past performance does not predict future performance......

It's easy to go looking for funds that have outperformed the indices historically, but how would you suggest choosing the ones that will outperform in the future?

It is also telling that out of the hundreds of funds out there, you could only find less than 10 that outperformed.....

I would say that this is a fair comparison overall. Without a doubt, Dodge & Cox is a good shop. You can do far worse. Indeed, D&C Balanced has outperformed in the past. But that tells us nothing going forward.

This study simply looks at return. There's more to the equation than that. The sample Vanguard portfolio is far more diversified. I haven't looked at it in detail, but it's possible that D&C Balanced outperformed by taking on additional risk. Sometimes that bet may pay off. But eventually risk comes back to bite you.

D&C Balanced is actively managed to its discredit, but it's not a poor choice as actively managed funds go. But to choose a fund on the basis of past performance is simply an exercise in data mining. Remember: reversion to the mean!

As far as a retirement allocation goes, I'm partial to the strategy laid out in Larry Swedroe's "Winning Investment Strategy" book involving Treasury zeros and stocks.

JC

JC, you’ve clearly done your homework, so thanks for “taking me to school.” Without benefit of having read Swedroe, let me offer a few comments...

Warren Buffett invests in a relatively small number of companies. And he looks for value. Why does he do so well? Could it be that indices can NOT be selective, but active managers can?

The return for a given index is the average of a defined population of companies. An actively managed balanced fund does not need to invest in the entire population, so they can be more selective.

Same goes for market segments. With indexing, once you pick an allocation model, the basket of equities becomes relatively fixed. A fund like D&C Balanced can choose to overweight or underweight market segments to take advantage of trends.

[In the case of D&C Balanced, at the end of ’04 they had less than 100 stocks. Because of the small population of stocks, they can pick ones that are “on sale.” My wife does the same when grocery shopping. If chicken is on sale today, we have more chicken this week. Same thing goes is she finds a good deal on pork or steak next week...]

Also, many high net worth investors place a strong emphasis on capital preservation. Likewise, retirees with modest portfolios value this same characteristic. So under performing the market over a long period of time is not a primary concern. Performance like we’ve seen the last 5 years is, however, a tough pill to swallow.

If you look at the 10 year charts for D&C Balanced (and some of the other funds in Step 5), their growth rate is relatively straight line. They may under perform a strong up market. But they also “resist” falling in a down market. Again, something someone in my situation values.

A younger person’s goals will differ from mine. Potentially making a pure index play more attractive for their core funds.

JC, mentions that "Vanguard portfolio is far more diversified..."

But many feel that today’s valuations are high. Is there not risk that indexers may not be able to “escape” a prolonged soft market?

idiotvestor states, "I haven't looked at it in detail, but it's possible that D&C Balanced outperformed by taking on additional risk. Sometimes that bet may pay off. But eventually risk comes back to bite you."

If you look at the charts for a good actively managed balanced fund, the risk is underperforming an up market. Given D&C’s style, you are all but assured of out performing a bad market.

idiotvestor states: "It's easy to go looking for funds that have outperformed the indices historically, but how would you suggest choosing the ones that will outperform in the future?"

Much the way you would find and court a potential spouse. Take it slow and get to know them before taking the plunge. I would start by using Morningstar's fund selector tool under a variety of criteria to begin a master list. Narrow the list to a few likely candidates. When you look at the funds past performance, see how they have done year by year the past 5 - 10 years (because averages tend to obscure this detail). I would then hit Google to see what's being said. Same for Morningstar's analyst reports. I would then add them to a portfolio tracker (Yahoo, Morningstar, etc.) and watch their performance over time. If I like what I see, I then make a minimum investment and dollar cost average into the fund over a year or two.

BTW: Keep an eye out for funds mentioned in business magazines and the Wall Street Journal. I found my PIMCO All Asset from an article in business week. This is a new fund. All Asset's goal is CPI + 500 basis points -- which they have outperformed so far, making it attractive for someone with my goals. [This fund is unusual in that it is a fund of funds -- so the manager actively manages the asset allocation, then chooses from PIMCO's pool of funds.] Earlier I wrote a post on how to save money when buying this fund. You will find under "money saving tips" above.

Tip: When using Morningstar, balanced funds are under "moderate allocation."

idiotvestor states: "It is also telling that out of the hundreds of funds out there, you could only find less than 10 that outperformed....."

