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Disclosure for Backtested Performance Information on the Simulated Strategies
of IFA Indexes and IFA iPortfolios (Index Portfolios):
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 January 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 IFA i Portfolios. - 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 Social Responsible Index Portfolios or Investing for Catholics'
IFC Index Portfolios, please see SRI Index Portfolio Time Series Construction and Sources and Descriptions
of Data ).
Simulated index data is based on the performance of indexes and live mutual funds
as described in the
IFA Indexes Data Sources page
. The index mutual funds used in IFA’s iPortfolios 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 and an equivalent mutual fund expense ratio is deducted from
simulated index data. Live (or actual) mutual fund performance is used after the
inception of each mutual fund. Fees and expenses of mutual funds are deducted from
the monthly returns. prior to the reporting of the returns by the mutual fund company.
The IFA Indexes Times Series Construction goes back to January 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.
As of January 1928, there are 4 equity indexes and 2 bond indexes, in January 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 December 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 standard deviation
of 22.00%. IFA advises clients to diversify their investments, however, this stitching
together of index and live fund data and adding international and emerging markets
only had a slight impact on risk and return over this 82 year period. Instead, it
demonstrates the value of a small and value tilt in global equity markets, since
over the same period a Simulated SP500 only had a return of 9.33% (with no advisor
fee deducted), at a standard deviation of 19.32%.
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 and live data 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.
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 iPortfolios™) 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. - History of Changes to the IFA Indexes:
1991-1999: Index portfolios (IFA iPortfolio)
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. Portfolios (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.
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 iPortfolio 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:
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Reported Return for
October, 2009
(Assuming annual
rebalancing on Jan. 1)
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October, 2009 Return
(Assuming monthly
rebalancing)
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Index Portfolio 5
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-0.57%
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-0.43%
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Index Portfolio 50
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-2.45%
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-2.24%
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Index Portfolio 90
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-3.79%
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-3.85%
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Index Portfolio 100
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-4.43%
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-4.55%
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Reported Return for Year-to-Date
October, 2009
(Assuming annual
rebalancing on Jan. 1)
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Year-to-Date October, 2009 Return
(Assuming monthly
rebalancing)
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Index Portfolio 5
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5.60%
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5.75%
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Index Portfolio 50
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16.93%
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17.18%
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Index Portfolio 90
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27.00%
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26.64%
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Index Portfolio 100
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28.48%
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27.99%
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The reason for the small difference in the monthly returns observed above is that
a mixed equity and fixed income portfolio like IFA iPortfolios 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 IFA iPortfolios 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.
When IFA Indexes are shown in IFA iPortfolios, all returns data reflects a deduction
of 0.9% annual investment advisory fee, which is the maximum IFA fee. Your fee may
be less depending on assets under management at IFA. Unless indicated otherwise,
data shown for each individual IFA Index is shown without a deduction of the IFA
advisory fee. We choose this method because the creation, choice, monitoring and
rebalancing of diversified index portfolios are the services of the independent
investment advisor and at that point the fees are appropriate to deduct from the
whole portfolio returns. Since we accept no fees from investment product firms,
IFA compares index funds based on net asset value returns, which are net of the
mutual fund company expense ratios only.
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.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.
- 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.
- Performance results for clients that invested in accordance with the iPortfolios™ 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.
- 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.
- 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.
- IFA Index and Index Portfolio (also referred to as Indexfolio; IFA iPortfolio™)
Value Data is based on a starting value of one, as of January 1, 1928. (Calculator).
- 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 1999-2010.
- 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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