Why when it comes to equities, I'm sticking to funds...

[Running_Man]

William Bernstein has a new article at his site that discusses the value of active management. As usual, it is a good read.

http://www.efficientfrontier.com/ef/0adhoc/excel.htm

Some nuggets:
"For many years, I’ve been troubled by a conundrum: If mutual fund investors are not earning the market return, even adjusting for expenses, who is taking the winning side of their transactions? The yawning gap between dollar-weighted and time-weighted mutual fund data demonstrates just how far short John Q. Public falls. Amazingly, professionals, as represented by the managers of hedge funds, mutual funds, and pension funds, don’t do that much better."

. . .
"The message of both pieces is: If you want to earn high investment returns, you’re going to have to look far from the overgrazed investment commons. At a bare minimum, you have to tune out the noise from the media and analysts of all stripes, and actually think for yourself. This is not something everyone can do; abstracting investment ideas from Forbes does not count.

Beyond that, you’ll probably need to avoid the public securities markets altogether and invest privately. Needless to say, purchasing and running a diversified stable of small concerns is not for the faint hearted, the quantitatively weak, or those without razor-sharp interpersonal skills, exquisite business training, and huge gobs of spare time."
. . .

"If you want to pick your own stocks and bonds, be my guest. Just don’t imagine that making your decisions on the basis of publicly available information and analysis will lead you anywhere but to the poor house. You’re going to have to look at the primary data and analyze it entirely by yourself. And you’d better be good at it."

What a total crock. I really am not interested in what managed funds do versus index funds, that has no impact on my investments as an individual owner. The implication that an individual cannot properly value securities is laughable. Perhaps Mr. Bernstein should look at the facts behind Wall Street Journal article on Illinois Tool Works. Everyday managers are expected to look at companies and come up with ideas for acquisitions with the goal of 16% stock growth over the long term. One of their most recent purchases was a publicly traded company called CFC International. Anyone could have been purchasing that stock it traded over the years for a laughably low price of $4 per share after going public at 12 per share and went as high as $25 per share before the CEO tried to sell out at 20 percent under the market, recognizing the stock was overpriced.

It was not too difficult to see the stock was too low at $4 or too high at $25. Illinois Tool Works could value that as well, I know they turned down an opportunity to buy at $20 when it was selling $25 and eventually bought at $16 when the market came back to the proper price. Of course Bernstein would say this is an impossibility - that Illinois Tool Works just got an underpriced company which always happens in these circumstances - just so happens he is dead wrong.

 

[samclem]

Anyone could have been purchasing that stock it traded over the years for a laughably low price of $4 per share after going public at 12 per share and went as high as $25 per share before the CEO tried to sell out at 20 percent under the market, recognizing the stock was overpriced.

It was not too difficult to see the stock was too low at $4 or too high at $25. Illinois Tool Works could value that as well, I know they turned down an opportunity to buy at $20 when it was selling $25 and eventually bought at $16 when the market came back to the proper price. Of course Bernstein would say this is an impossibility - that Illinois Tool Works just got an underpriced company which always happens in these circumstances - just so happens he is dead wrong.

So, it was too low at $4, and too high at $25. "Not too difficult to see". I'd agree with "not too difficult to see in retrospect." If it were truly easy to see in advance, then people would do so and bid the prices up/down accordingly. Bernstein merely points out that the data needed to truly evaluate the value of these companies as well as the experience needed to properly utilize this data is not available to most investors. And even managers expressly paid to do it get it wrong as often as right. Still, as mentioned previously, please try to find those diamonds waiting to be discovered--it really does a service for us all, and helps keep the market efficient.

 

[Running_Man]

So, it was too low at $4, and too high at $25. "Not too difficult to see". I'd agree with "not too difficult to see in retrospect." If it were truly easy to see in advance, then people would do so and bid the prices up/down accordingly. Bernstein merely points out that the data needed to truly evaluate the value of these companies as well as the experience needed to properly utilize this data is not available to most investors. And even managers expressly paid to do it get it wrong as often as right. Still, as mentioned previously, please try to find those diamonds waiting to be discovered--it really does a service for us all, and helps keep the market efficient.

