the ongoing "active" vs "passive" debate

[mw]

Ok, so now your commissions are $9.99 at TDW. Unless I am confused, you would get the same at just about any major discount broker (E*Trade, Qtrade, Credential Direct).

Costs even with Scotia were not all that bad; execution / platform wasn't great though.

Re 9.99, you are missing one of the costs. I've detailed these elsewhere, so lets net this out and first restrict the discussion to *only* brokers which offer a "direct access" platform - a Windows based application that makes it possible to manage many orders and accounts in a sane way that a web site will not. Its not practical to use a web interface when dealing with many orders a day / week / month. That said, I did that for a long time, once Scotia dropped the Schwab Canada order entry interface.

Back to 9.95 - for direct market access there are more costs to consider. Of those that offer this - TDW, Tradefreedom (a division of Scotia now), Questrade, Disnat, ETrade - all of them offer the same platform.

All of them pass on "removing liquidity" costs, *except* TD.

If one is exiting or entering a market quickly and hitting the best bid or offer (frequent in my case) these costs add up. 0.34 cents per share. As I trade in share lots 5000 - 20000 (these days broken down into smaller components), that liquidity fee adds up. If you break such an order down, it atts up even more.

ETrade puts a cap on that charge, the rest do not.

Except TD, which, if you allow them to route orders automatically, *does not pass on that cost*.

As an example, entering or existing a 20,000 size position in 4 lots with Etrade, Tradefreedom, Disnat, TD:

Disnat, Etrade: 4 * 26.95 = 107.80
Questrade: 133.80
Tradefreedom: 311.80 (1 cent a share on top!)
TD 4 * 9.95 = 39.80 (or 4 * 7.00 = 21 depending on trade volume)

Disnat not long ago dropped their 1 cent a share.

For other brokers not offering "direct access" order entry systems, Credential (and TD web broker with the large account rate) would also be good choices - flat 9.95 fees.

edit: To give some idea as to the scope of these fees, in an "inactive" year my fees at TD would be around 5 - 6K; Etrade/Disnat/Questrade - around the 16K mark; Tradefreedom - 50K+ in fees. Scotia even on "Select" pricing - more than 100k. Multiple those by 4 - 8 times for an active year. I certainly do not go out of my way to trade more than I have to as I recognize fees, even if they seem small, eat into profits surprisingly quickly, but having lower transaction costs does open up opportunities I would otherwise take a pass on.

Frankly I should have moved accounts a while ago but there never seemed to be a good time to take two weeks off.

For my particular situation - TSX focussed (but they also offer the no liquidity fee potential on US markets too, plus "wash trades") in an RRSP account, TD has the lowest costs for a non-professional individual trader/investor. Plus I rather like having the security of being with a large bank (as opposed to the smaller firms).

http://www.tdwaterhouse.ca/activetrader ... cation.jsp

[randomwalker]

On the General Electric (Symbol-GE) thread,

MW wrote:

"I aim for steady weekly growth. Active years - > 30%.
Less active years (I have a 12 year track record to look back at) - average 23.5% CAGR **after all costs**. This year will be an active year, like last year. Currently accounts are up 24.3% over Dec 31 close."

The Market Wizards I think far outperformed me, so no, I am not in their company... I ask no proof from you on your record, nor do I care what anyone else is able to achieve.

MW I think you grossly under estimate your abilities. While a Compound Annual Growth Rate of 23.4% may not qualify for a chapter in Jack Schwager's next book it certainly does qualify you for the Canadian Market Wizard category. A quick search of Globefund.com found only two managers with public records that even came close to your 12 year performance, Normand Lamarche at Front Street and Eric Sprott.

With respect to mine or anyone else's record, in the three years I have been associated with FWF I have found that ralely if ever do those posting make mention of such things as to do so without supporting documentation renders such references meaningless. As in other matters a gentleman niether asks nor tells.

Moving on.

