Law of large numbers strikes again

[mickeyd]

This is another passive is better than active article that works Bill Miller and his fall from grace a few years ago into it all. We had many chats here about Bill over a dozen years or so. Don't hear much about him these days.

The downside of being wrong is that the actively managed mutual fund significantly underperforms the market, leaving investors in a possibly worst financial return than otherwise could have been earned by just sticking with a globally diversified portfolio of index funds. As we have mentioned in previous articles on stock picking managers, the odds are NOT stacked in the favor of fund shareholders.

Bill Miller was once the king of the active fund management industry. Although some may believe that he has lost his touch, we believe he has simply fallen victim to the law of large numbers.

Lady Luck can be vicious!

https://www.ifa.com/articles/large_numbers_bill_miller_fall_from_grace/

 

[jazz4cash]

When I read Law of Large Numbers I thought they would say the fund got so large that it became more difficult to pick stocks that would beat the index ( which isn't S+P after all). Instead they say maybe his success was just luck! I am 95% index.


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[Totoro]

25% of funds outperform each year. Suppose only randomness decides this each year, independent and randomly.

That means (rounded):
Y1: 25% outperforms
Y2: 6% (25% x 25%)
Y3: 2%
Y4: <1%
Y5: <0.1%

In practice, we observe that 5% still outperforms after ten years (also per the article). Let's say the bulk of those guys aren't due to luck.

A naive estimate then gives .. 5% consistent outperformers / 25% outperformers = 20% chance a winner in a certain year will continue to win.

So here is the puzzle: If I can't be trusted to do individual stock picks, why would I be able to select a good fund (manager) when I have at best a one in 5 chance to select a winner?

[I know the math isn't fully correct since the assumptions are off]

 

[meierlde]

When I read Law of Large Numbers I thought they would say the fund got so large that it became more difficult to pick stocks that would beat the index ( which isn't S+P after all). Instead they say maybe his success was just luck! I am 95% index.


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In fact Fidelity Magellan is a perfect example. In 2000 it had over 100 billion in investments, today it is down to 18 billion partly after making a one time capital gains distribution of 18% of assets.
Basically it got big enough it had to effectively index a good bit of the s&P 500 because it had so much to invest. It was closed to new investors between 1997 and 2008.

 

[jazz4cash]

In fact Fidelity Magellan is a perfect example. In 2000 it had over 100 billion in investments, today it is down to 18 billion partly after making a one time capital gains distribution of 18% of assets.
Basically it got big enough it had to effectively index a good bit of the s&P 500 because it had so much to invest. It was closed to new investors between 1997 and 2008.

Sure. That's the Law of Large Numbers I think of but this article is about something entirely different. The better active managers close the funds to new investors well before it becomes an issue.


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[Texas Proud]

In fact Fidelity Magellan is a perfect example. In 2000 it had over 100 billion in investments, today it is down to 18 billion partly after making a one time capital gains distribution of 18% of assets.
Basically it got big enough it had to effectively index a good bit of the s&P 500 because it had so much to invest. It was closed to new investors between 1997 and 2008.

According to Fidelity it is $15 billion in assets.... and a .85 expense ratio.... and has not beat the S&P over the last 10 years...


My mom has had a small amount in this fund for many many years... I just do not sell because of cap gain... however, I have been thinking of consolidating and doing it...

 

[Totoro]

Performance handicaps of larger funds sometimes is called elephantiasis. Not at discussion here.

Really good performers (like Medallion) are typically closed to outside investors and limit the size of their fund.

 

[jazz4cash]

Well I looked up law of large numbers and it was not what I thought it was so I was wrong to disparage the way it was used in this article. Actual definition is more like regression to the mean.


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