Don't you see that is the point Illinois Tool Works had the opportunity to buy CFC at $20 per share when the stock was trading at $25 and TURNED IT DOWN? Why? According to your logic properly pricing the stock is impossible the market has spoken only later can it be shown that is wrong, yet the price came to what Illinois Tool Works felt was a fair price. This happens again and again in the markets.

Do you feel no company should buy company stock? Perhaps companies should only invest in index funds.

Do you agree with Bernstein that only people who are altruistic can be great stock pickers. He gives props to several very successful managers after stating in his book only 2 ever beat the market consistently. Altruism is the reason he gives for endowment funds outperforming mutual funds. Instead of coming up with an emotional reason for the endowment funds 20% premium return perhaps it is the fact that endowment funds do not have to worry about the shareholders cashing out and managing cash flow and matching to indexes. How is it that Bernstein can identify a very large group of individuals who mange large amounts of money and outperform the market by 20% yet still argue that the markets are totally efficient and will send to the poor house anyone trying to purchase stocks? Again and again I have read Bernstein have totally contradictory statements and then use them to argue indexing is the only way.

 

[haha]

Bernstein doesn't like being a neurologist, so he talks up his business. Beyond "one must be careful" I don't seen much of any value in his preaching.

Ha

 

[Nords]

Well, I guess we've identified at least two investors on the other side of John Q. Public's transactions.

You guys will have to get back to us with your 20-year records. Until then we're all a bunch of coin-flipping monkeys.

Now that I'm devoting the time to it I'm a much better stockpicker than I was five years ago, and I'm making a lot more money at it. My reaction to that is "Feh." Now that I get it, and now that I've satisfied myself that I get it, there's little motivation to continue the effort it took to get it. I think it was Bernstein (or maybe Swedroe) who said that there are plenty of other ways to achieve financial independence while still having a life. I'm trying to officially retire my coins and cash in my bananas as needed to support my other pursuits of monkeying around.

As for Bernstein, I think he's writing to his audience-- the vast majority of whom have neither the time, the inclination, nor the discipline to invest in stocks. He didn't say that you guys can't make money in stocks-- only that it's not as easy as Bill O'Neill and his ilk make it seem and that you have to do it on your own instead of blindly following Bill's books & TMF subscriptions. There are many ways to get to ER so I can see why people would eschew a more difficult route, despite its potential for being more enriching.

 

[al_bundy]

Bill doesn't say it's easy either and says you have to do a lot of research. he just tells you what to look for when picking a stock since your valuation of a company doesn't mean squat.

 

[Running_Man]

Well, I guess we've identified at least two investors on the other side of John Q. Public's transactions.

You guys will have to get back to us with your 20-year records. Until then we're all a bunch of coin-flipping monkeys.


As for Bernstein, I think he's writing to his audience-- the vast majority of whom have neither the time, the inclination, nor the discipline to invest in stocks. He didn't say that you guys can't make money in stocks-- only that it's not as easy as Bill O'Neill and his ilk make it seem and that you have to do it on your own instead of blindly following Bill's books & TMF subscriptions. There are many ways to get to ER so I can see why people would eschew a more difficult route, despite its potential for being more enriching.

Nords you make many great posts but Bernstein does say you cannot successfully pick stocks
Bernstein quote: If you want to pick your own stocks and bonds, be my guest. Just don’t imagine that making your decisions on the basis of publicly available information and analysis will lead you anywhere but to the poor house. ----- Now I take that to mean Bernstein feels only by getting inside information from talking to corporate insiders can you make money, which is ludicrous.

Bernstein never comes to a reasonable conclusion that the reason Illinois Tool Works is no longer buying US companies is because the market is no longer undervalued so they don't buy. Instead he uses that as proof of an efficient market, yet how can a market be efficient only recently? It is one of the luxuries of doing your own analysis - if prices are too high you don't buy. Of course if Illinois Tool Works were to be being index funds they would always be buying because of course market prices cannot be adequately judged.