Front Street Special Opp Canadian
http://www.globefund.com/servlet/Page/d ... 2612697484

Sprott Equity Fund
http://www.globefund.com/servlet/Page/d ... 2612697484

[mw]

I've said this many times before: someone managing a big fund does not have the flexibility I have. Few Canadian *fund* managers are, for lack of better terminology, operating an active raw-return hedge fund - but that is what I do for our family accounts.

I can go 100% to cash, switch sectors, strategies or walk away from the market completely when I'm otherwise occupied or when it makes sense to. Show me a comparable high performing Canadian "alternative strategies" fund with that flexibility.

I realize that I'm throwing oil on the fire, but since I made that GE post our combined accounts now stand at +30.952% from Dec 31 2007 close. The IRR for 2008 based on today's date is a silly 146.70%, but I certainly don't believe I can maintain that for a whole year. I take holidays, and so does the market.

I am not perfect; I do leave money on the table, and I do take small losses from time to time. But I get my fair share, and I do not suffer significant draw downs.

As I said, its time to move on. I will not discuss this further.

[Bylo Selhi]

Thanks for the compliments and questions!

I've attempted to address el12e's concerns on the blog

There is another dimension to tax efficiency for those over age 65 who collect OAS. Dividend income is "grossed up" by 45% for tax purposes (and perhaps higher in a few years as corporate taxes come down.) CRA uses this substantially higher amount to determine if and by how much to claw back OAS payments. That may not be an issue for low-income seniors who won't hit the clawback threshold, but given that MAPF's investors must be accredited, it's likely that this issue could become material for many of your unitholders.

Comments (or a link if you've dealt with this before)?

[I suppose this applies to dividend-paying stocks and preferreds in general, not just to MAPF and regardless of its turnover.]

[kcowan]

There is another dimension to tax efficiency for those over age 65 who collect OAS. Dividend income is "grossed up" by 45% for tax purposes (and perhaps higher in a few years as corporate taxes come down.) CRA uses this substantially higher amount to determine if and by how much to claw back OAS payments. That may not be an issue for low-income seniors who won't hit the clawback threshold...

Actually this grossing up also generates clawbacks for GIS recipients at a much lower threshhold. There are many other takeaways as well (e.g. Pharmacare subsidies in BC).

[George$]

Has this been posted before?
The Cost of Active Investing by KENNETH R. FRENCH

Abstract:

I compare the fees, expenses, and trading costs society pays to invest in the U.S. stock market with an estimate of what would be paid if everyone invested passively. Averaging over 1980 to 2006, I find investors spend 0.67% of the aggregate value of the market each year searching for superior returns. Society's capitalized cost of price discovery is at least 10% of the current market cap. Under reasonable assumptions, the typical investor would increase his average annual return by 67 basis points over the 1980 to 2006 period if he switched to a passive market portfolio.

[jiHymas]

There is another dimension to tax efficiency for those over age 65 who collect OAS. Dividend income is "grossed up" by 45% for tax purposes (and perhaps higher in a few years as corporate taxes come down.) CRA uses this substantially higher amount to determine if and by how much to claw back OAS payments. That may not be an issue for low-income seniors who won't hit the clawback threshold, but given that MAPF's investors must be accredited, it's likely that this issue could become material for many of your unitholders.

Comments (or a link if you've dealt with this before)?

[I suppose this applies to dividend-paying stocks and preferreds in general, not just to MAPF and regardless of its turnover.]

Sorry for the delay, I've only just seen this.

Quite right; the qrossed-up-dividend problem is independent of MAPF and of its turnover. I will say that I've never seen anybody give an example where the "interest equivalency factor" (the factor used to multiply pre-tax dividend yields into their interest equivalent) is so small as to make one suspect that a taxable bond position would provide a greater after tax return.

I don't give tax advice. Any question on taxation gets met with a "consult your personal tax advisor" response.

The software can be tuned, when necessary. If somebody had a high effective tax rate on dividends, I could input their personal tax rates (as supplied by them!) and optimize the portfolio based on those numbers.

