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Disclosure
for Backtested Performance Information on the Simulated Strategies of
IFA Indexes and IFA Index Portfolios (Indexfolios):
1. Index Funds Advisors,
Inc. (IFA) was incorporated in March 1999 and placed its first independent
client investments in early 2000. The performance information presented
in the chart or table represents backtested performance based on combined
simulated index data and live (or actual) mutual fund results from Jan
1, 1928 to period ending date shown using the strategy of buying, holding
and annually rebalancing globally diversified portfolios of index funds.
Backtested performance is hypothetical (it does not reflect trading
in actual accounts) and is provided for informational purposes to indicate
historical performance had the index portfolios been available over
the relevant period. IFA did not offer the index portfolios until November
1999. Prior to 1999, IFA did not manage client assets. The
IFA indexing investment strategy is based on the principles of Modern
Portfolio Theory and the Fama and French Three Factor Model for Equities
and Two Factor Model for Fixed Income. Index portfolios are designed
to provide substantial global diversification (approximately 11,600
companies in 40 countries) in order to reduce investment concentration
and the resulting increased risk caused by the volatility of individual
companies, indexes, or asset classes. Client portfolios are monitored
and rebalanced, taking into consideration risk exposure consistency,
transaction costs, and tax ramifications to maintain target asset allocations
as shown in the twenty index portfolios.
2. A review of the
IFA
Index Data
Sources and IFA
Indexes Time Series Construction is an integral part of and should
be read in conjunction with this explanation of backtested performance
information. For detailed descriptions and definitions of the underlying
criteria and data used to construct backtested performance, see these
two links: Data
Sources and IFA
Indexes Time Series Construction. Simulated index data is based on
the performance of indexes as described in the Data
Sources page. The index mutual funds used in IFA’s twenty index
portfolios are IFA's best estimate of a mutual fund that will come closest
to the index data provided in the simulated indexes. Simulated index data
is used for the period prior to the inception of the relevant live mutual
fund data an equivalent mutual fund expense ratio is deducted from both
live and simulated data. Live (or actual) mutual fund performance is used
after the inception of each mutual fund.
The IFA Indexes Times Series Construction goes back to Jan. 1928 and
consistently reflects a tilt towards small and value equities over time,
with an increasing diversification to international markets and the real
estate index as data became available. In Jan. 1928, there are 4 equities
indexes and 2 bond indexes, in Jan. 1970 there are a total of 8 indexes,
and there are 15 indexes in March 1998 to present. If the original 4
equity indexes from 1928 are held constant until Dec. 2009, the annualized
rate of return is 10.31%, after the deduction of a 0.9% IFA advisor fee
and a standard deviation of 22.80%. The evolving IFA Indexes over the
same period have a 10.57% annualized return after the same IFA fees and
a 22.00% standard deviation. It is IFA’s advice that the value
of having a longer time series exceeds the concerns of index substitutions
over the 1928 to present period. Due to the very high standard deviations
of returns (22%) a 60 year or more sample size of data is recommended
to reduce the standard error of the mean. In other words, in IFA’s
opinion, smaller sample sizes introduce larger errors than the errors
introduced by stitching together indexes over time. This is the advice
IFA provides to its clients. Click HERE
to see the analysis of the evolution of these portfolios.
Backtested
performance is calculated by using a computer program and monthly returns
data set that starts with the first day of the given time period and
evaluates the returns of simulated indexes and index mutual funds, see
Data Sources. In 1999, tax-managed funds became available for many
different index funds. IFA uses tax-managed funds in taxable accounts.
The tax-managed funds are consistent with the indexing strategy, however,
they should not be expected to track the performance of corresponding
non-tax-managed funds in the same or similar indexes. As such, the
performance of portfolios using tax-managed funds will vary from portfolios
that do not utilize these funds.
3. Backtested
performance does not represent actual performance and should not be interpreted
as an indication of such performance. Actual performance for client accounts
may be materially lower than that of the index portfolios.
