^ I need to use banal platitudes sometimes so people get the point that it is possible to beat the markets and there is nothing near perfect efficiency about them. To others, they don’t see it as a given that active investing can beat passive investing. As ohai mentioned the threshold is extremely hard when SPX is up 30 percent, but in years when the market does not go on a tear, i see active investors that beat it with measured regularity. It happens, and it happens more often than the academics know. It is just a shame that most of the people doing the academic writing or pontificating about whether active can beat passive aren’t actually investors themselves.
^ I need to use banal platitudes sometimes so people get the point that it is possible to beat the markets and there is nothing near perfect efficiency about them. To others, they don’t see it as a given that active investing can beat passive investing. As ohai mentioned the threshold is extremely hard when SPX is up 30 percent, but in years when the market does not go on a tear, i see active investors that beat it with measured regularity. It happens, and it happens more often than the academics know. It is just a shame that most of the people doing the academic writing or pontificating about whether active can beat passive aren’t actually investors themselves.
^OK. It makes a little more sense now. Certainly less tautological than “if you’re better than average, you’ll do better than most people.”
Well, most of Bogle’s written work seems to revolve around “if you pay smaller than average fees, and you’re average, you’ll do better than most people”.
And that core is hardly original original work (Malkiel, 73, building on Fama and Markowitz). Bogle gets well deserved praise for monetizing and publicizing that idea, which is useful to many people. That said, Haugen, Shiller and others have pretty much disproved it, even before Bogle started writing books (I’d say even Fama himself disproved it, although not deliberately, with the 3 factor model).
As a side note, net 8% instead of 6% compounds to twice the future wealth after 40 years (even adjusting for regular deposits/smaller Macaulay duration makes a big difference). Just blindly following Greenblatt’s latest book or Haugen’s criteria could represent the difference between retiring in Boca or in Hackensack - and Hackensack may be wildly overpopulated in 40 years.
Markets are not a zero sum game, markets are positive sum as long as there are productivity improvements happening in the economy. Alpha is a zero sum game (negative sum, if you include transaction costs), but markets arent.
The reason that a passive index is not a bad strategy is because over time the economy becomes more efficient at production, and these ultimately end up in profits that get distributed to shareholders. Sometimes the companies are able to capture the benefits of efficiency and the profit falls to the bottom line; sometimes companies have to cut their costs due to efficiency improvements, in which case what happens is that consumers have more money left over to spend on other things, so the company who is efficient does not benefit directly, but other companies benefit from the increased consumer surplus.
I agree in the long run markets are positive sum for the reasons you’ve mentioned, but in the short term and from a traders perspective they should be treated as zero sum.
You’re a trader now, numi? I thought the whole point of fundamental analysis was to make superior investment decisions over the long term. If you are a short-term trader, fundamentals tend not to revert very quickly, except if you have identified catalysts appropriately, which is in itself very challenging, but perhaps not impossible.
I don’t think anyone is saying that if you are going to retire in six months, it’s best to invest in a passive index, but you probably aren’t going to do any better with an active manager either: returns are just too noisy.
So what’s your logic: In the short term, your only hope of a positive outcome is an active manager, so just ignore the long term and pretend that returns are a zero sum game?
I know that it’s important for active managers to argue that passive investing is for idiots, but you should at least have your logic straight.
The arugment for active management is that you know who the suckers are and how to beat them. The suckers aren’t those who are indexing, it’s other people who aren’t indexing (which includes people who call themselves indexers but who aren’t able to maintain the discipline). If you know how to take money from those people on a consistent quarter-after-quarter basis, then you have a case for active management.
Finally, even trading is not zero sum. If I sell my portfolio because my liquidity needs have changed, or my risk tolerance has changed due to external cirumstances, it is entirely possible that the trade is win-win. People’s investment time frames are not all identical, and the same trade can be a winner or a loser depending on the timing of the trade. This means that the same trade can be zero sum, positive sum, or negative sum, and that’s one reason that trades in a free market can happen at all.
Trading patterns and catalysts almost always matter for well-executed entry and exit points, even for fundamental investors (and I would argue especially for fundamental investors, because most don’t pay enough attention to this kind of stuff).
I’m a fundamental investor, not a “trader” per se, but there is one thing that matters to what we do here and it’s just stuff that works and an event path to value. We have a very flexible mandate.
Also keep in mind if you work in anything investment related, you may have to report your trades and/or even get prior approval from your employer. Going with a passive indexing strategy may be worth it in order to not have to deal with this inconvenient red tape all the time.
I may as well follow a passive strategy b/c I don’t know shit like u negros.
But after cfa, why would I still be passive? Don’t even go for cfa if u want to be a passive pussy like greenballs.