SPECULATION: I bet that BNA.PR.C and YPG.PR.B would look absolutely gorgeous in such a situation, given that so much of their computed yield results from capital gains deferred until their (presumed!) softMaturity in 10-odd years!

[kcowan]

Mr Hymas

Somhwere in this maize, I posted an article that proclaims that Canadian dividends are the worst after tax and clawback investment a senior could possibly choose (assuming they qualify for OAS). I would be interested in your comments?

[Studebaker Hawk]

Active fund managers keep lagging indexes

Only 8.2 per cent of Canadian equity fund managers outperformed their market benchmarks in the first quarter as actively managed portfolios continued to lag the indexes, Standard & Poor's said Tuesday.

“In addition ... results continue to show that active fund managers lag their passive counterparts on a one-, three- and five-year period.”

So much for active managers outperforming index managers in down markets. Of course, this could all change before the down market ends. Or maybe not. So far they've not been too nimble.

[jiHymas]

Somhwere in this maize

Sounds pretty corny.

I posted an article that proclaims that Canadian dividends are the worst after tax and clawback investment a senior could possibly choose (assuming they qualify for OAS). I would be interested in your comments?

I have no expertise in taxation and I'm still looking for some kernels of wisdom from an authoritative source. In the meantime, a commenter and I have guessed that the effect of the OAS clawback is to reduce the equivalency factor from 1.4x to 1.3x when it reaches its maximum effect. See my blog, Marginal Tax Rates: Ontario 2008.

Authoritative sources - by which I mean readily available, signed opinions from people or firms who may be expected to have some expertise and will be gravely embarrassed if they're wrong - and other comments will be gratefully welcomed.

[kcowan]

Somhwere in this maize

Sounds pretty corny.

Written while in Mexico where maise is more important than maze

I posted an article that proclaims that Canadian dividends are the worst after tax and clawback investment a senior could possibly choose (assuming they qualify for OAS). I would be interested in your comments?

I have no expertise in taxation and I'm still looking for some kernels of wisdom from an authoritative source. In the meantime, a commenter and I have guessed that the effect of the OAS clawback is to reduce the equivalency factor from 1.4x to 1.3x when it reaches its maximum effect. See my blog, Marginal Tax Rates: Ontario 2008.
Authoritative sources - by which I mean readily available, signed opinions from people or firms who may be expected to have some expertise and will be gravely embarrassed if they're wrong - and other comments will be gratefully welcomed.

Clawbacks source thread
That thread took the direction that seniors benefits are equivalent to welfare so was not terribly productive. The linked analysis there took into consideration:
OAS/GIS clawback
Age credit clawback

but not
Drug plan clawback
GST credit clawback
Municipal property tax relief
Other means-tested benefits?

so it is fair to conclude that the analysis is not worst case. I would conclude from the general analysis that Prefs belong in TSFAs and RRIFs (& RESPs) after age 65.

I would welcome your more knowledgable conclusions.

My experience with this subject is limited to MIL in BC and Dad in Ontario both of whom experienced clawbacks. Since they are both now deceased, my interest is now to help 'steves' with RRIFmetic changes needed to properly handle TSFAs and clawbacks.

[jiHymas]

I saw the millionDollarJourney.com post last night while preparing my blog comment but, with all respect, do not consider it authoritative enough or influential enough to remark on in my blog.

It's good enough for here, though!

Using the quoted figures, the following table of interest-equivalency factors can be derived:

To / Marginal Int / Marginal Div / Equivalency Factor

10M / 50% / 73% / 0.54
15M / 78% / 66% / 1.55
31M / 22% / -6% / 1.36
37M / 37% / 16% / 1.33
63M / 46% / 30% / 1.30
74M / 43% / 23% / 1.35
103M / 52% / 33% / 1.40
121M / 43% / 20% / 1.40
+ / 46% / 25% / 1.39

These figures indicate a definite marginal effect on the bonds/prefs decision in the range of 31M-74M taxable income. So, say we have a situation in which long corporates yield 6% and an investor has decided that, all in, he wants an extra 100bp of pre-tax interest-equivalent (PTIE) yield before buying a pref. Therefore, his required PTIE yield is 7.00%

At an equivalency factor of 1.4x, he needs 5.00% dividends to do this. If his equivalency factor is only 1.3x, he needs 5.38% dividends to give him the same after-tax after-clawback income.

