Hi Guys,
Well I’ll risk jumping from the frying pan into the fire with this reference, but it does address a serious shortcoming in many investor's behavior.
I’m referring to a recent Motley Fool article cobbled together by Morgan Housel titled “How to Get Less Stupid at Investing”. The article touts the benefits of seeking a divergent set of market opinions, especially those that directly conflict with your special preferences and biases. Here is the Link:
http://www.fool.com/investing/general/2014/07/08/how-to-get-less-stupid-at-investing.aspx?source=iaasitlnk0000003Housel’s bottom-line observation is: “If you want to become less stupid at investing, one of the best things to do is surround yourself with people who disagree with you….”.
That’s one of two primary reasons why I have been a constant visitor and occasional contributor to MFO. My other reason harbors a goal to diminish investment innumeracy, especially in the statistical domain. Individual investors better understand and appreciate that historically, equities offer a 7 out of 10 likelihood of positive annual returns over quoting the same statistic as a 70% probability. That’s surprising, but is true.
Near the end of the article, Housel formulates a Law: “This made me realize the First Law of Financial Conferences: People think they go to conferences to learn something, but most often they go to have their beliefs confirmed and reinforced by others.”
Unfortunately, I suspect more than a few MFO members populate and interact on this fine website for the same dubious purpose. To steal a famous Charles Ellis quote and book title, that’s a “loser’s game”. That’s a primary contributor as to why individual investors consistently don’t realize market-like returns.
There is a common human tendency to summarily reject new data or new findings that contradict a previously established position. In the academic community, this tendency has a name; it’s called the “Semmelweis Reflex”. In the end, this Reflex erodes investment performance.
I suppose one of the lessons from this body of research is that we should all seek and be tolerant of divergent market perspectives and investment opportunities. I believe most MFO participants are in this cohort.
So, permit me to conclude with yet another frying pan exposure which will test your active fund manager appetite.
Recent academic studies once again conclude that about 75% of active fund managers have long term performance records that roughly hover near the zero Alpha benchmark. Of the residual 25%, about 24% produce negative Alpha. That means that only 1% generate measurable positive Alpha over an extended timeframe. That’s the sad odds when establishing an actively managed portfolio.
Good luck to all you guys who pursue the active strategy, and I really mean it. Most importantly, I want everyone to succeed. Almost equally importantly, it is the pursuit of active management that keeps the market pricing discovery mechanism functioning well. Thank you for accepting that necessary and costly task. In a sense, the passive Index fund investor is indeed getting a free lunch.
Best Regards.
Comments
@MJG: thanks for your post. Would you be able to provide a reference, URL or link to any of these studies that suggest 1% of managers generate measurable positive Alpha.....and that these are the odds against establishing a successful actively managed portfolio of mutual funds? Thanks.
Thank you guys for your pity observations.
It doesn’t get too much older then this, but Publilius Syrus in the 1st century BC said: “It is a bad plan that admits of no modifications”. That ancient wisdom applies today and everyday, especially in spades, for investment matters. All investment decisions, both bad and good, are transient and require constant monitoring and hopefully infrequent changes.
I took the mutual fund Alpha performance data from a 2010 report that I failed to reference. Sorry about that. The title of the study is “False Discoveries in Mutual Fund Performance: Measuring Luck in Estimated Alphas”. The three authors are Barras, Scaillet, and Wermers. For completeness, here is a Link to that study:
http://www.rhsmith.umd.edu/faculty/rwermers/FDR_published.pdf
The paper is rather dense. I only reviewed the Introduction and Conclusions sections.
For brevity in my initial post, I omitted some other findings and observations by these researchers that might interest you. For example, the authors discovered that the overall positive Alphas generated by active fund managers have significantly eroded over time. They report that positive Alpha funds have decreased from a roughly 15% level to the present 1% level in the last 20 years.
Are fund managers getting dumber? My answer is NO. My interpretation is that active fund managers have proliferated and the field had gotten stronger with increased competition that lowers opportunities to outperform.
Another intriguing aspect of the study is the rather long-term survival of the underperforming funds. The authors included the following statement in their Conclusions section: “Still, it is puzzling why investors seem to increasingly tolerate the existence of a large minority of funds that produce negative alphas, when an increasing array of passively managed funds have become available (such as ETFs).”