Study the criteria in step 5. This search only looks at funds in the Moderate Allocation category, and further required they outperform the S&P 500 in EVERY timeframe. New funds would not make the cut. A fund that over performed in 10-year, but underperformed YTD would not make the cut. So this is a pretty tough standard.

Also, when you refer to revision to the mean, the idea (with actively managed balanced funds) is to pick one from the top 1 – 2% in their field. Microsoft and Oracle are on top for a reason. Funds are no different. Some are better run than others.

Thanks again for the input. 1stMill

1stMill,
So you're saying that you're committed to active management. Ok. Just go into that enterprise with your eyes open knowing that it's an uphill battle.

You asked about Buffet. Hate to put it so bluntly, but you can't be like Buffet. He takes over the companies he invests in and participates in their management. He's more a businessman than an investor. It's an apples to oranges comparison.

You talked about active managers being able to be "more selective". What's the criteria? If you chase performance, you're buying high. If you buy stuff in the tank, you're taking extraordinary risk. Again, the solution is not to find the needle in the haystack, but to own the whole haystack.

You talked about D&C Balanced resisting the fall in a down market. That's what balanced funds are designed to do.

You said, "many feel that today’s valuations are high. Is there not risk that indexers may not be able to “escape” a prolonged soft market?" What market are we talking about again? When people talk of indexing "the market", I fear they're confusing what I'm advocating with simply owning the S&P500. Bogle advocates simply owning the Wilshire5000 for a total portfolio. I disagree with him here. I'm more convinced by the so-called "slice & dice" approach. As a result, I've only got 33% of my assets in US equities. The other 2/3rds of my portfolio are invested elsewhere. I'm not concerned about the US market being toppy. When this market zigs, the others zag and my equity curve rises steadily. When any of the markets I invest in have an extended bull run, I'll underperform it. But in the long run, I'm concerned about the total after tax return on my whole portfolio. Put it this way: I like the look of my equity curve.

When idiotvestor asked how you would choose an outperforming fund you mentioned using M* (a public tool), and watching it for a while and then if you like what you see, you would DCA into it. What would make you like a fund that you were watching? If it went into the tank would you like it? Probably not. What you're looking for is a fund that continues to outperform. Thus you're buying into a fund with recent strong performance. We call this "chasing performance" a.k.a "buying high". It's a sure route to poor returns.

You also said you're buying funds on recommendations from financial magazines! We need better input here. I read the same story in Kiplinger's on PIMCO All Asset. If somebody's going to gamble with your money, it might as well be YOU for Pete's sake.

Reversion to the mean. You talked about picking the top 1%-2% in their field because they're better run than others. Indeed, they're better run TODAY. Give some serious thought to my comments above on chasing performance, buying high, and reversion to the mean.

Lastly, you said you haven't read Swedroe. Make a $15.00 commitment and get his book "The Only Guide to a Winning Investment Strategy You'll Ever Need." Larry takes academic finance and makes it more accessible to the average Joe like me. Easy read. Very convincing. At least check out a far better defense of MPT than my posts on this board.

Cheers,

JC

Hi JC,

Let’s start with disclosure... Neither of us make good proxies for most pfblog readers: Two-thirds of your investments lie outside of the US. And the majority of my holdings are fixed income. So, most US-based investors couldn’t assume your currency risk, and most need to assume more market risk than I. Agree?

To your points...

JC “So you're saying that you're committed to active management. Ok. Just go into that enterprise with your eyes open knowing that it's an uphill battle.”

1. Admittedly, most managed funds under perform my holdings. So that plays into your argument. If an investor is not willing to invest time to find and monitor their funds, they are probably better off in index.

2. I should also clarify my definition of actively managed funds. My primary mutual holdings also have (some) leeway to manage asset allocation. Outside of international, I do not own sector funds.

JC “You asked about Buffet. Hate to put it so bluntly, but you can't be like Buffet. He takes over the companies he invests in and participates in their management. He's more a businessman than an investor. It's an apples to oranges comparison.”

I don’t want to be like Buffet. But I do think that D&C has similar values in terms of how they select potential winners. Both look for value.

JC “You talked about active managers being able to be "more selective". What's the criteria?”

Investor sentiment plays into valuation. A value manager would look at the intrinsic value of a company. Some managers do better than others - this I believe.

