Vanguard's Bogle comments

[FUEGO]

So in short, passive investors, please describe your approach and your definition of passiveness.

"You can't beat the market. Own it and let the intermediaries extract as little wealth as possible from you."

The way I implement this also ties in some research that suggests there is a small increase in risk-adjusted return in the small cap sector and the value sector (ie the return more than compensates for any increase in risk). I'm a slice n dicer. My portfolio tilts towards value, and small and I mix in a little REITs. I'm betting on multiple relatively uncorrelated asset classes with the goal being lowering overall portfolio volatility and as a result getting a higher risk adjusted return. My method of implementing this strategy are index funds due to low expense ratios, low hidden trading costs (turnover related), tax efficiency, low tracking error, knowing what you are buying, etc. I do own an actively managed fund, VTRIX - Vanguard International Value but it has a profile very similar to passive mutual funds is comparable to the best international value ETF's available.

The fact that adherents to the strategy implement it with a multitude of variation does not detract from the inherent strength of the strategy.

 

[clifp]

You'll have to walk me through the difference between the performance of a stock picking fund manager and the performance of the fund for which he picks stocks.

Magellan is classic example. Over the last 10 years it has been mediocre fund, and probably over the lifetime only slightly better than average, but when Lynch was running it, it had a terrific performance. Yet when the academic do studies of efficient market they always look at the performance of funds and not the performance of the individual managers.

Here is an interesting thought experiment. Large funds have many assistant fund managers. Imagine that while Lynch was at Magellan there was a guy called Ben,who made some terrific picks and really accounts for much of Magellan success. Fidelity moves him to take control of a sector fund, once again he does a great job, a kills the sector competition. However, the sector is a out favor and he underperforms the S&P 500. So Fidelity won't give him a bigger fund. He leaves Fido and runs a medium fund somewhere else for 5 years, again he does a great job, but lets say he is a lousy manager and people hate working for him. He switches firms again managing a different fund every three-five years or so. For each fund he clearly adds alpha. Finally in 2005 he takes over a big multibillion dollar fund. In 2007 he tells every body the housing bubble is going to burst but the fund family says, we hear you, but you aren't allowed to short and you shouldn't keep more than 10% in cash. In 2008 Ben fund his only down 25%, but still down 25% isn't good.

So over the course of 30 year career, Ben has always outperformed his peers by a comfortable margin over every 5 year period. However, because of his lack of tenure with any one fund he never appears on the radar screeen as far as the media is concerned. Morevoer, Because his superior stock picking skill is spread over 1/2 dozen or so fund, many of whom are competitors he actually reinforces the efficient market theory. So people conclude lots of fund have great runs for a few years Magellen, Janus 20, etc, which proves that stock picking is useless, but nobody makes the conclusion that no Ben had a great 30 year run maybe there is skill involved.

I suspect that Wall St. has quite a few guys like Ben that labor in relatively obscurity much like offensive lineman. Of course they do generally get paid quite well

 

[Gone4Good]

Yet when the academic do studies of efficient market they always look at the performance of funds and not the performance of the individual managers.

It is beyond belief that an oversight as simple as this would not have been uncovered by the decades of peer-reviewed research into the topic.

 

[Nords]

It is beyond belief that an oversight as simple as this would not have been uncovered by the decades of peer-reviewed research into the topic.

Let's look at it from another angle: How long would it take these peer-reviewed researchers to get around to Bernie Madoff's record?

 

[NW-Bound]

Here's one mutual fund manager who apparently agrees with you:

We stunk - MarketWatch.com

I read the posted link, and I have found a couple of interesting statements from the same speaker that lead to different observations from what RW saw.

"Whether in stocks or bonds, it seems as though the same old strategies were followed
-- be fully invested...and don't diverge from your benchmark too far," he said.
​

Ah... So it appears these MF managers forced themselves to whatever principles they picked, hence cannot avoid the potholes, whether they could see it or not. Again, whom would they sell these Bear Stearns, Lehman, and AIG stocks to?