Note that I cannot comment one way or another on the veracity or lack thereof of the millionDollarJourney.com figures. I am not a taxation expert and know no more about taxation than, say, a 28-year-old engineer; I have to be very careful to point this out when commenting under my own name.

These figures indicate a definite marginal effect on the bonds/prefs decision in the range of 31M-74M taxable income. If, for example, we say that long corporates yield 6.00% and an investor wants an extra 100bp yield before buying prefs, then he wants 7.00% interest equivalent.

At 1.4x, this implies 5.00% dividend yield. At 1.3x, he needs 5.38% dividends to reach this level.

Another way to put this is: say that in this situation the investor is looking at a high-quality PerpetualDiscount paying a dividend of $1.20 p.a.

To get his 7.00% interest-equivalent out of this when his equivalency factor is 1.4x, he needs to be able to buy the stock at $24.00 or less.

If his equivalency factor is 1.3x, his maximum price is $22.30.

Sorry about all the edits. I was attempting to add the last bit (under the self-quote) and pressed "edit" instead of "quote" ... and have had to reconstruct my original comments.

[Shakespeare]

the following table can be derived

If I'm reading it correctly, only the GIS clawback at very low incomes causes interest to be preferential to dividends.

[adrian2]

Clawbacks source thread
That thread took the direction that seniors benefits are equivalent to welfare so was not terribly productive. The linked analysis there took into consideration:
OAS/GIS clawback
Age credit clawback

but not
Drug plan clawback
GST credit clawback
Municipal property tax relief
Other means-tested benefits?

The thread linked above also has my comment about the caregiver amount which roughly doubles the age credit clawback.

See also this thread which touches on the GST credit, property tax and CCTB reductions.

[kcowan]

Thanksn for the link Adrian. I had missed that thread.

There seems to be enormous potential for a credible what if tool. Would this be a Qfile add-on or is RRIFmetic the best way to go? It would always be slightly out-of-date, e.g. TFSAs, but better than nothing.

[brucecohen]

Mark Hulbert writing in the NY Times:

The Prescient Are Few
By MARK HULBERT
Published: July 13, 2008

HOW many mutual fund managers can consistently pick stocks that outperform the broad stock market averages — as opposed to just being lucky now and then?
Skip to next paragraph

Countless studies have addressed this question, and have concluded that very few managers have the ability to beat the market over the long term. Nevertheless, researchers have been unable to agree on how small that minority really is, and on whether it makes sense for investors to try to beat the market by buying shares of actively managed mutual funds.

A new study builds on this research by applying a sensitive statistical test borrowed from outside the investment world. It comes to a rather sad conclusion: There was once a small number of fund managers with genuine market-beating abilities, as judged by having past performance so good that their records could not be attributed to luck alone. But virtually none remain today. Index funds are the only rational alternative for almost all mutual fund investors, according to the study’s findings.

The study, “False Discoveries in Mutual Fund Performance: Measuring Luck in Estimating Alphas,” has been circulating for over a year in academic circles. Its authors are Laurent Barras, a visiting researcher at Imperial College’s Tanaka Business School in London; Olivier Scaillet, a professor of financial econometrics at the University of Geneva and the Swiss Finance Institute; and Russ Wermers, a finance professor at the University of Maryland.

The statistical test featured in the study is known as the “False Discovery Rate,” and is used in fields as diverse as computational biology and astronomy. In effect, the method is designed to simultaneously avoid false positives and false negatives — in other words, conclusions that something is statistically significant when it is entirely random, and the reverse.