Backtested
performance results have certain inherent limitations. Such results do
not represent the impact that material economic and market factors might
have on an investment adviser's decision-making process if the adviser
were actually managing client money. Backtested performance also differs
from actual performance because it is achieved through the retroactive
application of model portfolios (in this case, IFA’s twenty index
portfolios) designed with the benefit of hindsight. As a result, the models
theoretically may be changed from time to time to obtain more favorable
performance results.
4. History
of Changes to the IFA Indexes:
1991-1999: Index
portfolios
10, 30,
50, 70
and 90 were originally
suggested by Dimensional Fund Advisors (DFA), merely as a example of
globally diversified investments using their many custom index mutual
funds, back
in 1991 with moderate modifications in 1996 to reflect the availability
of index funds that tracked the emerging markets asset class. iPortfolios (individualized and indexed)
between each of the above listed portfolios were created by IFA in
1999 by interpolating between the above portfolios. Portfolios 5,
95 and 100 were created by Index Funds Advisors in 1999, as a lower
and higher extension of the DFA 1991 risk and return line. As of March 1, 2010, 100 iPortfolios are available to IFA clients, with iPortfolios between the shown allocations being interpolations of the 20 allocations shown.
In January 2008, IFA introduced three new indexes and twenty socially responsible
portfolios constructed from these three indexes and five pre-existing
IFA indexes. The new indexes introduced were: IFA
US Social Core Equity, IFA
Emerging Markets Social Core, and IFA
International Real Estate.
All three use live DFA fund data as long as it has been available. Prior
to live fund data, they use index data supplied by DFA modified for fund
management fees.
Click Here to see a summary of changes made to the IFA Indexes and Portfolios.
5. Backtested performance results assume the reinvestment
of dividends and capital gains and annual rebalancing at the beginning
of each year. In reality, client’s accounts will be rebalanced
either more or less frequently depending on the fluctuation of the asset
classes and the cash flow activity of the client. It is IFA’s opinion
that the assumption of annual rebalancing is a reasonable approximation
to reality. It is important to understand that the assumption of annual
rebalancing has an impact on the monthly returns reported for the IFA
index portfolios in both Table
11.9 and in the Index Calculator.
The reason for this difference is that with annual rebalancing, the monthly
returns are calculated by applying the asset class percentages to the
year-to-date returns as of the beginning and the end of the month, unlike
monthly rebalancing which assumes that the portfolio is perfectly in
balance at the beginning of the month. Below is an example of the monthly
and year-to-date returns for October 2009 and how they would have differed
if monthly rebalancing had been assumed:
| |
Reported Return for
October, 2009
(Assuming annual
rebalancing on Jan. 1) |
October, 2009 Return
(Assuming monthly
rebalancing) |
| Index Portfolio 5 |
-0.57% |
-0.43% |
| Index Portfolio 50 |
-2.45% |
-2.24% |
| Index Portfolio 90 |
-3.79% |
-3.85% |
| Index Portfolio 100 |
-4.43% |
-4.55% |
| |
Reported Return for Year-to-Date
October, 2009
(Assuming annual
rebalancing on Jan. 1) |
Year-to-Date October, 2009 Return
(Assuming monthly
rebalancing) |
| Index Portfolio 5 |
5.60% |
5.75% |
| Index Portfolio 50 |
16.93% |
17.18% |
| Index Portfolio 90 |
27.00% |
26.64% |
| Index Portfolio 100 |
28.48% |
27.99% |
The reason for the small difference in the monthly returns observed
above is that a mixed equity and fixed income portfolio like IFA Portfolio
50 that started on January 1st would be overweight in equities and underweight
in fixed income at the beginning of October. Since equities did worse
than fixed income in October, the annually rebalanced portfolio did worse
than the monthly rebalanced portfolio. However, on a year-to-date basis,
the annually rebalanced portfolio did better because the monthly rebalanced
portfolio would have sold equities only to see them rise further. It
is IFA’s opinion that the overall impact of the assumption of annual
rebalancing on the reported monthly and year-to-date returns is not material
enough to warrant the creation of a second set of monthly figures. It
is important to bear in mind that for any given month, the difference
in the expected returns between annually and monthly rebalanced portfolios
is statistically insignificantly different from zero.