Rodriguez said he's lost business since 2007 because he'd gone into cash. The losses included one $300 million client that left because his approach upset their asset allocation model. "We have been penalized for taking precautionary measures leading up to and during a period of extraordinary risk," he said.​

All I can conclude from this article is that an individual investor must take matters into his own hand and not rely upon MF managers. As I said time and time again, I give them the benefits of doubts that not all of them are that lousy as investors. However, they have limitations put on them by their short-attention-span investors and by the lack of mobility due to their size. They may get penalized for deviating too far from the pack. Better to stay with the crowd. And of course the average MF will trail the S&P due to management costs.

So, what's the remedy? Some will say to join the bogleheads forum.

I have not been there, but just from indirect knowledge, I see that there will be so many different twists that can confuse the heck out of newcomers. Just because you should not rely on MF managers should not mean you are stuck with Vanguard products, right? Not that there is anything wrong with Vanguard, but as an individualistic person, I tend to view any congregation with jaundiced eyes.

And by the way, although I consider myself an active investor, meaning I try to pick stocks and sectors, my portfolio turnover is usually lower than many MFs. I do not have an exact number, but the average is about the same or less than the more conservative MFs like Wellesley and Dodge and Cox at 27% yearly turnover. Of course when I saw (due to my luck again) that sh*t was going to rain on the financials, my portfolio turnover jumps up to 50% in 2008. I hope not having to sell much in the coming months. If it works, leave it alone. Yes? I consider myself diversified but again, I do not feel I need to own everything under the sun.

I also do not frequent investment Web sites such as bogleheads and M*. In fact, the typical member here appears to surf these sites more than I do. Why, if you want to stay the course and follow your own conviction? I do listen to the media and read news Web sites, and usually try to get to the facts and not put weight on the commentaries. Secondary sources like forums only have the facts as second-hands and then, with even more commentaries added.

That said, investment decisions take time (and guts), and they may be only worthwhile when your portfolio gets to a certain size. Investors can do a whole lot worse than joining the bogleheads forum -- they should stay clear of some stock forums I stumbled upon. I still wonder if the different opinions in the bogleheads forum would confuse the heck out of the newcomers though. They still have to understand the differences between schools of thought and choose their own portfolio mix, as there is no orthodox boglehead left who invests solely in VFINX.

 

[samclem]

Imagine that while Lynch was at Magellan there was a guy called Ben,who made some terrific picks and really accounts for much of Magellan success. . . . I suspect that Wall St. has quite a few guys like Ben that labor in relatively obscurity much like offensive lineman. Of course they do generally get paid quite well

Let's consider poor old neglected Ben and continue the thought experiment. Let's say Ben is not only good at picking stocks, but he is convinced that his performance is not due to luck. He's got the knack--the amazing golden ability that somehow has eluded the ability of academia and Wall Street to recognize or to train others to perform. He's a regular Midas. What should he do?
a) Start trading for himself using these principles. Through the amazing leverage offered by options, if Ben is right only a little better than chance, he'll be fabulously wealthy in a few short years.
b) Open a mutual fund. Ben is not just talented, but also magnanimous. He could make more money by simply trading for himself and maximizing his own riches before asset bloat drags down his performance. But he wants to help others, so he starts a mutual fund. Ben's outperformance will quickly get him noticed, and his fund will be the new Magellan.
c) He decides to write a newsletter, giving other people stock picking advice. Nobody quite understands why Ben would do this, since he'll make far less money than the above two options.
d) Continue to jump from fund company to fund company. His skill isn't recognized, and he makes far less than he would under options A and B.

I'm looking for these Bens in the real world. There may be a few Bens who took option A (Pickens, Buffett, etc), but the way these folks operate (by actually changing/adding value to the companies they buy, or exploiting deals few others have access to) takes them out of the league of stock pickers. The literature doesn't reveal any exploitable evidence of Bens at work in Option B. Option C: Mark Hulbert conducts a lot of indepth analysis of financial newsletters, over 180 of them. A newsletter writer has a lot of advantages--especially the fact that he can pick any securities he wants and he can buy/sell them without feeling the impact of the change in market price. Surely the Bens should be doing well here. What did Hulbert find? Here's what Money Magazine's web site says.

