Sunday 17 November 2013

Passive Aggressive - It All Depends on Which Index You Choose

Much as I enjoy the active investment process, I do have a lot of sympathy for the passive index investors out there.

Although they do seem a bit too smug sometimes, I admit that they have some excellent advocates - including Warren Buffett, William (Four Pillars of Investing) Bernstein and of course the Grand-daddy of low-cost index investing, John Bogle.

But it seems to me that the results obtained depend crucially on which index you choose, and how you structure your portfolio. So I was intrigued when I came across a useful summary of performance of the key worldwide indices...

The summary is provided by the Accumulator and published on Citiwire. It provides an overview of a range of asset classes over different periods up to 5 years.

Here are a few of the more pertinent numbers (for the DIY Income Investor portfolio) from the 15/11/13 issue (which I hope I have copied correctly):
  • 2013 to date -
    • S&P 500: 29.2%
    • MSCI Europe ex UK: 24.8%
    • FTSE World: 22.3%
    • FTSE 100: 17%
    • Funds that can invest 40%-85% in shares: 9.2% 
    • UK Corporate Bonds: 2.5%
    • MSCI Emerging Markets: -2.5%
    • Gold: -22.2%
  • 3 years:
    • S&P 500: 59.9%
    • MSCI Europe ex UK: 30.4%
    • FTSE World: 38.0%
    • FTSE 100: 28.4%
    • Funds that can invest 40%-85% in shares: 18.7% 
    • UK Corporate Bonds: 24.8%
    • MSCI Emerging Markets: -3.3%
    • Gold: -7.3%
  • 5 years:
    • S&P 500: 111.0%
    • MSCI Europe ex UK: 76.2%
    • FTSE World: 94.6%
    • FTSE 100: 89.9%
    • Funds that can invest 40%-85% in shares: 56.8% 
    • UK Corporate Bonds: 63.8%
    • MSCI Emerging Markets: 97.6%
    • Gold: 58.0%

Compare those results with the total returns from my DIY Income Investor portfolio:
  • 2013 to date: 19%
  • 3 years: 47%
  • 5 years: 87%
(These numbers are calculated by adding the monthly value growth percentages, which are net of any new money added that month.)

I should point out that five years is a relatively short time, and does not include a full economic cycle - so any conclusions reached on such a small sample of results should be treated with caution. In particular it does not include the 2007/08 crash, which had a profound effect on my asset allocation. However, I personally find it difficult to look forward more than one year, let alone five; regular readers will know that my 'sell' rule is based on banking capital gains of more than five years' income - on the basis that this seems like a really long time during which anything could happen!.

But back to the index results. Not surprisingly, the funds - on average - don't seem to have performed very well (well they wouldn't would they, after sucking the life out of their investor's money). One surprise - to me - is gold, which some people got very excited about, but which has not really performed well over the three periods.

Turning to the good results, it looks as though if I had held a simple S&P 500 index ETF, then it would have beaten the portfolio - and it would certainly have been a lot less work! Holding the FTSE 100 index would have given results broadly similar to the portfolio. So ditto.

But the stand-out result for me is the FTSE World index, which has outperformed the portfolio, whilst being widely diversified geographically. This is not an income-oriented asset class per se but may be worth some further investigation.

Model Passive Portfolios

Being able to cherry pick indices after the event is not really convincing - what is needed are some passive portfolios to review. However, there just don't seem to be many featured on the Web (probably because it is basically quite boring - although in a good way).

One I am familiar with is Monevator’s Slow and Steady portfolio - a model passive investing portfolio. This was set up at the start of 2011 to show the features of passive investing and to discuss low-cost platforms and funds.  The 2013 Q2 update reviews the structure of the fund, made up of  low-cost funds for:
  • 25% North American equities
  • 24% UK Gilts
  • 15% UK equity
  • 12%  European equities excluding UK
  • 10% Emerging market equities
  • 7% Pacific equities excluding Japan
  • 7% Japanese equities

The gain up to 2013 Q2, since the creation of the portfolio at the start of 2011 - therefore covering two-and-a-half years - is given as only 17%: not a terribly exciting result, it has to be said. The portfolio emphasis on US equities proved to be correct - they put on an excellent performance but the 25% allocation to UK Gilts has been a brake on returns. However, as mentioned above, the comparison period is quite short: time will tell if this portfolio can blossom in the future.

The Importance of Asset Allocation

The point I want to make - and this is a common theme in investing academic research - is that portfolio asset allocation is probably a more important decision compared with the choice between 'active' versus 'passive' investing styles. And it is difficult to chose this allocation correctly because it is impossible to predict the future.

My own 'semi-active' approach (I now hold over 30% in income-oriented ETFs) is based on a belief that yield is a good indicator of risk (of course) but also of being 'out-of-favour' with the wider market - and that regression to the mean will, most of the time, work in your favour.

Unfortunately, we won't know which approach is more successful until it is too late to change.

[If any readers are aware of other passive portfolios that report their results - do comment below.]

Update 1/11/13. Read about Bogle Jr - the active investor!

I am not a financial adviser and the information provided does not constitute financial advice. You should always do your own research on top of what you learn here to ensure that it's right for your specific circumstances.


  1. Sisyphus I like your style of explaining the matter. Before any investment investor needs to take complete knowledge and advice in this regard.
    Venture Capital Trusts UK –

  2. Surely, you should be comparing your returns with the "Funds that can invest 40%-85% in shares", since this would be more inline with your portfolio. In this regard, you've considerably outperformed the benchmark.

  3. An interesting piece, sounds like you are being slowly evolving towards becoming an income investor (yes we are smug bunch - people don't become passive investors...they evolve). 5 years is a very short time frame, one of the big draw backs of an index investment approach is it arguably only really makes sense if your time frame is more like 20,30 or even 50 years!