The Big Investment Lie (excerpt)

[pedorrero]

Some excerpts from Michael Edesses's book of the same title (highly summarized by me):

The Simple Facts about Investment Performance

Step 1: Obviously, the average performance of all investors will be equal to the market average, right?

Step 2: Investors in the U.S. stock market are of two types: professionals who are paid to invest their clients' money and everybody else.

Step 3: If professional investors know how to get better investment performance, then their performance as a group ought to be better than everybody else's, right?

Step 4: Professional investors as a class do not outperform the market.

Step 5: Now wait a minute. You keep saying "as a class." Everybody knows that some professional money managers -- the good ones -- outperform the market. But...

Step 6: Some investors will always outperform the market -- probably about half of them.

Step 7: But don't some professional investors consistently beat the market averages?

The answer is no.

Step 8: Nearly all reputable statistical studies show there is no significant consistency or predictability in the performance of professional investors.

Step 9: Market-beating performance is unpredictable.

[pp. 88-90]

This is the best book I've ever read that makes the case that trying to predict the market is a fool's errand (or a Motley Fool's errand, perhaps for some of us.) One out I see here, although Edesses wouldn't approve: perhaps if you are an "amateur" investor you stand a better chance than the pros? If nothing else, you can cut out the middleman (brokers, etc.) and save up to several percent. I dabble in stocks (don't we all?) But to think you can beat the odds is forgivable human nature too. That's "behavioral economics" -- topic for another time.

 

[Retire Soon]

None of this information is new. John Bogle, founder and former chairman of Vanguard Group brought all of these ideas to light in in analysis of the stock market. In his 1994 book, "Bogle on Mutual Funds," he offered proof that attempting to beat the market is a "fools errand." He has written many subsequent books on his theories. No mutual fund company in the U.S. wanted anything to do with low cost index funds until Vanguard first offered them and proved their superiority.

 

[clifp]

There are two types of football coaches in America the highly paid professional coaches who coach the Division 1A colleges and the NFL, and the vast number of amateur or semi-professionals who coach for Pop Warner, High School, and Jr. High.

As a group even at the professional level football coaches win no more games than they loss. The performance of a football team is highly unpredictable some times they are near the bottom of league and the next year they go to the Super Bowl. Nor do coaches seem to have much impact on performance a coach could have a winning record for several years, go to another team and have a series of horrible years and vice versus.

There is considerable expense associated with a higher a football coach, not just his salary but his assistant salary and changes in the personal needed to adept to his system.

The average NFL owner of University Athletic Department head would be much better of replacing his coach with a computer program, which consists of all of the offensive play and defensive formations, carefully weighed to reflect NFl usage.

How many want to fire the coach of your favorite team, and seem him replaced with computer?

 

[growing_older]

This doesn't seem like a usable analogy to me. All the teams do not play football against each other. The job of coach is a great deal more than simply play selection. Now, if you had statistics to show that within the NFL, there is a group of especially highly paid coaches whose results are no better than other NFL coaches, then you might have an argument that overpaying coaches is not beneficial to the team at this level of play. I doubt you'll find that. But even in you did, it still wouldn't favor using "market weight" play selection. Football games are not that kind of a marketplace.

 

[cute fuzzy bunny]

Yep, big diff. Part of a football coach's job is managerial...preparation, selection and execution. Part of it is leadership...motivation, emotional buy-in, giving the extra effort.

An investment manager can offer improved managerial skills, but its hard to express leadership in the markets unless you're one of a handful of people who are so well regarded that their words can move a stock price.

The reason why nobody can legally outperform the market is simple: its just too damn complex to know whats going to go where.

The weather is simple compared to the markets. Yet "persistency" is a better predictor than the best forecasting system operated by the sharpest weather forecaster.

And the weather isnt shaped by all manners of known unknowns and unknown unknowns perpetrated by individuals and groups, all with their own agendas.

 

[UncleHoney]

Yep, big diff. Part of a football coach's job is managerial...preparation, selection and execution.

Ah yes, and if the coach doesn't manage, prepare and make the right selection, he gets executed.

 

[FinanceDude]

You mean, THIS GUY??:

Synopses & Reviews

Publisher Comments:

Michael Edesess learned early in his career that the investment industry’s claims that it could beat market averages were simply not true. Professional investors, it seemed, could not predict stock prices better than the nearest cab driver. The Big Investment Lie helps readers cut through the thicket of hype in this perilous area, showing how widespread acceptance of the “lie” allows an entire industry to prosper on the small investor’s dime. Edesess shows readers how to break free from this pervasive falsehood and pursue sensible investment policies. Individual chapters cover such subjects as the high cost of investment advice, effective pitches to sell the big lie, the hedge fund bonanza, derivatives, the “good old boys’ club” of institutional investors, and much more. The final chapter, “Ten New Commandments for Smart Investing,” gives a simple, sound plan for everyday investors to maximize long-run wealth and achieve a secure financial future — without the “help” of predatory professionals.

