yes, I like this thread
Here’s another data point that may help address your question…
Of the 97 mutual funds in this space today, 24 of them were in existence on 01.01.1987. Meaning, that 24 of these funds had a 15 year track record, at the beginning of the 15 year time period we just analyzed. There were only 3 benchmarks with performance from 1.1.1987 - 12.31.2001, and those three generated 13.13% annual performance for those 15 years. Of those 24 mutual funds, only 8 outperformed those benchmarks…meaning 67% underperformed.
BUT, to directly address your point. How did those 8 outperformers from 1.1.1987 - 12.31.2001 perform in the subsequent 15 year period? The answer is that just 1 of them outperformed over the following 15 years. So, with MASSIVE hindsight bias allowing us to avoid all those crappy funds that died off due to bad performance…if we only chose ‘good funds with strong track records’ for the 15 years ending 2001, we would have bought 8 funds, and 7 of those would have underperformed the market over the next 15 years. Only 1 fund outperformed the entire way.
Yeah, this last post answered it. And while STL is generally a thoughtful guy, it’s clear he is either purposefully ignoring the economic significance of survivorship bias or knows that understanding this would hurt his ability to sell. Perhaps he doesn’t have to think probabilistically in his role. At any rate, thanks for the discussion.
Survivorship bias has absolutely nothing to do with my job. It may surprise people here, but people in my position don’t even talk about performance. Analysts already have all the info they need. Institutional/professional buyers are much more interested in the process a fund uses and if it’s repeatable, and how the fund fits into an overall portfolio setting. Peer rankings, outperformance, attribution, alpha…really none of this comes up.
So, I wouldn’t say I’m ignoring survivorship bias. It’s more that I just don’t think it matters in practice. This is much more a personal matter than a professional one. If someone wanted to use this report as a reason to go passive, I have problems with that. Perhaps I haven’t been as thoughtful in my comments as I could have been so allow me to briefly restate. If you’re an advisor picking funds for your clients today and you look at this report and go, “gosh, I have a less than 1% chance of outperforming using an active manager for my small cap growth space” you’re retarded and shouldn’t be allowed to invest other people’s money.
Hopefully that clears up my position.
I think I understand your point, but I still do not understand how you think these things are not related. Even in this thread, you suggested that the past performance is a useful heuristic in choosing a fund manager. This means that if I naively relied upon only that criteria, I will be able to pick funds (from a pool of those who have existed 15 years) that outperform over the next fifteen years better than guessing funds. While I agree there could be variables here that make this true, they do not seem to be the case based on huskies above analysis. Of course anyone can look at the results after the fact and pick the winners, but our challenge is we have to make a determination today for the next fifteen years. And the base rate of this choice is not the same as the percentage of funds who have existed for 15 years and have beaten the index, since the persistence of outperformance seems to mean revert pre-fees.
Hopefully that makes sense. Posting from a phone is challenging on topics like these
STL said " Institutional/professional buyers are much more interested in the process a fund uses and if it’s repeatable, and how the fund fits into an overall portfolio setting. Peer rankings, outperformance, attribution, alpha…really none of this comes up. "
This I agree.
I also agree with Huskie that yes, I am 100% with you and active mgmt for the lack of better word stink.
But the funny thing is people dump money into active mgmt and hedge funds every year despite these damning reports. My previous fund never outperformed the benchmark but still managed just a tad under 1 billion - making its partners filthy rich in the process. My current fund is the same - we have never beat the benchmark or the market but we still have money from investors. The owner took homes in the 8 digits last few years riding the equity bull market. Investors never ask for the regression analysis to the bench, comparison to SP500, how much they have paid us in the form of 1.5/20, etc…They just meet/call for our investment process, meet with few people here and there and good to go for another few years.
The reason so many underperforming funds still attract assets is because the industry has done a very good job of marketing and altering the way we view and discuss returns. The average joe on the street doesn’t say ‘man, I should hire an advisor so they can get me access to the markets in a low cost broadly diversified and tax efficient portfolio so I can accomplish my financial goals in 25 years’. No, consumers are taught to outperform, to pick great stocks, to hop in and out of the market when appropriate, and of course, focus on short term activity and news.
