This article seems to be a short rehashing of material from the titular book. In that regard it's mostly content marketing for Index Fund Advisors Advisors, a firm with a bias against expensive active management (but hey, it's not exactly an unjustified bias these days :). I do think it raises a good point, just as the book did - for the most part, customers do not get rich in the markets with active management, despite how highly paid many professionals in the industry are.
It's a little enthusiastic in its point about there being no evidence that active management can be successful, even in the paper it cites. One of the difficulties with points against active management from research papers or e.g. Buffett's public bet is that the entire industry as a whole is often assessed, not just the outliers consistently capable of beating the market. The firms that can consistently beat the market exist in an entirely different strata from the rest. There are fair arguments against their ability to perform consistently, but a more honest analysis would follow the relative few that have evidenced success in the past. Otherwise they conflate "most active managers are not successful" with "the industry is based on a fundamental fallacy."
It's probably easy to read this and overlook the fact that while rare, there are indeed active managers who make their clients far richer than they are when they start, sometimes extremely so. These managers and their firms more or less quickly become richer than the dreams of avarice themselves, along with all the celebrity that comes with. It's not hard to find people who beat the market consistently - the real magic is finding them before everyone else does and prices you out of investing with them.
Finally, for the most part truly successful active managers work with institutional investors, for whom "where are their yachts?" is not necessarily a coherent question. The customers of hedge funds who become very rich are not necessarily going to indicate this in a visible way. The legitimate argument raised by the article and the corresponding book should probably have a more modern question used to convey its point.
I'd agree that there are some investment opportunities that can "beat the market".
But typically, the average retail investor doesn't get access to them. There are some hedge funds or VC/PE firms that might have alpha, active management skills, the golden touch (or just such a reputation that they get the best deals), but they tend to be closed by now or require huge investments. If you're a Goldman partner, you'll come across some excellent investment opportunities.
Furthermore, as you highlight, just like it is difficult to evaluate single stocks ex ante, it is difficult to evaluate active managers ex ante. Thus, as their expected contribution is negative, I think the advice to most retail investors to go for cheap, passive funds is sound.
Cheap passive funds are good advice if you want to maximize your return in the most frequent outcomes, but it ignores some powerful psychological stuff that's real and in play.
An index fund is like a bus: everyone is going to the same place, and you're not driving. Many investors just can't deal with that, and may rationally and happily take bigger risks seeking excess returns, even if they know the odds are against them.
Most investors I know, even beginners, believe they can beat the market with minimal effort and essentially zero knowledge about it. The usual results are, however:
That's a good point, though I would think you can handle a lot of that with the macro asset allocation (shares, bonds, alternative; domestic, international; etc.), which is still something one needs to do and look at every year or so.
What are you talking about? That gives you opportunity to gamble and speculate, not to invest.
Of course, if many people gamble, some will win, and they might post somewhere about it, but it is foolish to suggest that you can beat the market by significant amounts as a retail investor with options and margins without a commensurate increase in risk (and, because the options and margins are not provided by your friendly investment banker for free, with an increase in cost reducing your expected risk adjusted return).
Gambling, you bet (might win or lose) on something very random (dice, roulette wheel).
Speculating, you bet (might win or lose) on something "economic", "business"-like.
Those two terms have a connotation of imprudence (at least for me): You might win, but that's because you're lucky, not because you're smart. And you might lose.
If you invest, you try to take luck out of it as much as possible, for example, by investing in something that you have a very deep understanding of, or investing (unleveraged) very broadly in the market.
It's basically a continuum, with investing on the lower return, lower variance, less luck, more prudent end of things, and speculation at the other end.
Sorry if this isn't the best article on the topic, it was a quick google search.
My friend got bit hard by this. He had a HFT algorithm that was essentially guaranteed to at least break even by providing liquidity in the market by doing some fancy tricks that he's used for embedded digital signal processing. Problem was, his bids weren't being fulfilled even though he'd made them hours, sometimes days, previously. Given the amount of information available to him it looked like his orders were first in line at a given strike price to have his orders filled once the price moved to him. The only thing he could figure out was that someone was able to submit subpenny orders that would fill before his.
I was skeptical initially, then some weeks later it started making the news that dark pools were managing to make subpenny bids on various digital exchanges. Far as I know the SEC turned a blind eye since the dark pools already had special privelidge in exchange for being market makers and liquidity providers.