JC “You talked about D&C Balanced resisting the fall in a down market. That's what balanced funds are designed to do.”

Amen.

JC “You said, "many feel that today’s valuations are high. Is there not risk that indexers may not be able to “escape” a prolonged soft market?" What market are we talking about again? When people talk of indexing "the market", I fear they're confusing what I'm advocating with simply owning the S&P500. Bogle advocates simply owning the Wilshire5000 for a total portfolio. I disagree with him here. I'm more convinced by the so-called "slice & dice" approach.”

From what you describe, YOU have become the allocation manager. Many investors would not have the ability to pull this off.

JC “I like the look of my equity curve.”

You are either good or lucky. Many investors, even those in indices, may not feel the same of their curve.

JC “When idiotvestor asked how you would choose an outperforming fund you mentioned using M* (a public tool), and watching it for a while and then if you like what you see, you would DCA into it. What would make you like a fund that you were watching? If it went into the tank would you like it? Probably not. What you're looking for is a fund that continues to outperform. Thus you're buying into a fund with recent strong performance. We call this "chasing performance" a.k.a "buying high". It's a sure route to poor returns.”

My investing history has no shortage of buy-high mistakes. What I have learned (through the school of hard knocks), is to buy the management team and the fund philosophy. Also look beyond the average returns, because averages mask flaws.

My statement re. watching the funds may be a bit stupid. But I like to see how a fund reacts to different stimuli (like movements in interest rates for example).

JC “You also said you're buying funds on recommendations from financial magazines! We need better input here. I read the same story in Kiplinger's on PIMCO All Asset. If somebody's going to gamble with your money, it might as well be YOU for Pete's sake.”

I watch the pubs to get IDEAS for funds to investigate. Not for recommendation to buy.

JC “Reversion to the mean. You talked about picking the top 1%-2% in their field because they're better run than others. Indeed, they're better run TODAY. Give some serious thought to my comments above on chasing performance, buying high, and reversion to the mean.”

I hear you. And I have a better understanding, and respect for what you preach. You invest heavily outside the US.. Anyone mostly tied to US indices should also give serious thought to my comments about what happens if the US goes through a protracted sideways market?

As far as better run TODAY. If the "manager" leaves, that may be a good time to get out.

JC “Lastly, you said you haven't read Swedroe. Make a $15.00 commitment and get his book "The Only Guide to a Winning Investment Strategy You'll Ever Need." Larry takes academic finance and makes it more accessible to the average Joe like me. Easy read. Very convincing. At least check out a far better defense of MPT than my posts on this board.”

I’ll take your recommendation. Do me a favor and pick up “Mosaic – Perspectives on Investing by Mohnish Pabrai.” His writings may shed some light on value.

JC, as much as we don’t see eye to eye, I learn from your comments. I can only imagine that readers do as well. Thanks for the discussion.

Best regards, 1stMill

Ok, 1stMill I'm glad we have this understanding.

Just a few points to clarify:

All my international holdings are fully hedged. I don't do currency risk. Also, that doesn't mean that I'm 2/3rds international. I've got 1/3rd international 1/3rd domestic and the rest in REIT's Commodities and bonds of various stripes.

I agree with your emphasis on value (buy low). That's why I'm overweighted towards value. I'm into that whole Fama/French thing... ha!

You accused me of being my own allocation manager. Not so fast. I realized long ago that I can come up with some great and creative allocations myself, but I had a problem: as long as I was dealing with funny money, it was all good. But as soon as I put my own hard-earned cash on the line, things got fuzzy. I realize that I am not the most objective person when it comes to my own money. Little things like fear and hope and greed get in the way. So my big decision was in finding the best advisor that money can buy. Then I got out of his way and let him do his thing. So I'm NOT my own asset allocator. I've got a expert on retainer for that. Someone who is more objective towards my money and not as fearful, or hopeful, or greedy as me... (The investor is likely to be his own worst enemy! - Benjamin Graham) I consider the small fee I pay him as a valuable insurance policy. It's an insurance policy against me screwing up my own financial future. Well worth every penny...

You said something about a manager leaving and that might be the trigger for you to get out of a fund. Oh great! Now I've got a huge taxable event on my hands! Passive management avoids this pitfall.

I'll check out the work by Pabrai. I've never heard of him. If he's going to preach on value investing, I'll probably be on board with most of it. Just take that value emphasis, do it passively and you're good to go!