Both of those problems have plagued previous studies of mutual funds, Professor Wermers said. The researchers applied the method to a database of actively managed domestic equity mutual funds from the beginning of 1975 through 2006. To ensure that their results were not biased by excluding funds that have gone out of business over the years, they included both active and defunct funds. They excluded any fund with less than five years of performance history. All told, the database contained almost 2,100 funds.

The researchers found a marked decline over the last two decades in the number of fund managers able to pass the False Discovery Rate test. If they had focused only on managers running funds in 1990 and their records through that year, for example, the researchers would have concluded that 14.4 percent of managers had genuine stock-picking ability. But when analyzing their entire fund sample, with records through 2006, this proportion was just 0.6 percent — statistically indistinguishable from zero, according to the researchers.

This doesn’t mean that no mutual funds have beaten the market in recent years, Professor Wermers said. Some have done so repeatedly over periods as short as a year or two. But, he added, “the number of funds that have beaten the market over their entire histories is so small that the False Discovery Rate test can’t eliminate the possibility that the few that did were merely false positives” — just lucky, in other words.

[parvus]

A few paragraphs later is a thought on how costs crowd out alpha.

WHY the decline? Professor Wermers says he and his co-authors suspect various causes. One is high fees and expenses. The researchers’ tests found that, on a pre-expense basis, 9.6 percent of mutual fund managers in 2006 showed genuine market-beating ability — far higher than the 0.6 percent after expenses were taken into account. This suggests that one in 10 managers may still have market-beating ability. It’s just that they can’t come out ahead after all their funds’ fees and expenses are paid.

[Bylo Selhi]

To be fair, that's only one possibility. Wermers also considers "that many skilled managers have gone to the hedge fund world" and "that the market has become more efficient."

In any case, MERs have generally gone up since 1990, especially in Canada. (See e.g. the story of how TGF went from <1% to >2% overnight.) The higher MERs enabled the fundcos to grow their assets and especially grow their profits due to the resulting economies of scale but has done little to benefit investors.

[parvus]

To be sure.

What I find interesting about the hedge fund world is that it is the aggressive growth mutual fund managerswho seem to have fared the best (Sprott, Rohit Seghal, Nandu Narayanan, although Nandu is more of a black-swan trader) rather than the quantitative market-neutral types (with the exception of Salida, which is multi-strategy and I suspect has some involvement in special situations).

OTOH, market efficiency presumes a two-sided, long/short market ... which makes one wonder how passively managed 130/30 funds will do (130% long the best prospects in an index, 30% short the worst) and how they will affect market efficiency. Of course, many mutual funds are allowed to short up to 20% at CI, Dynamic, Jovian, but so far the results have not been convincing.

Still, costs, or Dr. Norm's analyses, seem to have attracted attention elsewhere, at least in the active vs passive sphere. The question of costs (or perhaps it's just value added) applies to hedge fund performance fees too. (I'm agnostic, so long as there's an appropriate benchmark and high-water mark.)

Anyway, like WW, I'm trying to get rid of old clippings (lest ever-efficient DW throws them all out ). Here's a germane one from Carrick: How to get the skinny on your fund's fat fees.

Just some thoughts (it's too hot to argue today ).

[WishingWealth]

Light reading in The Star.

Do-it-yourself revival: Dot-com era day traders are gone but `active traders' are taking their place

Just call it the renaissance of the "day trader" – or at least a savvier incarnation of that tech-bubble trend.

A growing number of Canadians are becoming "active traders," creating a boon for online brokerages at a time when gyrating stock markets and dour economic forecasts are weighing heavily on other parts of the investment community.

Active traders are generally considered to be those who buy or sell 30 times or more per quarter, or at least 10 times a month. Instead of shying away from the current volatility, that growing segment of self-directed investors is embracing the turbulence, say discount brokerages.

...