The performance of the twenty IFA index portfolios reflects and is net
of the effect of IFA’s annual investment management fee of 0.9%,
billed monthly. Monthly fee deduction is a requirement of our software
used for backtesting. Actual IFA advisory fees are deducted quarterly,
in advance. This fee is
the highest fee IFA has ever charged. Depending on the size of your
assets under management, your investment management fee may be less.
Backtested risk and return data is a combination of live (or actual)
mutual fund results and simulated index data, and mutual fund fees and
expenses have been deducted from both the live (or actual) results and
the simulated index data.
Although index mutual funds minimize tax liabilities from short and long
term capital gains, any resulting tax liability is not deducted from
performance results. Performance results also do not reflect transaction
fees (as seen here)
and other expenses charged by broker-dealers, which reduce returns. IFA
is not paid any brokerage commissions, sales loads, 12b1 fees, or any
form of compensation from any mutual fund company or broker dealer. The
only source of compensation from client investments is obtained from
asset based advisory fees paid by the client.
More information about advisory fees, expenses, no-load mutual fund fees,
prospectuses for no-load index mutual funds, brokerage and custodian
fees can be found on the HERE
and on the Fee link in the gold navigation bar below and on every
page of this internet site.
6. For all data periods,
annualized standard deviation is presented as an approximation by multiplying
the monthly standard deviation number by the square root of twelve. Please
note that the number computed from annual data may differ materially from
this estimate. We have chosen this methodology because Morningstar uses
the same method. (see
IFA Indexes Time Series Construction)
In those charts and tables where the standard deviation of daily returns
is shown, it is estimated as the standard deviation of monthly returns
divided by the square root of 22.
7. Not all of IFA
clients follow our recommendations and depending on unique and changing
client and market situations we may customize the construction and implementation
of the index portfolios for particular clients, including the use of
tax-managed mutual funds, tax-loss-harvesting techniques and rebalancing
frequency and precision. In taxable accounts, IFA uses tax-managed index
funds to manage client assets. However, the tax-managed index funds are
not used in calculating the backtested performance of the index portfolios,
unless specified in the table or chart. Some clients substitute the mutual
funds recommended by IFA with investment options available through their
401k or other accounts, thereby creating a custom asset allocation. The
performance of custom asset allocations may differ materially from (and
may be lower than) that of the index portfolios.
8. Performance results
for clients that invested in accordance with the Index
Portfolios will vary from the backtested performance provided on the
site due to market conditions and other factors, including investments
cash flows, mutual fund allocations, frequency and precision of rebalancing,
tax-management strategies, cash balances, lower than 0.9% advisory fees,
varying custodian fees, and/or the timing of fee deductions. As the result
of these and potentially other variances, our clients have not and are
not expected to have achieved the exact results shown since November 1999,
when we placed our first investment. Actual performance for client accounts
may differ materially from (and may be lower than) that of the index portfolios.
Clients should consult their account statements for information about
how their actual performance compares to that of the index portfolios.
9. As with
any investment strategy, there is potential for profit as well as the
possibility of loss. IFA does not guarantee any minimum level
of investment performance or the success of any index portfolio or investment
strategy. All investments involve risk (the amount of which may vary significantly)
and investment recommendations will not always be profitable.
10. Past performance
does not guarantee future results.
11. WHY GO
TO ALL THIS TROUBLE?
This type of analysis
is important because a shorter time period introduces a large statistical
sampling error for both risk and average returns. Past performance does
not predict future performance, however, analyzing 30 years or more of
simulated risk and return data is a more reliable source of information
concerning the cost of capital for firms and their shareholders and the
resulting expected returns for investors who trade their cash for shares
and bonds of those firms. That is the essence of capitalism.