The trouble with any successful market beating strategy is everyone will copy it as best they can, causing it to revert to mere market performance. The way to consistently beat the market is to keep your strategy a secret, have an edge (like being electrically closer to the exchange), or cheat like Bernie Madoff.
Absolutely, that's why the managers of the funds that are making money will never publish a book or paper on their strategies... The best are even returning all the client capital back and trading their own money only...
Whenever I see one of those seminars advertised "Get Rich Quick Through Real Estate Investing" I wonder why the presenter is doing seminars rather than being out getting rich through real estate investing.
But picking managers who will beat the market is harder than picking stocks that will beat the market. Because stocks are more likely to have above market returns than funds (because of fees).
This isn't good enough. As I said in another comment, quantify it for me. I want you to demonstrate with real calculations how likely it is for a firm like RenTec to arise because you got enough monkeys in a room to hit some kind of statistical critical mass.
My contention is that there aren't enough professional traders or hedge funds in the world for the number of them that enjoy astronomical success to be purely a result of chance.
We have clear and irrefutable evidence of firms that consistently beat the market over 10, 20 and 30 year timespans. If you want to seriously suggest that they are a normal result of statistical distribution you'll need to really quantify that. I've never seen rigorous calculations that can support that hypothesis.
Moreover, I don't understand how that argument is easier to swallow than the argument that you can reliably beat the market. What is so difficult about the idea that it is possible to reliably and legally obtain material information that the rest of the market doesn't have an edge on, or that it's possible to identify predictive patterns?
The more refined argument I've seen is that 'Alpha - Fee' is negligible, not that alpha doesn't exist. Once high-performing active managers are found they raise their fees accordingly. RenTec is one of the world's best performing funds, but also one of the most expensive. The only way to "win" with RenTec would have been to identify them BEFORE they had a proven track record. And that is much more of a gamble. Some folks have tried to address this with funds of funds. But then top performers average out and you loose most of YOUR alpha again.
I suppose a smart-ass response is "in the Bahamas, because we make them so much money".
In any case, excellent analogy there to illustrate the random walk.
Now, the article alludes to the idea that successful active management is a fiction. If this is the case, what's the currently most plausible hypothesis for why active fund management is so attractive? Somehow fund managers have sold themselves as Gene Sarazens, and supposedly there is evidence that they are not. And the evidence is strong. And yet these not-Genes successfully sell their services. How?
People seek out active managers because it's not a fiction that there are successful ones. They're simply difficult to identify before they become celebrities, at which point they're too expensive for all except institutional investors. Unfortunately, the relative few spur the hunt for the supermajority, who are mediocre.
Keep in mind two other facts. First, this piece is published by the Index Fund Advisors, which implies a fundamental bias against active management (and that's not necessarily bad! Index funds are almost inarguably superior for almost everyone). Second, Eugene Fama's Efficient Market Hypothesis does not have widespread support in its strong form. In the years since his thesis, even Fama has walked back to a more reasonable position that allows for people to beat the market. The weaker form of the hypothesis allows for successful managers, just comparatively few of them.
There are successful coin flippers too, who can flip heads 10 times in a row! Just have to get a room full of few thousand coin flippers and when you find the guy who does 10 in a row, ask him how he became so skilled.
The tired coin flipping trope is just dismissive and does nothing to seriously argue against the possibility of people consistently beating the market. Even Warren Buffett, the champion of index funds, has argued against the coin flipping analogy.
Empirically map your coin flipping analogy to a probabilistic model of the likelihood of beating the market and then we can reasonably talk about it. There are real arguments to be made, but saying "coin flipping!" does nothing to seriously engage with the debate.
The problem with the big funds are that they remaking money from their fees... e.g they do not have incentive to look for alpha... best strategy for them is preserve capital and live off the 2% fees
You'd have a point if the competition charged fees on a percentage of "alpha" generated -- but they don't, they largely charge more fees than index funds, irrespective of whether they outperform.
There are so many complex things at play here, but...
1) there are people who work for major institutional investors (think pension funds) who are paid very well to pick managers. If they just pick beta funds, it is hard for them to justify their salaries.
2) not all market participants are interested in 'beating markets'. Many are interested in matching the liabilities to their assets or accomplishing another goal.
3) I believe that there are some managers that are much better than other managers for at least short times. I do not believr i know how to pick them, but the idea that it may be possible may make this bet worth it.