I suppose, many of us are slow learners and/or are reluctant to omit a mistake. Another dimension to this misguided loyalty is that we often fail to make relevant benchmark comparisons. I attribute this failure, at least partially, to our limited understanding and trust in statistics.
As Zig Ziglar said:” The first step in solving a problem is to recognize that it does exist”. I believe successful investing requires testing outcomes against some pertinent (designed for your specific purposes) benchmark standard. I suspect that some (perhaps most) individual investors don’t do this simple task to their end financial detriment.
Thanks again guys for keeping this discussion fresh.
Best Wishes.
How much of these underperforming funds held by investors are in 401k plans with very limited or poor choices?
>> “If you want to become less stupid at investing, one of the best things to do is surround yourself with people who disagree with you….”.
Well, jeez, within limits. See below.
>> goal to diminish investment innumeracy, especially in the statistical domain.
oh, hear, hear!
>> People think they go to conferences to learn something, but most often they go to have their beliefs confirmed and reinforced by others.” Unfortunately, I suspect more than a few MFO members populate and interact on this fine website for the same dubious purpose. To steal a famous Charles Ellis quote and book title, that’s a “loser’s game”. That’s a primary contributor as to why individual investors consistently don’t realize marketlike returns.
I dunno; I think it's chiefly cuz they don't stick with their plan ('investor returns'), and research bears this out. In other words the kind of people who have stuck with it over the years do not poke around the web and do not post here or anywhere. They enjoy life and do not obsess over investments. We are a forum it seems of aggressive changers and surely frequent traders in some percentage or other. How many times do you read here 'I am going to give it another few months ...' and 'I am thinking of swapping X for Y' and the like?
>> There is a common human tendency to summarily reject new data or new findings that contradict a previously established position. In the academic community, this tendency has a name; it’s called the “Semmelweis Reflex”. In the end, this Reflex erodes investment performance.
This is an extremely hot new journalism meme for sure, without question, esp in politics and finance. Knowing a fair amount about psychology, I call bullshit on it in a great many instances. Confirmation bias, please. I and most others do need to immerse ourselves in creationism, climate-change denial, audio tweakism, supply-side / constant government-denigrating rightwingism, gold advocacy or any other contrary views just to, what, realign or make a good dent in our friggin bias?
If you had been in smallcaps since say 1980 despite the warnings and conference talks about how they were going to something or other, you would have done well. If you had been in largecaps, the same, ignoring those who disagreed and told you to go to smallcaps, you woulda done fine. Indeed if you had stuck with high-yield, or invest-grade bond, or growth, SP500, value, or balanced --- any one of those and only that --- you woulda done just fine.
If you are looking for certainty before 1980, well, sticktoitiveness is no worse than anything else.
>> I suppose one of the lessons from this body of research is that we should all seek and be tolerant of divergent market perspectives and investment opportunities. I believe most MFO participants are in this cohort.
depends
>> Recent academic studies once again conclude that about 75% of active fund managers have long term performance records that roughly hover near the zero Alpha benchmark. Of the residual 25%, about 24% produce negative Alpha. That means that only 1% generate measurable positive Alpha over an extended timeframe. That’s the sad odds when establishing an actively managed portfolio.
Right, concur, roger --- except when it is not. They say, oh how they say, how they repeat, how they admonish, that past performance does not etc etc etc.
Jeez, then what good IS it?
If you had picked long ago (35y) a category above, within a fund family, much less a given manager or group, that was highly regarded back then by some metric or other, guess what? You woulda done fine. That's what my backtesting shows me, cuz I did it --- or failed to. I chased outperformance, stupidly. From 1982 reading I coulda stuck with Fulkerson (CENSX), Fidelity Trend (my father), Janus, much less LOMMX, PENNX, DODBX, Contrafund .... but I woulda second-guessed when they slumped or changed managers or whatever, and woulda bailed. I am positive that this is what most do.
If the triumph of passive investing is that people stick with it, then that's a real and indeed revolutionary triumph. It is NOT a reason not to actively invest or seek superior managers. SPX performance is the least of all of those above, btw. So, I say, make a few seemingly sound decisions based on past performance (go ahead) and leave it the hell alone for a decade.
Easy to preach about this.