After all, there’s not much money to be made on marketwatch.com or CNN money if they run the same ‘diversification pays off in the long run’ story. Their incentive isn’t to educate their readers, it’s to generate views that lead to higher ad revenue. And so, over time, this has become the default way our industry is perceived. Investing needs to be flashy and exciting, a form of entertainment. If you’re not blowing whistles and honking horns, shouting at the top of your lungs and working 100 hour weeks…you must not know what you’re doing. And so the tens of thousands of mostly clueless employees who manage a company’s 401k benefits, or sit on the board of directors for an endowment or foundation have this default view of how things should be done.
But, of course, that’s changing. The wave of AUM from active to passive is in it’s early stages and we’ve got a long way to go before the mostly worthless employees of active managers are forced to find new employment in a field where they actually have a positive contribution to humanity. There will always be greedy investors, easily led astray by the promise of outperformance, and they’ll pay high fees to underperform…so it’s not like active management is going away, it’s just that it’s heyday is far behind it.
maybe but I think it is simpler than that. Plus, investors at HF and PE are not average Joe like you have suggested. They are institutional investors, which for individuals is minimum 25MM in investable assets. But most are fund of funds or banks or pension funds with few CFA charters here and there and a lot more folks with impressive MBAs. They just go with the flow.
For me, I don’t care if you are special situations, long short equity, large cap value, etc…All I care is how much money did I make net of fees and did you guys beat SP500?? I say SP500 because well it is easily investable at very very cheap price. So for me, is it worth it to jump through hoops and pay all these fees only to lag SP500 (even if they say well your risk downside was blah blah and sharpe ratio is blah blah)…I’d say to them ok that is all rosy and all but at the end of the day I would have taken home more money if I went with Vanguaed SP500??? Why the ef did I pay you guys and what for? But i think people invest because they think they will hit the jackpot…Or like STL has said, people don’t give a damn. “check that last name sounds right, check that school is a great school, check their process sounds good”
Again, I probably could have been clearer. Taken by itself, past performance is not indicative of future results. However, let’s say I’m evaluating a fund. I’m going to look at performance data going back a long time. 15 years is a pretty good time frame. Either one of two things could have happened during that time. Either the PM team has essentially stayed the same, or there have been significant changes to the team. If it’s the former, then I do put quite a bit of weight on past performance. If it’s the latter…not so much.
So let’s stick with the first scenario. Same team has been managing the fund through a market cycle or two. Next I’d want to find out if they have a disciplined process they’ve adhered to, or are they gunslingers (think Bruce Berkowitz). If I’m using this fund as part of a larger portfolio, I want the former because I can’t account for the latter and I have less faith that their past success can be repeated.
Now I’ve narrowed my funds down to tenured managers that stick to a disciplined process. I get on a call with the team and find out when they believe their process should be in favor and when it should be out of favor. I’ll take a look at monthly or quarterly attribution to see if what they’re saying matches up with their fund’s performance profile. If everything checks out and assuming the fund has the characteristics I’m looking to add into my larger portfolio, I’m now about as confident as I can be that I’m making the right decision.
That’s a very simplified example, but hopefully that gives you some additional context when I’m talking about past performance. I’m not (just) talking about absolute returns, std dev, or MPT stats. Those matter, of course, but I’m taking a much more holistic, philosophical view of the team’s past “performance.”
If you’re going to invest in fundamentally run funds, you have to believe in the team and the process. The only way to do that is to judge them on how they’ve done in the past (or maybe they wow you with some new mousetrap, but outside of the liquid alternative space I’ve never seen that happen).
Hopefully that clears up my earlier statements.
I might work at an actively managed fund that may or may not be in the small cap space. Net of fees It has outperformed it’s benchmark over the last 15 years (Russell BM). I agree with Huskie’s reasoning but also see the truth and value in STL’s statements. Individuals have very different strategies for investing than large pension consultants and view risk/return differently.
large funds cant just hold cash like us peons, theyMUST be invested at all times.
thats why folks that dont have significant skin in the game have no credibility with me, doesnt matter what your last name is or what school you went to or what gpa you got.
we win or lose together.
So clearly your position is that it’s possible to pick funds that will outperform in the future. And, provided there’s not significant manager turnover, you place ‘quite a bit of weight on past performance’.
So it’s 2002, and I ask STL to pick me a winning large cap value fund for the next 15 years. As I’ve already shown, there are only 24 mutual funds in this space with a 30 year track record. STL is going to look at 15 year returns because, as he’s said, he places quite a bit of weight on that factor. As we know, 8 of those 24 funds had outperformed from 1987 - 2001, so STL is going to start his search with those 8 funds. And somehow, through his interview skills, he is going to eliminate the 7 funds that subsequently under-performed and find you the 1 fund that did outperform.