The result of this
data is a probability distribution with an average return and a standard
deviation around the average, which best characterizes future random events
that are totally unpredictable like the roll of the dice or flip of a
coin, yet these random events over long time horizons, like 30 years or
more, accumulate to new distributions. These distributions are, to varying
degrees, similar to a large sample of previous distributions, such as
30 years. Shorter time horizons demand lower risk investments, while longer
time horizons allow for regression to the mean. The "mean" refers
to the average expected outcome of returns, which is also the most probable
outcome. The distribution of historical market data is a leptokurtic distribution,
meaning it is not conclusive in any way as to the limits of losses or
gains (see
Leptokurtic distributions). The dice and coin flip does have
limits, but the market does not. There is an unlimited risk on stock market
investments that can not be clear in even very long term historical data.
For example, in the stock market crash of 1929, the market declined 89%
and many investors had leveraged their capital and lost all of their investment.
The stock market is a risky investment and investors can lose all or nearly
all of their money because of the risk of firms going out of business,
general macroeconomic and political risk, and challenges to the ideas
of capitalism in general.
IFA utilizes standard deviation as the quantitative measure of
risk of both portfolios and indexes. This is based on the idea that distributions
of returns are approximated by a normal (bell-shaped) distribution. If,
for a particular investment strategy, the underlying distribution of
returns is not normal, then historical standard deviation is not an appropriate
measure of risk. For example, some investment strategies have a systemic
failure risk which does not show up in the historical standard deviation
during a period when the strategy is successful. An example of such a
strategy is selling put options to generate a steady stream of income.
Another example is the use of leverage which increases returns during
successful periods but also increases the probability of a complete collapse.
However, this analysis
is far more useful than the traditional 1, 3, or 5 year returns and risk
data used by the great majority of individual and professional investors.
Without such longer term analysis, investors would be merely speculating
on the risks and expected returns of their investments with a statistically
unacceptable sample, like a gambler in a casino hopelessly trying to beat
the casino statistician, who may be referred to as the dice, card, and
roulette wheel actuary. This is in fact what investors do and several
of studies have confirmed it is the source of their near zero average
returns over the last 17 years, after inflation and taxes. As Louis Bachelier
stated in the first published paper on the random character of stock market
data, The Theory of Speculation (1900), "the expected return of speculation
is zero." Statistically speaking, investors have a relatively high
standard error of the mean (average return) with data of less than 30
years.
Because Index Funds
Advisors is recommending mutual funds that correlate to the investment
criteria of the simulated index data, there is a greater chance that the
data is useful to index funds advisors than it is to actively managed
mutual fund advisors that do not replicate the index and therefore engage
in style drift. Past performance for active managers is an especially
poor indicator of future results, due to the relatively small number of
years of performance data available for each active manager and the fact
that even during that period they are style drifting.
This analysis and
investment strategy is consistent with Modern Portfolio Theory, which
is the term used to summarize the combined research of Harry Markowitz,
William Sharpe and Merton Miller. They were awarded the Nobel Prize for
Economics in 1990 for their efforts to describe how financial markets
work and how to build efficient portfolios.
12. IFA Index and Index Portfolio (Indexfolios) Value Data is based
on a starting value of one, as of Jan 1, 1928. (Calculator).
Sources and Disclosures: As stated above, dfaus.com, and yahoo.com.
13. Your use of this
site is acknowledgement that you have read and understood the full
disclaimer. Index portfolios times series standard deviations and
returns source: DFA FA Returns 2.0. © Copyright 1999-2009.
14. IFA has chosen to use monthly rolling periods as the basis for many of it's analysis of risk and return over various periods of time. For a discussion of possible distortion of data associated with rolling periods, also referred to as overlapping periods, versus non-rolling periods, click here.
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The IFA Calculator:
See 82 years of monthly risk and return data for 20 Indexfolios and 19
Global IFA Indexes HERE. Over 40,000 monthly returns to analyze.
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