As for my 20 year record - it is irrelavent. Early in my investment career my first broker talked me into my first investment - Brock Hotel which at the time owned Showbiz Pizza. So in 1985 I went to a Showbiz pizza and the pizza was terrible and the business slow. I called the following day and wanted to sell and buy a stock I thought had a very bright future - Miicrosoft. He argued I could never understand all the positives his research had shown on Brock and the risks of such an unproven company and holding the Brock Hotel stock. He talked me out of the course of action I had felt confident in myself but deferred to his expertise. Within a year Brock Hotel declared bancruptcy and well you know how Microsoft turned out and I never bought a share. In fact the first 3 stocks I bought were all on my brokers recommendation: Science Managment (went from 18 purchase sold at 4) Moog class B (bought at 16 sold at 10) and Brock Hotel.
The $4,000 I lost on Brock Hotel was nothing compared to the education I received on how poor the advice is given that is considered "professional". Nords you may look at that and see as proof of the need to index investment it taught me that I my investment ideas were as good or better than most professionals selling from behind a desk.

I view Bernstein's advice in exactly the same mold. His arguements are contradictory and to the average investor he says you can never understand this business it is too complicated. Hogwash I say.

 

[Nords]

Nords you make many great posts but Bernstein does say you cannot successfully pick stocks
Bernstein quote: If you want to pick your own stocks and bonds, be my guest. Just don’t imagine that making your decisions on the basis of publicly available information and analysis will lead you anywhere but to the poor house. ----- Now I take that to mean Bernstein feels only by getting inside information from talking to corporate insiders can you make money, which is ludicrous.

Sorry, RM, I read the same words and interpret them to say that you have to do your own stock-picking work by talking to management, visiting stores, & building spreadsheet models. By "publicly available info & analysis" I think he's referring to ratings services like M* or TMF... or Schwab's stock ratings. Or anything that's publicly available to anyone who can navigate to a website or pick up a newspaper.

Why don't you e-mail Bernstein and ask him yourself?

As for my 20 year record - it is irrelavent.
I view Bernstein's advice in exactly the same mold. His arguements are contradictory and to the average investor he says you can never understand this business it is too complicated. Hogwash I say.

Well, most statisticians and investment-manager analysts (like Hulbert) claim that a 20-year record begins to separate random chance from actual performance. Bill Miller's streak was just beginning to separate him from the other (2^^15 -1) fund managers who would randomly beat their benchmark from one year to the next. That's why I used the term "coin-flipping monkeys".

20 years is also significant if you're trying to build an ER portfolio. Read the first chapter of Gary Smith's "How I Trade For A Living" where he discusses spending that much time (and much much more money) learning to effectively trade his IRA to ER. He's trying to show how hard he worked to achieve his experience, his credibility, and his portfolio. I gained the impression that the best years of his life sucked for a really really long time before things turned around, and maybe spending 20 years on that pursuit wasn't the most effective use of his time. I think most people-- especially people with families-- would turn to other pursuits.

So when you dismiss Bernstein's writing based on your interpretation of his vocabulary, I think you're throwing out the hogs with the hogwash. But that's just my opinion.

Nords you may look at that and see as proof of the need to index investment it taught me that I my investment ideas were as good or better than most professionals selling from behind a desk.

Ye gods, man, have you been reading any of my posts about the asset allocation that spouse and I have in our ER portfolio? Hardly the hallmark of index investors. Kindly refrain from putting words in my mouth.

I read Bernstein as saying that stock-picking is hard work-- and also saying that it's impossible if you don't do your own research & analysis. However do I believe that there are people who are able to pick stocks. Why, gosh, we have over 30% of our ER portfolio in Berkshire Hathaway. Walter Schloss, Ruane, Simpson, Munger, Fisher (two generations)-- all guys who have managed to accumulate decades of index-beating accomplishments.

I don't "need" to index invest. I choose to do so with most of our portfolio because there are too many other things I'd rather be doing than devoting the proper amount of time & effort to picking stocks, and because indices generally provide a better return than active management. (So I don't have to expend the effort on picking managers either.) However I'm not entirely free of the lure and I may never be-- I guess I'm just a recovering stock-picker.

