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Beware of Index Fundamentalists Dylan Minor

Beware of Index Fundamentalists Dylan Minor. Investing in index funds over actively managed funds is a subject of ongoing debate;

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Beware of Index Fundamentalists Dylan Minor

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  1. Beware of Index Fundamentalists Dylan Minor • Investing in index funds over actively managed funds is a subject of ongoing debate; • Bogle : investors should invest in low-cost index funds. His findings suggest “ the magnitudes of difference (of Index over actively managed funds) are so large and so consistent as to devastate the concept of high cost active management”; • Implications are enormous – if index fund proponents are correct, it will make actively managed funds unattractive;

  2. Beware of Index Fundamentalists • Bogle analyzed performance of each of the nine Morningstar investment classes in comparison to a matching risk-adjusted index fund over the period 1992-1996. • Purpose of this study is to reexamine Bogle’s claim by using a different set of data. The period covers 1990 – 1994. • Implications are enormous – if index fund proponents are correct, it will make actively managed funds unattractive;

  3. Beware of Index Fundamentalists • Exhibit 1 - Morningstar Style Boxes • Exhibit 2 – Morningstar Returns and Risk 1990-94 • Exhibit 2 – Morningstar Sharp Ratio 1990-94 • Sharp Ratio = (R fund – R Risk free)/ Std. Deviation • Treynor Ratio = (R fund – R Risk free)/ Beta • Higher Sharp ratio indicates better risk adjusted rate of returns.

  4. Value Blend Growth Large 0.385 0.361 0.369 Medium 0.441 0.440 0.482 Small 0.472 0.464 0.540 Beware of Index Fundamentalists Exhibit 3-Morningstar Sharp Ratios 1990-1994

  5. Value Blend Growth Large 0.327 0.360 0.329 Medium 0.396 0.411 0.387 Small 0.496 0.349 0.209 Beware of Index Fundamentalists Exhibit 4-Index Fund Sharp Ratios 1990-1994

  6. Value Blend Growth Large 17.79% 0.23% 11.95% Medium 11.23% 6.91% 24.32% Small -4.85% 32.82% 158.96% Beware of Index Fundamentalists Exhibit 5- Managed Fund Risk Adjusted Return Advantage 1990-1994 • Managed funds , except Small-Value performed better than index funds during the 1990-94 period.

  7. Beware of Index Fundamentalists • What do these findings mean? • Avoid making general conclusions about capital markets on just 5 year data; • Bowen and Statman (1997) suggest analyzing 50+ years of data to definitively address this issue; do not have data for this long period

  8. Beware of Index Fundamentalists • This issue may have a paradoxical conclusion: if Bogle is right, he will be wrong; and if he is wrong, he will be right. • If more people become convinced they can beat the market (Bogle is wrong), the more efficient the market becomes. Less likely they will outperform it. • If investors believe active management is a waste of money (Bogle is right), fund mangers will be replaced by index funds. Worsen market efficiency. The remaining fund managers will have a better chance of outperforming the market.

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