I don't know where to turn to find disagreeing viewpoints that are worth spit. I guess that sounds awfully vain. But I am kind of tired of hearing about confirmation bias and its ills, for anyone who is the least bit self-skeptical, investigative but not OCD about it, and tries to monitor his or her own prejudices.
As I said: “If It Works Don't Screw With It!”
I can only confirm that after my 60 plus years on this planet, that I am fully assured that my intuition (the summation of all my experiences combined with my original DNA) provides for reasonal investment returns that in most cases, year after year outperforms at least 5 percent of the active fund managers and the majority of hedge funds.
And of course, I am much ahead of the 99% of folks who don't care or don't know about investing.
What more could a person ask for; in spite of the original expression of this thread.
What a lucky fellow I am.
End of story.
Signed: Smart Ass
NOTE: perhaps an equity buying chance coming our way near term; after some of the selloff smoke clears.........well, at least if the machines don't jump back into the game too soon.
Regards,
Catch
I want to thank you all for your thought provoking and pithy replies. Yes John Chisum, I did intend to say pithy. Sorry about my defective spelling. I hope that’s not an early signal of defective investment thinking.
Scott, I have made a practice of purposely not discussing my portfolio holdings or of recommending specific funds because I do not believe in a one-size-fits-all-purposes philosophy. I even abstain from making specific recommendations to my immediate family members. Decisions like this are a very personal matter. Everyone is more likely to stay the course when rough patches are encountered if he alone owns the decisions.
For what its worth, I initially invested in individual stocks in the mid-1950s. I was not particularly successful, but continued to do so until the mid-1980s. I suspect I played a small role in a wealth transfer operation. A large part of my savings ended in the pockets of stock brokers.
In the mid-1980s, my first mutual fund adventure was with Peter Lynches’ Magellan fund. Before investing with him, I naively telephoned and actually spoke with George Soros. He politely informed me that I was not a qualified candidate client. I sold Magellan after Jeff Vinik was released for making an untimely and uncharacteristic losing bond wager.
From that time until about one year ago, I held mostly actively managed mutual funds. For example, I was an original investor in the Masters Select Equity fund. I believed in the concept of a concentrated portfolio to make a meaningful wealth impact, and in a carefully designed and executed manager selection and monitoring process. Results were marginally acceptable until my recent epiphany. Any marginal benefits from active fund management are accidental (with a few noteworthy exceptions) and are not worth the effort.
I am in the process of converting my portfolio into one with a passive-to-active mix of about 80-to-20. I have held positions in balanced fund stalwarts DODBX, VWINX, and VWELX since the mid-1990s and plan to retain them. When I sold Magellan, I transferred my holdings equally into FCNTX and FLPSX. I plan to retain a reduced percentage in these positions. I am expanding my Index positions in an incremental manner.
That’s as far as I’m willing to go. I consider myself a very pedestrian investor. I do NOT recommend that anyone duplicate my portfolio. My comfort zone or needs are surely not anyone else’s comfort zone or needs.
As far as I can remember, I have never made fund recommendations in any of my MFO postings. If pressed on this issue, I have consistently punted and recommended other (like Scott) MFO members to carry the ball. You guys are surely more prescient and more up to date on this matter than I am.
Basically, I’m slowly retiring from the investment world.
I really want great success for you guys in achieving whatever investment goals you define.
Thanks again for contributing to this spirited discussion.
Best Wishes.
>> “If It Works Don't Screw With It!”
My point was partly to do this even if it does not work or is not working, or seems not to be, in the moment, or the short term.
In other words, don't screw with it period, and have faith still, if you had enough faith in the past to make the initial commitment after some historical due diligence. Most of us would have done well, or better than we did, if we had not bailed on D&C, Weitz, Miller, or Berkowitz, just to name four, and were still with them.
Nicely written.
Since I am now retired I have dialed my risk downward within my own portfolio from where it was five, or so, years ago. This was because five years ago I felt there was better value to be had in the markets and I was willing to dail my risk upward and carry a heavier allocation in equities. Presently, I feel there is less value to be had in the markets and with this I have reduced by allocation to equities plus my age factor and now being retired.
I always enjoy reading your comments.
My best to you.
Old_Skeet
I highly recommend retirement- it's just great!
Regards- OJ