^ CFA doesn’t teach you how to make superior risk adjusted return. There’s no literature out there that can teach you that.
Bchad’s comments made me notice an important distinction that I may have missed in previous comments.
If you’re a full-time investor, smart and hard working, you have a pretty good chance of beating passive management (better than 50% if you’re disciplined, as shown by research).
If you’re not a dedicated investor and need to hire someone to make you money, passive management will usually be better. Choosing right managers is probably harder than choosing the right stocks. Reversion to the mean is stronger, most investors won’t be able to even access true top quartile managers (which are very rare outside of VC and PE anyway), and fees are a strong drag on returns.
At the end, the world is pretty logical. If you’re a financial analyst, go buy some stocks. If you’re a plumber or a doctor, try to best the best plumber/doctor you can be, build a diversified portfolio and stop worrying about it.
^ You’d be surprised how many financial analysts who follow the market for a living cannot beat a passive index in the long run. Most are unaware because they don’t track their returns against an index over a significant period. If they do, they cherry pick the time period. If the majority of portfolio managers can’t beat a passive index, what makes you think the average person working in the industry can.
I do think it is possible for active portfolio management to consistently outperform index funds by taking on calculated incremental risk; however, I also think that active stock selection, which refers to most active equity mutual funds, produces inconsistant results and is therefore unluckly to consistently outperform index funds.
An easy example of active portfolio management that should add incremental value and also risk is securities lending. If you have a cash portfolio of all the individual stocks in the S&P 500 at it’s exact weight, that is lent out to brokers, who then pay you interest on the lent shares, you should consistently outperform the S&P 500 index if counterparty risk never arise; this strategy should of worked with TBTF banks during the crisis. A similar strategy would be if you sold a single deep in the money put option on an bond like stock each year, maybe an utility company, and it matures without hitting the strike, then you would of beat the index by taking on incremental risk for that return. Look into the PIMCO StocksPlus fund for a similiar strategy.
I don’t think active security selection can consistently outperform index funds, the markets are just way too complex and random. I noticed funds with strong long term track records made large bets back in the day, such as avoiding financial/home building stocks in 07/08, or avoided tech in 2000, which helps with their long term track records. To be honest, in today’s market, I would invest with an index fund overlayed with a short seller strategy. When markets run for this long, trashy stuff are bound to get bid up beyond their realistic price.
I also think there might be some validity on “smart beta” indices a.k.a Rob Arnott and his fundamental indices, but thats a differet thread.
Yes, you are right. “Should I hire an active manager” is not the same question as “can some active managers beat the market”.
If you hire a manager, you should not just believe that they can outperform their benchmark. You must believe they can outperform the benchmark, plus fees, plus trading costs, plus inconvenience from fund lock ups or any other rules, plus “doubt premium” (since you are never sure that they are actually good and not just lucky).
These guys are professionals at extracting value from investments. Why would they not extract the most value from customers as well?
Word.
I wonder if those who say “I can beat the market–I do beat the market” have actually studied their money-weighted return against the index. Level 3 Behavioral Finance reminds us that people tend to overestimate our ability, and when remembering our investment performance, we tend to remember our successes and forget our failures.
Correlation between human capital and financial capital just went to 100% with that comment.
Where does the passive index come from? Good investors buying stocks that go up and selling stocks that go down. Without active management there is no passive index that is difficult to beat. If the index is tough to beat, it is because it draws on the collective intelligence of market participants. Passive investing also has an inherent momentum bias, so it makes sense that it would tend to outperform during strong market expansions and not do as well during reversals.
Also, particularly in Intl and EM, ETF returns can vary widely from the index, so people should not buy them and necessarily expect an index like return. The variation has been on the order of 5% or so on more volatile years.
Lots of opportunity to make solid returns (and losses) in the small-cap swamp. It’s amazing how overlooked this is by the big passive buy an index fund type people. All of us here have an advantage when it comes to our personal accounts that we can invest in tons of securities that institutionals cannot and therefore are inadequately researched. If you do your leg work, there is money to be made here.
The buy and hold a large cap index fund types are missing out on what could arguably be the biggest advantage of being a small investor.
Assuming that you have the time and inclination to do the leg work. Since I work for such a small firm, I’m semi-self employed (hoping to become partner, where I will be fully self-employed). And I think that I’m better off doing my job and billing customers, and investing those proceeds in the index fund. I think I’m worth more doing that than by spending those extra hours researching some long-forgotten stock in Minneapolis.
Agree with Geo - lots of opportunity in the small cap space for retail investors. There are some great opportunities (and land mines) if you follow some of these stocks in depth. Not much analyst coverage in small cap space where the market is much less efficient. You have to enjoy it though and do your research otherwise you are better sticking your money in an index fund. Personally I enjoy the research and it plays well with my current job.