We know that STL had many more options than just those 24 funds though, we’re giving him the benefit of the doubt that he would have ignored the hundreds of other options in this area of the market over the years. We’re also giving him the benefit of the doubt that he would have maintained discipline for the full 15 years and never made a manager change. And even with those two extremely generous assumptions, his odds were still 1 in 8. All of this, and we haven’t even talked about taxes. Dollars in your pocket are what matters, and active mutual fund managers are less tax efficient than passive index funds. And if you’re going to turn managers over, there’s going to be capital gains due each time. We do this analysis with after tax returns and it’ll make the SPIVA numbers look pretty.
STL, your ‘process’ is incredibly generic. “we’ll look at returns, do an interview, make sure they have a real office, maybe some background checks, get their outlook on the utilities sector”. There is zero chance that you have any skill in picking winning funds. Even guys that actually belong in this space don’t have that skill. Buffett’s bet is a classic example of this. He let Protege Partners pick 10 hedge funds that would beat the S&P 500 over 10 years, and they didn’t even come close to succeeding. Not even close.
The fact is the majority of mutual funds underperform because they charge too much. And if the majority of funds underperform, the odds of selecting funds that beat an index are even smaller. And while that means it’s perfectly reasonable for someone to pick a winning fund for a short period of time, when we talk about meaningful amounts of time, say 15+ years its virtually impossible to outperform the stock market by simply picking winners and losers.
This is what I was alluding to with my HF and PE comment. There are certainly investors with needs that span beyond just generating market beating returns and they can’t get this by paying vanguard 0.05% in annual fees.
All valid points, but 99.43% still seems really high. Is that number legit?
Who invited this guy? Nah man, it’s fake.
So STL, your point seems to be the base rate vastly improves if you have 15 year track record and consistent manager and process? If that’s the case, that is an interesting point and it is an empirical question. Although the third variable (consistent process) seems like it’d be hard to quantify for the study. I don’t think we can find any data to dispute this hypothesis, but it does seem like we could test for the first two (probably need shorter time periods though). Interesting.
yes, they do win and lose together but mostly because they cannot deviate from their investments and cannot short. But with the cash issue, I believe they can hold up to 40% of cash at any one time - not sure on this since I am not familiar with mutual funds regulations
http://www.barrons.com/articles/for-mutual-funds-how-much-cash-is-too-much-1414818549
i heard a similar statistic for large cap active funds. 99% underperform after tax is considered (they didnt sound to confident on this number).
from a mornign star rep: 27% of active funds outperfrom index couterparts BEFORE TAXES on a 10 year track record, before taxes. so for after taxes this’ll be worse.
Couple points:
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HF/PE should not be included in this discussion. Private credit, roll up strategies, etc have access to valuable non public information that changes the game. I agree equity L/S has been tough, but that will not always be the case (see point 3).
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Over the last 15 years S&P says that their indices did extremely well. Ok, let’s take that at face value. It is unlikely that most finance professionals or layperson investors could handle the ride. 15 years puts you in Jan 2002, just after 9/11 and in 2000 the sp500 lost 9% then an additional 12% in 2001 following an unprecedented bull market in the 90s. Great, you’re fully invested, you got in cheap. Then in 2002 the sp500 loses an additional 22%. Most people cannot tolerate that and would sell at some point. Look up one of those charts that show investor returns versus market returns…investors underperform by a huge margin I believe.
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This discussion reminds me a little of 2010 when the sp500 returned basically zero on a trailing 10 year basis and people were talking about the end of equity investing. Well, we know how that turned out. Every single year since has been positive for the sp500 and return has been tough to beat in any other asset class. Again, this will not always be the case.
Yeah, that’s probably the hardest part. And, no one knows what’s going to happen in the future. You may pick a fund for all the right reasons but the market works against you. For instance, the large value space is an area where you generally win by picking funds that are a little more conservative. But this only works over the course of a full market cycle (the manager makes their alpha by protecting on the downside). You could have picked a great, rather conservative, large value fund in 2009 and still be trailing the index because we’ve been in this bull market forever. So, even if you pick a fund for all the right reasons, it may still go sideways on you.