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Reversion to the Mean

A helpful place to also put any annual reports etc, of your own portfolios
forrado
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Reversion to the Mean

#202806

Postby forrado » February 21st, 2019, 7:14 am

In The Little Book of Common Sense Investing (first published 2007, updated 2017) the recently departed John Bogle devoted a chapter headed “Reversion to the Mean”. In which he claimed that no matter how much an actively managed mutual fund outperformed a given index over rolling 5-year periods, at some point, 99 out of every 100 of them will begin to underperform – see …

https://www.investopedia.com/terms/m/meanreversion.asp

Bogle commented that this underperformance of an index was the result of a combination of factors at play. Such as a change of manager, a change of investment approach or just plain poor stock selection. Also, he added, not to forget the long-term dilution effect of charges on actively managed mutual fund returns.

Having recently sat down and analysed the performance of my SIPP over the past 7 years this reversion to the mean effect appears to be visiting itself on my portfolio following some 5 years of outperformance.

Early on I decided to take a very global approach with my SIPP holdings, adopting the FTSE All-World Index as the most appropriate benchmark. Furthermore, I settled on the Vanguard FTSE All World ETF as a more realistic after-charges yardstick, even though this particular Vanguard EFT was launched on 22/05/2012, and some 6 months after that of my SIPP.

Now for the numbers:

Starting value of my SIPP as of 29/10/2011 … £150,759.97 (all cash)
Value as of 21/02/2019 … £337,902.16
That’s an increase of 124.1%
Note # No monies have gone in or out of my SIPP during the period

Compared to Vanguard’s FTSE All World EFT (VWRL)
Which since launch on 22/05/2012 is up 130.9% (on a total return basis)

For supporting documentation see …

https://drive.google.com/drive/folders/1_nt5vIEA_3o1o-j1aRekJTgfdeCes-bK?usp=sharing

Oh dear! What to do going forward! Time for a rethink!
The most obvious course of action would be to change all my active horses in favour of one single FTSE All World Index passive mount and cover the entire field.

ADrunkenMarcus
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Re: Reversion to the Mean

#202815

Postby ADrunkenMarcus » February 21st, 2019, 7:50 am

I don't think your performance is bad.

Even passives (trackers) are guaranteed to under-perform any benchmark index because there will be (admittedly small) fees and potential tracking errors.

What's the SIPP invested in? Have these investments changed over the period? How has each investment performed?

Best wishes

Mark.

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Re: Reversion to the Mean

#202835

Postby forrado » February 21st, 2019, 9:20 am

ADrunkenMarcus wrote:I don't think your performance is bad.

Not being bad is not being good enough in my book. If overtime I can't beat a FTSE All World index tracker like Vanguard's ETF or HSBC's comparable OEIC, loaded as they are with low charges and miniscule tracking errors, then I'm the loser. I might as well buy the entire market and put my feet up for the duration while I wait.

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Re: Reversion to the Mean

#202927

Postby dspp » February 21st, 2019, 1:47 pm

forrado wrote:
ADrunkenMarcus wrote:I don't think your performance is bad.

Not being bad is not being good enough in my book. If overtime I can't beat a FTSE All World index tracker like Vanguard's ETF or HSBC's comparable OEIC, loaded as they are with low charges and miniscule tracking errors, then I'm the loser. I might as well buy the entire market and put my feet up for the duration while I wait.


Sounds correct to me as the rational conclusion from the observed facts :)

dspp

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Re: Reversion to the Mean

#202992

Postby Lootman » February 21st, 2019, 6:15 pm

forrado wrote:
ADrunkenMarcus wrote:I don't think your performance is bad.

Not being bad is not being good enough in my book. If overtime I can't beat a FTSE All World index tracker like Vanguard's ETF or HSBC's comparable OEIC, loaded as they are with low charges and miniscule tracking errors, then I'm the loser. I might as well buy the entire market and put my feet up for the duration while I wait.

Depends how you define "loser". It is fairly well known that most active investors under-perform a neutral and passive tracker. But that doesn't mean they should not try. By trying and failing they presumably learn things that they would never learn by holding a single global tracker, and that may help them do better in the future.

Where a problem arises is where an investor fails, as most do, but doesn't understand why. In fact the very act of measuring your performance shows a healthy attitude towards learning. It would not shock me if most active investors not only fail to beat the index but nonetheless believe that they actually beat it. Or at least believe in some excuse why they did not.

If you enjoy following the market and managing your portfolio, and you come in a little under the index, that's not a tragedy, as long as you derived other benefits from doing it. People enjoy betting on the horses without necessarily winning money.

The other factor of course is that most of any investor's returns come from beta, absent a few. So beating the market is really a matter of a few successful tilts and skews to a neutral portfolio, rather than making massive bets on a handful of prospects. So you can mostly track the index but have some fun around the edges trying to capture some alpha without taking too much risk to your wealth.

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Re: Reversion to the Mean

#203022

Postby Hariseldon58 » February 21st, 2019, 8:10 pm

@Forrado

I think you are being hard on yourself...

You have previously posted the holdings in your SIPP and I rather think you are comparing apples and oranges.

I have previously held an Investment Trust portfolio, in a similar style to your portfolio and made the move to a portfolio that is similar to an All World Tracker, using individual ETFs that I could adjust to my prejudices ( more small, value and less Japan)

This worked well but I have largely moved back to the IT approach over the last six months because of reversion to the mean, oddly the reason you have doubts !

The World tracker approach is good, simple and cheap but it is heavily biased to one market (the US that has had a wonderful run), the US market is likely to revert to the mean and those areas of the market that have done badly are likely to do have their day in the sun. I believe that there are areas of investment that have done quite poorly and should do well in the future (trouble is when....)