If you're picking stocks to accelerate your journey to ER-- good for you. Now that I'm in ER, I'm finding out that money isn't enough motivation to continue to contend with all the risks of picking stocks. What are you going to be doing with your time during your ER, and what's your asset allocation going to be the day after you start it?

 

[clifp]

RM, I am with Nords. In essence what Berstein is saying is that if you think you can beat the market by listening to your broker, the analyst at Goldman, Merrill, Schwab, TMF, etc. you are kidding yourself. I think you agree with Berstein on this point.

In your earlier post you talked about listening to your broker rather than yourself about buying Microsoft. Now an interesting question to ask yourself, did I think Microsoft was a great buy, because I was confident about Microsoft industry dominance, or because I had carefully studied Microsoft financial, poured over their SEC filings, constructed a business model etc.? Personally, I have found in the past, that all to often while I have a good intuitive instinct about which tech companies would be successful, I often lacked the discipline and experience to do the analyst to see if the stock fairly valued or not. As I've gotten older, I've realized the importance of digging deeper before making investments, there are no short cuts for doing your own investment research.

However, I am not immune to taking other people advice, but more often than not I feel much less comfortable with my investments afterwords. For instance I bought JNJ 18 months ago because it has very long-term record or raising its dividend, and everybody and there brother was recommending it. Yesterday Cramer said sell JNJ, it doesn't have a good drug pipeline, and several of its most important drugs are going generic. Now I hardly ever listen to Cramer, but only fool would dispute that Cramer can move stocks. Meanwhile, the M* Dividend investor editor said buy more, and gave 1/2 dozen reason why.
Unfortunately, my knowledge of JNJ is very superficial so have no idea who is right. In contrast, my conviction on my Berkshire Hathway investment is much stronger. if people start dying from eating See Candy's and the stock dropped $10,000 and Kramer says SELL, SELL, SELL, Boyah, I'll laugh and buy more, because I understand the impact of See's on Berkshire (tiny). Still I'll follow the hot tips of smart guys like Brewer and buy DSX, but I'll only buy a small quantity. But I'll be in trouble of Brewer disappears and some news happens to the company.

After listening to Pillars and reading the back articles on the efficient frontier website, I have to say I am less impressed by Berstein when I just knew of him by reptuation. I know he is right that index funds are the right choice for most investor, and those investor includes everybody who isn't serious about investing. Where I and suspect you disagree with Berstein is when he makes the task of beating the market seems impossible, limited to just Buffett, Lynch, and guys at Yale, and Harvard.

I knew about dozen guys and gals who had careers on both Wall St as analyst and fund managers, and at tech companies, in marketing and finance. In some cases they started in Wall St and then went to a tech company, in other cases the worked at AMD, or Intel and then went to Wall St as a Semiconductor analyst. I am not sure what their depature or arrival did for the average IQ at the Wall St firm, but I know with two exceptions, the average IQ at the tech companies was higher without the Wall St. type.

In order for the average investor to beat the market they don't have to be a sharp as Buffet, they just have to be better than roughly 2/3 of the other investors. (Much as hiker in the woods, encountering a bear doesn't have to outrun the bear just the other guy.)

While indvidual investor have several disadvantage compared to institutional investors, we also have several advantages. I think the internet, and low cost trading have really narrowed our disadvantages. While cutting back of analyst covering smaller companies have amplified the advantages of individual traders. After all I, along with many people, retired at very early age, I have to smarter than the average bear about investing.

 

[mb]

In order for the average investor to beat the market they don't have to be a sharp as Buffet, they just have to be better than roughly 2/3 of the other investors. (Much as hiker in the woods, encountering a bear doesn't have to outrun the bear just the other guy.)

Interesting thought - but I think that it has to be volume weighted.

In other words you don't need to beat 2/3 of the individual investors you have to beat investors that are trading 2/3 (or 1/2?) of the volume and since the volume is dominated by large institutional traders they are the ones that you have to beat.

Perhaps based on your comment on relatively IQs you don't think that this should be to difficult?

MB

 

[clifp]

Interesting thought - but I think that it has to be volume weighted.

In other words you don't need to beat 2/3 of the individual investors you have to beat investors that are trading 2/3 (or 1/2?) of the volume and since the volume is dominated by large institutional traders they are the ones that you have to beat.

