categories, but think of that
as icing on the cake rather than "essential for a good outcome."


- quote -

Buy diamonds, ticker: DIA.

Waterhouse also has a Dow-based index fund: WDOWX. It's only available
through a TDW account.

Looking beyond the yield, you'd need to be comfortable with the way
stocks are weighted in the Dow 30, it's pretty arbitrary.

- quote -

Or, not-so-sound, and not-so-mathematical.

-Tad