Sterling and the UK market is really hated and detested because of the B word and I believe that the matter will be resolved one way or another and be positive for both.

IT discounts are attractive in many areas and combined with modest gearing there is room for progress.

Clearly we are now seeing ETFs covering value , size , income strategies etc etc..

When the current situation is resolved, I will probably return to the passive , smart beta approach but ITs do have a lot going for them.

John Bogles premise about reversion to the mean is probably about right, investors get the trend right but take it too far, in both directions.

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Re: Reversion to the Mean

#203200

Postby ADrunkenMarcus » February 22nd, 2019, 1:49 pm

Hariseldon58 wrote:IT discounts are attractive in many areas and combined with modest gearing there is room for progress.


How have the underlying assets performed? If the portfolio includes investment trusts and those are typically trading at a discount to their net asset value, then what would performance look like if that gap closed? Were they at a discount at the start of the period?

Surely an investment trust which sought to be a moderately leveraged world tracker would be likely to outperform over the long term due to judicious use of borrowing?

Best wishes

Mark.

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Re: Reversion to the Mean

#203222

Postby Hariseldon58 » February 22nd, 2019, 3:19 pm

@ADrunkenMarcus

Back of the envelope calculations for one UK trust I hold , suggests the 10% discount and approx 10% ish gearing is probably worth around .5% a year after the charges and costs (around 1%).

For a modestly geared low cost IT that was effectively a world tracker, the gearing would probably cancel out the charges over time.

In the active passive debate the Investment Trust structure is such that the costs need not be a huge drag.

The managers need to be sensible though .... numerous trusts went into the 90’s with very long term debt , at double digit interest rates... it didn’t end well.

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Re: Reversion to the Mean

#203225

Postby dspp » February 22nd, 2019, 3:28 pm

ADM,
Surely leverage simply amplifies beta ? That's fine if it is going in the right direction, not so good if it is not.

Forrado,
Likewise I also think you shouldn't be at all hard on yourself. Nevertheless, as I am sure you know from the way you are writing, anybody who is a personal investor ought to be asking themselves the exact same question - "why do I think I am better than average", and if the answer is "no" then a highly diversified tracker is a logical place to be. That I'm probably fooling myself is a thought I often have.

hs58,
Over what timescale can one reasonably make predictions about relative 'macro' movements ? Whilst I agree with you and have so overweighted non-US vs USA in my own portfolio I am by no means sure I am correct as it all depends on the timescale I look at the past history on. 10 yrs, 50 yrs, 500 yrs - makes a big difference to where China / India were in global terms. Conversely I think (? Lootman ?) has been overweight in USA and profited strongly from it ('scuse me if it is another Fool I am remembering). If I recall correctly his argument was that the USA is the best run capitalist market in the world, and so far he has been right.

regards, dspp

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Re: Reversion to the Mean

#203288

Postby Hariseldon58 » February 22nd, 2019, 6:59 pm

@dspp

How long macro moves take .... I wish I knew.

I do believe you can give a portfolio a nudge in a certain direction, hopefully over time you will make a little extra.

I haven’t given up entirely on the US market (still have £600k or so of exposure) but when everybody thinks it’s a great idea ...

I suspect that we may see sterling and UK markets move in the next few months...

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Re: Reversion to the Mean

#203302

Postby Lootman » February 22nd, 2019, 7:53 pm

Hariseldon58 wrote:I haven’t given up entirely on the US market (still have £600k or so of exposure) but when everybody thinks it’s a great idea .

I recall the last time that the US was a significant under-performer relative to the rest of the world. It was 30 years ago. At that time the US had been doing well. After all, stock markets roared during the 1980s. But relative to other parts of the world it was weaker. Why?

The 1980's was the year of Japan. Europe was shedding communism and booming. The emerging markets were taking off. And the UK was enjoying the Thatcher boom. In contrast the US was just so-so.

By 1989 Japan was 40% of global market cap, and of course was destined to decline in both relative and absolute terms. The US is now in that situation, at something like 53% of global market cap. Nonetheless, I am about 60% invested in the US. My reasons:

1) The leading businesses are almost all US, from Apple to Boeing to JP Morgan to Amgen. Nowhere comes close.

2) When markets fall, the S&P 500 and the dollar do best, at least in relative terms.

3) Political stability - in no country is free-market capitalism so well entrenched.

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Re: Reversion to the Mean

#203368

Postby OhNoNotimAgain » February 23rd, 2019, 9:06 am

Lootman wrote:
Hariseldon58 wrote:I haven’t given up entirely on the US market (still have £600k or so of exposure) but when everybody thinks it’s a great idea .

I recall the last time that the US was a significant under-performer relative to the rest of the world. It was 30 years ago. At that time the US had been doing well. After all, stock markets roared during the 1980s. But relative to other parts of the world it was weaker. Why?

The 1980's was the year of Japan. Europe was shedding communism and booming. The emerging markets were taking off. And the UK was enjoying the Thatcher boom. In contrast the US was just so-so.

By 1989 Japan was 40% of global market cap, and of course was destined to decline in both relative and absolute terms. The US is now in that situation, at something like 53% of global market cap. Nonetheless, I am about 60% invested in the US. My reasons:

1) The leading businesses are almost all US, from Apple to Boeing to JP Morgan to Amgen. Nowhere comes close.

2) When markets fall, the S&P 500 and the dollar do best, at least in relative terms.

3) Political stability - in no country is free-market capitalism so well entrenched.


Don't kid yourself that US business is run by Boy Scouts.

Shares in Kraft Heinz dived 27 per cent on Friday as Wall Street reacted with alarm to a “disastrous” update in which the company took a $15bn writedown

https://www.ft.com/content/aa05152c-36a ... 459962a812


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