WW

[paper prophet]

The books and literature indicate that it is very difficult to succeed actively picking stocks and timing the market. Buffet says most retail investors would be better off in index funds. This belongs in the "do as I say, not as I do" category of advice. Nonetheless, many of us still try to beat the market.

The problem I have is that the analysis is typically performed comparing active and passive funds. The active managers are moving millions or maybe even billions of dollars around to try to beat the market. ISTM that this is quite a handicap. The active manager cannot play in small or microcaps very well without moving the price north with their purchases. If the fund is large, it has to own a lot of stocks due to regulated maximums for a single holding. If a manager hits big on a couple of stocks, it might not even cover the management fees for the fund. As a final kick in the teeth, a big fund gets accused of being a closet indexer.

A single retail investor actively managing a stock portfolio seems much different. Most would be managing a portfolio of less than 5 million, and many less than 2 million. They can overweight a hunch as they see fit. They can be nimble when they need to be. They can play small caps and microcaps without moving the price too much. Perhaps most importantly, the retail investors only fees are brokerage which can be as low as $1 per trade. 5 trades a month could cost a whopping $60 a year. Compare that to a $3 million ETF portfolio with an average MER at a stingy 25bp costing $7500 a year.

The data show that most passive funds beat active funds over the long term. Does it deductively follow that most passive ETF retail portfolios beat active retail portolios?

[Bylo Selhi]

Welcome to FWF.

A single retail investor actively managing a stock portfolio seems much different. Most would be managing a portfolio of less than 5 million, and many less than 2 million. They can overweight a hunch as they see fit. They can be nimble when they need to be. They can play small caps and microcaps without moving the price too much. Perhaps most importantly, the retail investors only fees are brokerage which can be as low as $1 per trade. 5 trades a month could cost a whopping $60 a year. Compare that to a $3 million ETF portfolio with an average MER at a stingy 25bp costing $7500 a year.

"They can" do this. "They can" do that. Do you have any evidence that single retail investors in general (as opposed to a specific single retail investor) can do this productively, i.e. achieve higher net returns than that 25bp index fund, and can do this consistently over the long term? If not, then how does one determine in which group one belongs?

[queerasmoi]

Perhaps most importantly, the retail investors only fees are brokerage which can be as low as $1 per trade. 5 trades a month could cost a whopping $60 a year. Compare that to a $3 million ETF portfolio with an average MER at a stingy 25bp costing $7500 a year.

...umm... in Canada? Where the heck would you get away with paying $60 a year for 5 trades a month?? That is not realistic. Even if your broker is IB, there's a monthly minimum activity fee of $10 so you're paying $120/year.

[paper prophet]

Do you have any evidence that single retail investors in general (as opposed to a specific single retail investor) can do this productively, i.e. achieve higher net returns than that 25bp index fund, and can do this consistently over the long term?

I do not. I did not mean to imply that I did, rather I wanted to indicate what a retail active investor can do that a manager of a large active fund cannot.

Do you have any evidence that single retail investors using a passive ETF/index fund portfolio outperforms, on average, a retail investor who actively manages their portfolio?

(BTW, I realize that rephrasing the question you asked could be perceived as "cheeky" in the virtual world, but just so are aware, it is not intended as such).

[Lado]

Paper Prophet:

In order for a retail investor to beat the market he must have an edge over other market participants. You have, in my opinion, correctly pointed out some of the edges that a retail investor has in terms of being nimble, having the flexibility to over-weight certain sectors, not affect the price of stock when making a trade and invest in small and microcap stocks.

However, I think these factors alone do not provide enough of an edge to consistently beat the market. Other possible edges may include performing analysis in a manner that others aren't, better timing of entry and exit points, etc. If you are going to pursue an investment methodology that includes individual stock selection as opposed to simply buying a market ETF, ask yourself "What edge do I have over other investors?". If you can't answer that question, you should think long and hard about buying individual stocks.

The sideways market we are currently in makes it tremendously difficult to outperform the market. However, there are ways to beat the market but it certainly isn't easy.