JC

Sorry, I don't know what I was thinking. Of course my global stocks have currency risk. My global BONDS are fully hedged. My mistake.

JC

I'm impressed. I will read the book and give your plan more thought. Thanks for sharing. Best regards, 1stMill

We've talked about managers leaving (and taxes). The following shows why this should not be an issue at D&C. And in my opinion, it also helps explain why they get the results they do...

"Dodge & Cox is comfortably old-fashioned. The San Francisco-based special ist in bargain-priced stocks started its Balanced fund in 1931, and its Stock fund in 1965. Once an analyst or manager joins Dodge & Cox, it's often a till-death-do-us-part affiliation. "The last time a senior staff member left here, other than by death or retirement, was in 1983," says John Gunn, the funds' president.

The Dodge & Cox teams hunt for stocks of large companies that are out of favor but whose problems appear temporary. The funds make buy and sell decisions by committee and are willing to be patient. "We want companies whose shares we could put in a locked box and not touch for three to five years," says Ken Olivier, a Dodge & Cox fund manager."

Luckily most funds are not run this way, so the cream can rise to the top :)

BTW: Their International Fund is still open, and worth consideration for anyone needing such.

(A repost from my follow-up to another post, just want to jump into a more recent discussion).

Index management is good for most people who don't have much time to do fund research. But if you have more time and energy in research and picking good mutual funds, as those folks on morningstar's forum, with discipline, knowledge and experience, you surely can beat the market over time by picking good money managers.

Theorectical evidence:
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=414441

Empirical evidence
http://socialize.morningstar.com/NewSocialize/asp/FullConv.asp?forumId=F100000015&convId=155115#1006751

http://socialize.morningstar.com/NewSocialize/asp/FullConv.asp?forumId=F100000046&convId=148301#992245

If you still don't believe about active management, I can let you see from your own eyes.

Follow the performance of these no-load funds from today for any period you like,
RSPFX SGIIX DODFX FINSX BJBIX RHIIX

Benchmark: their relative percentile rank among their peers within the same category. Or give me your mix of indices that can beat these funds based on minmium variance optimization.

By the way, good funds tend to close early but I am only showing you a live example that active management can beat index and you can see yourself by how much. (I could give you a list of funds that are all open but I strongly suggest you do your own research).

JC,

I agree with your points. Pricing is best explained by the Efficient Market Hypothesis. Most EMH proponents admit that there are lapses in pricing efficiency (e.g. dot com boom) but those lapses can't be exploited in a manner that creates excess returns.

JC, you should check out Sharpe's monte carlo simulation tool for asset allocation: www.financialengines.com

The tool is integrated into the Vanguard website and free if you have >$100k in assets. Basically you identify your risk tolerance and it identifies the specific funds and allocations that have the highest probability of maximizing your returns.

cheers,
GP

Sorry guys, I've been out of town on business...

GP, I've got my own monte carlo program on my computer (for entertainment purposes only!)

Bibbub, there's nothing left to say. I've already rebutted this drivel. Anyone can datamine and pick outperforming funds after the fact... You refer me to M*?? PLEASE!! Read some real research and not the drivel spoon fed you by the investment industry. You think do-it-yourself "research" is going to save the small investor? You're deluding yourself and others.

Check some of my previous posts. I'm not going to rehash this again.

Cheers,

JC

JC, I am not sure if you read my post carefully and read the new real research as shown in my link. I did many research and found all those past research are flawed. Don't let Bernstein or Bogle fool you, they are right if you are a blind performance chancer. But that's not the way the pro pick funds.

I list several funds there and you can watch lively how they are going to trounce their indices from now on (forget their past performance), as long as they don't change their managers.

Bibbub,
Your "research" isn't worth the paper it's written on. That's not just my opinion, it's a tautology! (to quote Bogle...)

Anyone who accuses Bogle and Bernstein of "fooling" the public on investing issues is out of touch with reality. And probably hasn't read either.

You DON'T want to pick funds like a "pro" (unless you want to underperform like the pros do).

Go ahead, pick your funds, and in the long run you will leave lots of money on the table (another tautology!)

You've found the holy grail have you? You can pick funds that will outperform in the future! That's just the trick! And you've cracked the code! My goodness! You need to start a hedge fund (you'll make a mint!) Now if you can just get started on that cold fusion thing you can save the world too!

You have the last word my friend...

JC