Active and Passive Management

• Passive management aims to match the return of a market index, exemplified by index funds, and was pioneered by Jack Bogle.

Benefits of Passive Management

• Diversification
• Lower costs
• Simplicity

Risks of Passive Management

• Total market risk

• Lack of defensive measures

• Performance constraints

• Active management seeks to outperform a market benchmark or achieve specific investment goals.

Benefits of Active Management

• Opportunity for outperformance.
• Utilizes in-depth research
• Defensive measures to minimize losses by avoiding certain securities, sectors, or regions.

Risks of Active Management

• Underperformance (over 90% underperform over 20 years)

• Higher expenses

• On average, mutual fund performance is less than broad market performance due to loads, high expense ratios, and high turnover ratios.

• Due to the paradox of skill, most mutual funds do not have manager money invested in them.

• AUM in ETFs is rising rapidly compared to Mutual Funds (even though Funds have more AUM)

• The arguments for active exposure is that passive investing settles for average, passive participant are price takers.

• Expert knowledge of foreign markets and investors seek different exposure than what an index provides.

• The BofA ICE High Yield Master II Index, created in 1989, tracks below-investment grade debt in the U.S., weighted by market capitalization.

• The S&P U.S. High Yield Corporate Bond Index, launched in 2013, includes bonds with a maximum rating of BB+, Ba1, or BB+, weighted by market capitalization.

• Market Weighted Bond Indices allocate more to companies with higher debt.

• International Geographic Allocations enable investors to pursue different international and sector allocations than an index provides.

Sins of Active Management

• Tax Impact: Active strategies often result in higher taxes.
• High Cash Holdings: a large cash position in an equity fund can lead to cash drag and underperformance.
• Style Drift: strategy shifts due to past success expiring or incorrect benchmark assignments.
• Herd Behavior: people engaging in the same investment trends.
• Closet Indexing: portfolios closely resemble an index while charging high fees.
• Window Dressing: marketing tactic falsely presenting better performance.

Characteristics of Active Outperformance

• Low fees and expenses.
• Low turnover
• High active share (fund is different than index).
• Firm-wide focus and close alignment of interests: manager has personal money at stake.
• Mutual funds and ETFs allow investment in specific asset classes and regions, with risk and return characteristics determined by the assets held.
• Smart beta uses academic methods.
• Thematic funds focus on specific themes like AI, Fintech, or Cannabis.
• Environmental Social Governance (ESG) funds often underperform and lack clear company fit explanations.
• Target Date funds become more conservative with age, suitable for 401k plans.
• Net Asset Value (NAV) is assets minus liabilities per share.
• Closed-end funds have a fixed number of shares, with prices trading at a premium or discount to NAV.
• Open-end funds have no share restrictions, with prices equaling NAV.

Mutual Fund Fee Structure

• Expense ratio

• Operating expense

• Front end load

• Back end load

• 12b1 charges

• Expense Ratio: Covers operating costs and research administration.

• Soft dollars are commission kickbacks for investment process costs which can hide costs.

• Operating Expenses are costs incurred by mutual funds in their portfolios.

• Front-end loads are commissions paid when purchasing shares which reduces money away before investing.

• Back-end loads are "exit" fees when selling shares.

• 12b-1 charges are annual fees for marketing/distribution.

• The first ETF was created in 1993 (SPDR), and ETFs now exceed $15 trillion.

ETF Advantages

• Trading continuously, shorting ability, potential for lower taxes and costs due to a lack of marketing fees.

• Passive index funds should have extremely low expense ratios like 0.03%

• Active mutual funds average expense ratio is 1%.

• Funds that have survived for a long time is good.

• Passive funds tracking the same index can have different performance due to replication strategy, transaction costs, or expense ratio.

• Fiduciary: acts in the client's best interest with a legal obligation to provide the best products.

• Suitability puts investments into products suitable to the investment objectives.

• Registered Investment Advisers: act as fiduciaries and collect 1% AUM.

• Brokers follow suitability standards and profit loads, commissions, wealth manager, consultant, or financial advisor titles.

• Dual Registrants act as fiduciaries when giving advice but brokers when selling products.