You'd be much better off just throwing the money in the nearest dumpster than buying these newsletters and risking a big chunk of your nest egg in following the newsletters' advice. . .
At a recent investment presentation, Hulbert pointed out that if you had invested $10,000 in a portfolio in 1980 following the advice of the top-performing letter over the prior year, and then changed it each year to the top newsletter for the prior year, your investment would be worth just a few pennies. . . .

Hulbert noted that a much better strategy would be to take the advice of the newsletters with the best ten-year track records. The sustained performance is much more meaningful.
So would following the advice of the newsletters with the best long-term track records have padded our portfolios?
If you had taken your investment advice from the newsletters with the best ten-year track records, you still would have underperformed the broad stock market indexes in the years that followed. This means you would have been better off owning the entire market and settling for the market averages. And this result didn't even include the trading costs and the tax-inefficiencies of the market newsletter strategy.

Okay, so there are no discernible Bens who took Option C.
That leaves Bens who selected Option D--and these appear to be toiling away in total (and totally unexploitable by us) obscurity. We've identified just one, and he lives in your thought experiment alone.

 

[NW-Bound]

What if there are some Bens who did not fit under any option that samclem delineated, and who also are too busy having fun to even bother to enter into discussions in this forum?

My suggestion is that we cannot disprove the existence of some Bens, as they may be too busy counting their personal fortune to identify themselves to us.

 

[clifp]

Let's consider poor old neglected Ben and continue the thought experiment. Let's say Ben is not only good at picking stocks, but he is convinced that his performance is not due to luck. He's got the knack--the amazing golden ability that somehow has eluded the ability of academia and Wall Street to recognize or to train others to perform. He's a regular Midas. What should he do?
a) Start trading for himself using these principles. Through the amazing leverage offered by options, if Ben is right only a little better than chance, he'll be fabulously wealthy in a few short years.
b) Open a mutual fund. Ben is not just talented, but also magnanimous. He could make more money by simply trading for himself and maximizing his own riches before asset bloat drags down his performance. But he wants to help others, so he starts a mutual fund. Ben's outperformance will quickly get him noticed, and his fund will be the new Magellan.
c) He decides to write a newsletter, giving other people stock picking advice. Nobody quite understands why Ben would do this, since he'll make far less money than the above two options.
d) Continue to jump from fund company to fund company. His skill isn't recognized, and he makes far less than he would under options A and B.

My we are cynical today Sam.

I imagine Ben is motivated by more than just money. There are plenty of people who do things for the intrinsic pleasure in doing them. I know airline pilots who like to fly, and even pay money for the privilege. BTW, how is the homebuilt coming? I personally would be still enjoy managing my portfolio if was 1/10 the size or 10x bigger. Although if I was smart, I'd probably take Uncle Mick's advice and stick most into psst fund and reduce the hormone fund to 10%. Ben makes a $1 million a year on Wall St. that is plenty of money for him, he is motivated to beat the market and his peers with his mutual fund.

A.) I am sure Ben trades for his own account but there are restrictions on mutual fund managers and what they can do. I.e you can't buy stock X and than have the Mutual fund buy a lot more X the next day. Simply quit is an option but why take the risk you are getting $1 million a year to pick stocks with other people money and you get a chance to be on Money, Forbes lists.
B.) Open up a mutual fund. Why would somebody want to do this? My god you have to go out a raise seed money, deal with the SEC, and then you have to market the funds, what royal pain in the butt for pain. The actually stock picking is only a fraction of running a mutual fund. Ben is great and pick stocks, but sucks and dealing with people.
C.) Unless he is motivated to teach others, or is a scam artist, why would he want to do so. I agree that most of them aren't good for the reason you and the article enumerate.
D.) I know plenty of great engineers in Silicon Valley who job hopped their who careers. In fact, because they were great engineers they were generally recruited. Money was factor but generally only a secondary factor, often they found something else in their current job beside the work they didn't like. Some just need a new challenge every few years. I'd be surprise if Wall St. wasn't similar

Finally, I'd point out there is a whole group of people did pretty much what you point out. They are hedge fund managers, and I have yet to see a list of hedge fund much less a comprehensive study on their performance.