4) If there are good managers, the investment world is winner take all and they will accumulate a lot of assets.
Funds flow to winning strategies in the investment world so a repeatable strategy will grow their assets very very quickly. Liquidity of markets is the limiting factor.
> 3) I believe that there are some managers that are much better than other managers for at least short times.
There are always managers who outperform the market, if you look backwards. The problem is whether they're able to repeat their performance moving forwards or if it was due to pure luck.
There are people who believe that "technical analysis" works. I believe in semi efficient markets and do not believe technical analysis works, especially at scale.
I think that quantitative analysis can work in rare casis and generate alpha, but i do not believe that i can predict those cases or generate that alpha myself.
Technical analysis is a bit of a voodoo for me as well, but quantitative analysis works indeed, you just need to spend the time and work on it (as with any other skill in life)
It does until it doesnt. There are very few quant funds that have figured out how to navigate a rapidly changing economic environment. The problem with quant is that it is backward looking. When the market changes most quantitative funds do not have a good method of accounting for the change. They do not properly account for conditioning information and they end up completely hammered.
I am confident that there are people who have at least partially figured out how to invest this way, but i believe it is very, very few. Like less than 10 funds/people on earth.
It's difficult to distinguish the talent from the schmucks, because it's easy to take credit for broad economic growth and easy to blame the world for failure.
Your post reminds me of Frederick T. Gates, manager of the Rockefeller fortune, who once sold Lake Superior Consolidated Iron Mines to US Steel for 55 million dollars (1.5 billion with inflation) in profit for the Rockefeller family. I guess his response would be "my client considers yachts symbols of decadence, instead he owns several houses in downtown Manhatten, upstate, in the Berkshires, and in Florida."
The larger perspective is that the human brain is amazingly well designed for the sort of specific tasks involved in living as a hunter-gatherer, but these tasks are quite different from what is involved in choosing among investment options, and so most people tend to make bad decisions.
The other side of this is that about 1% of the population are sociopaths who make it through life threatening or fooling other people, and many of the the really bright ones realize they can make the most money through trickery in finance.
This is not true. Mutual funds and most hedge funds are designed for capital returns these days, and few of them optimize for capital preservation, despite the name. Beyond that, a minority of funds are consistently successful at beating the market.
Why don’t you test it yourself? Theses days you can find quant historical data on ebay for less than $100 bucks... You can backtest passive investing with ETFs, trend following, momentum, tech stocks, value investing, technical analysis... you name it... and who knows maybe you’ll turn to be the next Warren Buffett or the next big hedge fund quant genius ;-)
Once in the dear dead days beyond recall, an out-of-town visitor was being shown the wonders of the New York financial district. When the party arrived at the Battery, one of his guides indicated some handsome ships riding at anchor. He said,
“Look, those are the bankers’ and brokers’ yachts.”
“Where are the customers’ yachts?” asked the naïve visitor.
I bought Air Jordans. Where is my multi-million dollar NBA contract? I bought golf clubs...why am I not as rich as Tiger Woods? That is literally the same logic. Brokers provide a service to clients by managing money. Some do a better job than others. Whether or not such services are worth the fees is a matter of debate though. But expecting the recipients of a service to be as wealthy as whoever is providing them is unrealistic.
It's a little enthusiastic in its point about there being no evidence that active management can be successful, even in the paper it cites. One of the difficulties with points against active management from research papers or e.g. Buffett's public bet is that the entire industry as a whole is often assessed, not just the outliers consistently capable of beating the market. The firms that can consistently beat the market exist in an entirely different strata from the rest. There are fair arguments against their ability to perform consistently, but a more honest analysis would follow the relative few that have evidenced success in the past. Otherwise they conflate "most active managers are not successful" with "the industry is based on a fundamental fallacy."
It's probably easy to read this and overlook the fact that while rare, there are indeed active managers who make their clients far richer than they are when they start, sometimes extremely so. These managers and their firms more or less quickly become richer than the dreams of avarice themselves, along with all the celebrity that comes with. It's not hard to find people who beat the market consistently - the real magic is finding them before everyone else does and prices you out of investing with them.
Finally, for the most part truly successful active managers work with institutional investors, for whom "where are their yachts?" is not necessarily a coherent question. The customers of hedge funds who become very rich are not necessarily going to indicate this in a visible way. The legitimate argument raised by the article and the corresponding book should probably have a more modern question used to convey its point.