• Regulation Best Interest (Reg BI), effective June 30, 2020, amended the suitability requirement, addressing standards of care, disclosure, and conflicts of interest.

• Discount brokerage offers lower-cost security access without personalized advice.

• Robo Advisors use algorithms and model portfolios for investment allocation, charging lower fees than human advisors.

• Technical analysis predicts trends using market data patterns.

• Charts visualize human emotions in financial markets.

• Charles Dow is credited as the pioneer of technical analysis.

• Dow theory: states stock price movement is a form of technical analysis with sector rotation.

• Edwards & Magee identified stock trends as stock prices tending to move in trends, volume goes with the trends, and established trends tend to continue

Technical Analysis Assumptions

• Price is determined by supply and demand.
• Supply and demand are governed by both rational and irrational factors.
• Disregarding minor fluctuations in the market, prices tend to move in trends which persist for an appreciable length of time.
• Changes in trends are caused by shifts in demand and supply.
• Charts send advanced warnings of shifts in demand and supply.
• Market participants overreact to new information, are slow learners, and regularly change their minds.
• Markets Overreact using contrarian indicators like odd-lot trading and mutual fund cash positions.
• Contrarian Odd Lots recommends buying when odd lot sales are up.
• Contrarian Mutual fund cash positions suggest investing against peak positions (greatest at the bottom of a bear, lowest at the peak of a bull).
• The Contrarian Investment advisory considers the ratio of bearish advisory services, initiating buying when the ratio reaches a threshold (e.g., 60%).
• Shift in Supply & Demand employs contrarian indicators such as breadth of the market, support & resistance lines, and moving averages.
• Contrarian Breadth of the market measures the number of advancing stocks relative to declining ones.
• Support & Resistance Lines indicate potential major market movements if either is broken.
• Moving averages smooth trends to identify support and resistance.
• Fibonacci retracements are used as a type of Support & Resistance Line
• Bollinger bands are bands two standard deviations above and below a 20 day simple moving average.
• The interpretation of the bands is the price of an asset should remain within the bands about 95% of the time
• Relative Strength Index (RSI): Measures the velocity of a security's price movement to identify overbought (>70) and oversold (<30) conditions.
• Moving Average Convergence Divergence (MACD): Based on the convergence and divergence of 2 exponential MAs.
• Specialist Short sales have more information about future price movements than other investors and insider information can influence market directions.
• Elliott Wave Theory aims to predict price movements by identifying repetitive patterns, including Impulse Waves and Corrective Waves.
• Success in technical analysis depends on back testing, timely trading, and controlling trading costs.

Determinants of Technical Analysis Success

• Back testing

• Timely Trading

• Control Trading Costs

• Information regarding leadership can be gleaned from changes in short interest, insider selling, and large stock purchases.

Advantages of ETFs over Mutual Funds

• Trade Continuously

• More tax Efficient

• Open or Closed and can Have Front or Back End Load

• Sold Short

• There were losses due to 25% tariffs on Canada and Mexico.

• The equity markets ended the day with gains due to positive economic data.

Announcements

• A white house announcement that the tariffs would be delayed for a month.

• A white house announcement that the tariffs on automobiles would be delayed.

• The tariffs on Mexico and Canada would stay as is.

• Index funds can have different performances after fees and expenses due to different replication strategies, closet indexing, expense ratios, and transaction cost variations.

• The Carmen WSJ article suggests that the star system is strictly backward-looking and assesses past performance.

• Morningstar's star ratings influence financial advisors and investors, with 5-star funds displaying a high probability of future long-term outperformance; the system is a first stage screen, but not to be used in isolation.

• The registered investment advisor is held to a strict fiduciary standard.

• A with a load fund charges a sales commission, is defined as one in which the fund charges a sales commission to either buy into or exit from the fund.

• ESG (Environmental and Social Governance) is in which thematic funds has recently has experienced outflows.

• RSI measures the velocity of a security's price movement to identify overbought and oversold conditions.

• Charts capture supply and demand, fear and greed, monetary policy, economic cycles, and investor sentiment which Technical Analysts believe is captured in charts.