Coin Flipping Outdoes Active Fund Managers

[Midpack]

Mostly preaching to the choir here, but another POV for those still deciding on an IP (investment philosophy). Just FYI, you decide...

Coin Flipping Outdoes Active Fund Managers

Only 43.37% of top-half US equity funds were able to stay in the top half over two consecutive five-year periods. The remaining 56.63% of funds either ended in the bottom half or didn’t make it through the period due to a merger or liquidation. Flipping a coin has an expected success rate of 50%.

 

[dtbach]

I would agree with this. However I also believe that with some research you can pick out the top 20% of funds who do better than the market over time. Vanguard, Fidelity, Dodge and Cox all have funds that do great year after year, decade after decade.

 

[NW-Bound]

And then, suppose a fund beats the S&P by 20% gain in the first 5 years, but trails it by only 5% in the next 5 years? It would still beat the S&P overall. Yet, some people will say that win one, lose one so let's call it even.

Statistics can be presented in different ways to prove a point. Nobody can beat the S&P every year. Not even Buffett could do that, but look at his performance over several decades! Buffett (and other sensible money managers) would not want to compete with the S&P during the dot-com bubble and the housing/subprime mania anyway.

 

[David1961]

I think this reinforces the importance of using index funds as the foundation of your portfolio.

 

[dtbach]

I think this reinforces the importance of using index funds as the foundation of your portfolio.

You can do coin flips. I'm going to search out the good managers that can and do out perform the market over time (not every year) but over the long run.

 

[steelyman]

I did a toe in the water in 1994, when I started investing (so 20 years now). I put identical amounts, not a lot, in 3 active funds and said I'd give them 5 years to duke it out. I stayed and still am with the winner. The others are off on Gilligan's Island.

 

[Mulligan]

You can do coin flips. I'm going to search out the good managers that can and do out perform the market over time (not every year) but over the long run.

My father and I discuss this all the time. He is 100% of your persuasion and I am a buy and hold indexer. He has done very well over the years, and I am certainly doing better indexing than I was stock picking so we are both happy.

 

[NW-Bound]

One thing for sure is that performance chasing is bad, very bad. In the 1995-2000 period, there were so many mutual funds specialized in tech stocks and dot-coms. Remember the term "new economy"? "Brick-and-mortar" businesses were so old-fashioned and with high overhead, while "new economy" businesses were so "lean" and could virtually print their own money. There were a few articles poking fun at Buffett, saying that he had lost his golden touch because he trailed the index.

Yep, one could go with one of the many active MF managers back then and got burned bad. He would be better off doing index investing. There are many ways to make money, and even more to lose it.

 

[RunningBum]

Calling it a "coin flip" is odd. A coin flip means there are two choices, and you randomly pick one. Investing has a multitude of options, not two. Why not just say that more than half of active fund managers fail to beat the market or index?

 

[NW-Bound]

The author wants to make the point that an active MF manager's chance of beating the index is poorer than the 50% chance of a coin flip.

My counterpoint is that suppose an MF manager beats the S&P by 20% one year, then trails it by only 5% the next, the study still calls it 50/50 (one win, one lose). I call it a 14% lead over the S&P (1.20 * 0.95 = 1.14). See how statistics can be presented?

 

[easysurfer]

Think of how high the coin flip would have returned if a chimp did the flipping instead of a person?

I'm more than happy to just do the indexing approach and then concentrate on allocations. Lazy and easy... I like that

 

[NW-Bound]

So, the difference is with the coin tosser? I thought one would need a lucky coin.

 

[walkinwood]

There are much more persuasive arguments for indexing than these easy shots. Like NW-Bound says - this doesn't prove anything.

 

[CaliforniaMan]

For getting heads, I like to get a big roomful of people tossing for me. Then I take the ones that got the most heads to toss for me next year. Of these, I choose to use the best coin tossers to toss for me the next year. The next year, I again choose the ones who got the most heads to toss for me. That way I keep narrowing down my coin tossers until I have only the ones that always seem to toss heads.

There are ways to examine a population of stock pickers just as there are ways of examining a population of coin tossers. In every case I have seen, the number of outliers, those that consistently beat the market, are fewer than would be predicted by chance.

 

[growing_older]

You can do coin flips. I'm going to search out the good managers that can and do out perform the market over time (not every year) but over the long run.

This coin flipping nonsense is just someone looking for a flashy headline and has got very little to do with actual investment performance. On the other hand, if you really have a good way to find the managers who will outperform, then that would be something. I know of no way to identify them, though there seem to be plenty of people who will make recommendations if I pay them. I have very little confidence that prediction will do any better than a coin flip.

You seem confident you can find such managers. Can you share?

 

[NW-Bound]

Walkinwood saw the point that I repeatedly tried to make, and I am sure some other readers do too.

We of course all know one year performance means nothing, so we have to look at long-term performance for consistency. It's no different than batting average for baseball, a game which I really know very little about but guess that it would make a good analogy.

I am sure that only a few MFs can show long-term performance, however we are going to define it. Is long meaning 10 years, 20 or 30 years? And then, people will still say that the manager was lucky. Or they will say that even if it is the manager's skill, he will retire or die some day. See, I know all about the indexer's arguments, because I have read their stuff.

I have read and was told that some MFs have a committee who pick stocks and also decide what and how to sell/buy based on some metric that they maintain. With them being active stock pickers, I am sure it would involve some stock valuation as they do not buy the entire market but only segments of it that they think are more promising.

So, any performance would be due to the metric, which should outlast a single manager. An indexer may ask "but can the condition change, so that the metric stops working?" I can then ask if the market condition would change so that stocks would no longer be worthwhile to own and we should all buy CDs and annuities? See what we get into if we ask questions like that? We have to assume some basic things will stay constant, else there's no point in saying anything is better than something else.

So, who are these guys that can beat the market? I am no finance advisor, having no Web site of my own, nor being affiliated with anything on Wall St. So, I do not have records of MFs, nor the time or inclination to do extensive research. But after just a few days on this forum, I kept seeing "Pssstt Wellesley" from unclemick, and then learned that it was a quite popular MF here.

I put a bit of my money into Wellesley and also Wellington, but still wanted to check them out further. After 2 or 3 years, only recently did I bother to do a bit of work to study their performance. As these funds rebalanced between stocks and bonds, I wanted to see how they fared against an investor who did the rebalancing portfolio himself using a long-term bond fund and a total-market stock fund.

Results are shown here: http://www.early-retirement.org/for...-hapless-y2k-retiree-69942-2.html#post1398567.

Both Wellesley and Wellington did significantly better than the indexing investor who rebalanced on Jan 1st of each year. Are there others like these two? I do not know, but there might be.

 

[dtbach]

This coin flipping nonsense is just someone looking for a flashy headline and has got very little to do with actual investment performance. On the other hand, if you really have a good way to find the managers who will outperform, then that would be something. I know of no way to identify them, though there seem to be plenty of people who will make recommendations if I pay them. I have very little confidence that prediction will do any better than a coin flip.

You seem confident you can find such managers. Can you share?

It's called research. Start with Forbes and Kliplingers top 25 and see how funds have done in up and down years. Then research these on their manager or committee philosophy, what they looks for in stocks.

Over the years I've gotten into large positions in Mutual Quest, Columbia Acorn, Dodge and Cox Stock, Fidelity Contrafund, Low-Price and Growth. As well as Vanguard Wellesley and Wellington.

Take a look at how these funds have done vs index funds. I'm way ahead.