MB

I agree it probably is volume weighted, which does make it more difficult.

I

 

[clifp]

I was thinking about EMT today and I thought of an analogy, I'd be interested in peoples thoughts on it.

Let's say some academic research showed that over 50+ years, almost no professional sports teams (NBA, NFL etc) had a winning record much over .550. The study then went on to show that the average head coach wins less than 1/2 of his games, (ties, rained out games etc.) . Based on these two facts, sport teams owner should minimizes expenses by hiring the least expense coach. Since over the long-term, with the draft system, and the rise of pooled souting reports, it is virtually impossible for a coach to evaluate talent more effectively than the collective wisdom of the scouts.

Do you think any owner would pay attention to this study. Especially, when he discovered that virtually all of the research concentrated on the franchises records and very little on the records of the coaches

Furthermore, the study goes on to say that individual sport betters would be much better of makinga market weighted bet (the Pigskin index) at the beginning of the season on the Superbowl winner based the Las Vegas odds rather than picking individual teams. (For exampe if the 49ers are 50-1 and the Patriots are 5-1 you bet $2 on the 49ers and $20 on the Patriots.) Now if I knew little or nothing about Pro Football, (which I do) I'd probably take advantage of this system especially if the research showed me on average I'd make $108 for each $100 I bet, cause of tax incentives . But what about they guy who is a real Pro Football expert. If he knew that Chicago fans were crazy about the Bears year after year, causing the Las Vegas odds makers lowered the payout so they didn't go broke if Chicago won, should he still take the Pigskin index even though it includes a bad bet on Chicago? I think not

Now the analogy isn't perfect, but it is pretty close. Team owners hire coaches, Mutual Fund families hire fund managers. Coaches select players from a pool of players where much information is public but some isn't, and interpreting the information is the hard skill. Fund managers select stock with almost the same information. Of course coaches impact the performance of players,while manager have little or no influence on the performance of the stock. Finally the value of players is judged on a combination of past performance, current results, and future prospects, almost identical to stocks. Of course players can only be on one team, (except for the growing number of Fantasy sports leagues.) while stocks can be in many portfolios.

The problems I have with EMT, is that it starts with a tautology, on average investors earn average returns and goes from there.
It talks about everything compared to the average. "Among 5,000 mutual funds fully 65% of them didn't beat the S&P over a 15 year period." What proponents of EMT haven't done (at least in a study I've seen) is look at 20,000 mutual fund managers over long period of time and than evaluate those who have beaten the market and those who have following short. Is there any difference or is just that billion monkeys with typewriters, will eventually write Hamlet? The same thing is true of individual investors, lots of "studies" showing that on average we do worse than the market, but I got to believe on board of early retirees, at least a few of us have done better than the market. Finally, if stock selection is really an excerise in futility why does Wall St. continue to pay traders millions of dollars, is it just charity for Ivy League B school grads, or do the manager of Wall St. firms know something else.

 

[Nords]

The problems I have with EMT, is that it starts with a tautology, on average investors earn average returns and goes from there.

I think it gives EMH too much credibility to refer to it as a "theory". Maybe when it grows up it'll be big enough to upgrade from hypothesis!

The EMH bell curve is pretty flat with big fat tails. It doesn't follow a "normal" distribution. Within those tails there's plenty of room for individual investors to run rampant without having to face the consequences of fund bloat, survivor bias, excessive publicity, and legislative oversight (especially the expenses of Sarbanes-Oxley). Heck, we can't even get good returns data without having to sort out whether dividends & distributions are reinvested.

Unfortunately for those individual investors the left-hand side of the bell curve is at least as roomy as the right-hand side...

 

[wabmester]

I think the basketball team analogy is a good one.

If you want to beat the average mutual fund, all you need to do is beat more than half the fund managers. That's like an amateur basketball player beating half the professional basketball teams. It's not impossible, but it requires either professional-level skill, a lot of luck, or playing a different game.

I've made a pretty good return by playing a different game. Started my own business for one. Bet on long-term trends for another (most "pros" are playing a short-term game). But when I try to beat the pros at their own game, I usually don't do so well.