Review:

"Having learned deceptive sales practices as a teenager selling magazine subscriptions, Edesess sold overpriced credit life insurance before becoming an investment adviser after a boss told him that 'the way to make money is to handle money.' By 2004, he found himself in Florida, failing to entice investors into a trading scheme that lost 80% over six months, when the company promoting the idea collapsed without paying him. That experience, he says, 'provoked me to write' this book. But his pose as a reformed sinner is unconvincing. The how-to chapter on deceptive sales is more animated than his cursory review of academic literature arguing for low-cost, diversified, buy-and-hold strategies. He likes self-promoting investment failures, like the ones created by Charles Ponzi and the Beardstown Ladies, but disparages successful investors like Warren Buffett, Ed Thorp, George Soros and Julian Robertson. Edesses's most useful ideas are covered better in John Bogle's books, among others." Publishers Weekly (Copyright Reed Business Information, Inc.)
Synopsis:

This expos? of regularized falsehood reveals the unfortunate truth behind the financial advisory industry ? that professional investors cannot, and never have been able to, beat market averages. Written by a well-credentialed insider, this book additionally provides detailed insights into where people should really invest their money.

He sounds like a failed sales hack who needed to make a quick buck. Stick to Bogle, he has credibility........

 

[ats5g]

One out I see here, although Edesses wouldn't approve: perhaps if you are an "amateur" investor you stand a better chance than the pros? If nothing else, you can cut out the middleman (brokers, etc.) and save up to several percent. I dabble in stocks (don't we all?) But to think you can beat the odds is forgivable human nature too. That's "behavioral economics" -- topic for another time.

See Terry Odean's research papers on individual investors. Not too pretty.

- Alec

 

[clifp]

This doesn't seem like a usable analogy to me. All the teams do not play football against each other. The job of coach is a great deal more than simply play selection. Now, if you had statistics to show that within the NFL, there is a group of especially highly paid coaches whose results are no better than other NFL coaches, then you might have an argument that overpaying coaches is not beneficial to the team at this level of play. I doubt you'll find that. But even in you did, it still wouldn't favor using "market weight" play selection. Football games are not that kind of a marketplace.

Ok I'll concede that my football coach analogy is probably stretching it, and I don't actually belief that great coaches don't end up winning more games than bad coaches. Why because there is skill involved coaching albeit with a very amount of luck also. Over the short term the luck (random chance) is more important than the skill.

The problem with virtually every "beating the market is foolish study: is they are constructed poorly. First of all they they use aggregate data. Individual investors as group don't beat the market, professional as group don't beat the market. Well guess what NFL football coaches as a group lose as many games as they win.

I think valuing companies and stock prices is a skill and some people are better at than others. I am interested in seeing how much more money people make who are good at make. I have yet to see to study that actually evaluates the performance of individuals. Instead all studies that I have seen focus on the performance of mutual funds not individual managers. Since fund manager turnover is high (although probably no worse then NFL head coach) it is pretty hard to measure. Still head coaches take with them a lifetime win loss record. I have yet to see a mutual fund prospectus or study that starts of with. Fund manager
Steady Sam has a lifetime record of 18 years outperforming the market equaling the market 5 years and underperformed it by 3 year his lifetime average is +2.5%
He is backed up by two members of the fund team. Volatile Vicky who her 7 years money manage experience had crushed the market for 3 year by an average of 15% while under performing 4 year by an average of 5%. Finally we have Phenom Fred, who was top of his class at Sloan and during his 4 year at as assistant manager XYZ fund beat the market each year by an average of 8%.

Now what would be really interesting is to do a study of the top 100 Phenom Fred's and follow their career for the next 25 years. I beat that as group they'd crush the market. Of course the efficient market folks aren't interested in this stuff, because it is too hard.

 

[cute fuzzy bunny]

Yet we have tens of thousands of Phenom Freds to look at over the last 25 years, and only a few who beat the market. Odds are that if we were flipping coins or doing the old monkey dart throwing, that there'd be more than that.

In other words, history says that having ones hands on the thing screws it up.

Bear in mind I was a dyed in the wool managed funds guy until the folks around here changed my mind with a preponderance of data that managed funds dont succeed over the long haul, and an absence of data that says they do succeed.

 

[pedorrero]

FinanceDude, thanks for the review link. I think that trashing Edesses just because he is preaching against what he used to practice is unfair. If nothing else, he speaks as a reformed "sinner." It's like if you were selecting a speaker to speak against alcohol or drug abuse at a public school: Whom would you believe more: a PhD stuffed shirt who'd never done any substance abuse, or someone who'd overcome an addiction and the bad things that go along with it?


An interesting compromise in the "beat the experts" game might be (illusory though it might be): if you could invest with the "experts" with the best track records (and not pay anything!), you probably wouldn't do any worse than "average"

 

[growing_older]

I wonder if these studies are also hampered by a form of survivorship bias. If a manager truly has whatever secret sauce enables consistent market beating performance, why would they not simply take that secret with them into a private investment pool and no longer be part of any universe being included in the study.

 

[clifp]

Yet we have tens of thousands of Phenom Freds to look at over the last 25 years, and only a few who beat the market. Odds are that if we were flipping coins or doing the old monkey dart throwing, that there'd be more than that.

In other words, history says that having ones hands on the thing screws it up.

Really you've seen a study that follows the performance of individual money managers over several decades. I haven't seen anything like the that.
I have seen the efficient market folks hand wave away the Buffett, Lynch, Bill Miller, and Wally Weitz, with million monkey theory. As far as a study which trys and identifies the Buffett, Lynch's, in the careers and then follows them for a decade I'd love to see a link.

Bear in mind I was a dyed in the wool managed funds guy until the folks around here changed my mind with a preponderance of data that managed funds dont succeed over the long haul, and an absence of data that says they do succeed.

I am not talking about mutual funds, I am talking about money managers. I agree with you about managed mutual funds I own almost exclusively index funds or ETFs. My belief is that it is harder to pick a winning mutual fund than to pick a winning stock, so why pick a fund.


The studies I've seen suggest that professional money management of universities endowments outperform the market. I bet there are private money managers who also outperform the market, possibly even pension fund managers who over long periods of time outperform.

The problem is the nature of academic studies. It is easy to study mutual fund performance because it is public info everything else is private. For whatever reason most studies don't pay attention to individual managers and instead focus entirely on the mutual fund performance, or the performance of groups such as individual investor or institutional investors.

The mistake I think that people like Edesses make is taking a tautology. "On average mutual funds perform average except for managed fund which perform worse than average" and try to apply that same logic to individuals.

It maybe hard or perhaps impossible to identify people with superior investment early enough to be able to make any money.
I think efficient market is dubious at best, what the heck changed between Friday and today to make the US stock market worth 4% more? I think that valuing stocks is skill and proper study would you show bell curve of ability (I have know idea what the shake looks like.) I am confident that Warren Buffett, Peter Lynch, or Bill Miller are all on the left side of the curves, so confident that if they were 20 years younger and announced that they were raising $1 million from a 100 people for closed end partnerships, I couldn't get on the plane fast enough to give them my money.

 

[TickTock]

clifp,

Here's the problem, though - how do you identify them before the fact?

In other words, in 40 years there will be another Buffet, Lynch, Miller, and so on. But how will you know who they are before they establish their records?

IMO, the idea that NO-ONE can beat 'the market' is tenuous. But, the idea that identifying who will beat 'the market' before hand is so remote, that the idea has no practical merit.

 

[clifp]

clifp,

Here's the problem, though - how do you identify them before the fact?

In other words, in 40 years there will be another Buffet, Lynch, Miller, and so on. But how will you know who they are before they establish their records?

IMO, the idea that NO-ONE can beat 'the market' is tenuous. But, the idea that identifying who will beat 'the market' before hand is so remote, that the idea has no practical merit.

I pretty much agree. But here is a thought Wall St firms dole out millions of dollars in bonus to traders. I am honestly am not sure if these bonus are primarily based on hard data, or the normal BS employee evaluation, did you achieve your quarterly goals, did the clients like you, did you work hard etc.

If it is hard data than perhaps investing money with the best paid young Wall St trader would be a good idea. Still I think that both Wall St and Academia would find it in their interest to see if the best top paid trader after 5 years are still the best performers after 20 years.

 

[cute fuzzy bunny]

Aside from the well made point of figuring out who the guys are in advance, do you really need me to give you a link? Anyone who has "beat the market" is screaming their success at the top of their lungs and you've named them!

Lynch had a run that seemed to be coming to an end when he quit. I'm guessing he did well until the bloat caught up with him. Miller had 15 market beating years but most of them were barely beating the index, and he charged a lot in fees (1.65% ER, .91% 12-1b), then had a 6% shortfall year in 05. Buffet is one of a kind, IMO.

Thats it?

I'd give you a link, but I dont know of anyone else who did better over a consistent long haul basis and I'm sure if someone did they'd be telling everyone! About the only thing I could point you to was Bernsteins Four Pillars where I felt he fairly conclusively found that active management was a detriment.

I can tell you with great certainty how wall street traders get comped. Based on who brought in the most fees and profit dollars for the firm. Only part of which is influenced by the survivor biased, time frame limited, gamed numbers that bring in the general rubes to hand over their money.

Did you know that the Motley Fool guys' recommendations have gained 22.8% annualized since 2002? WOW!!!

Lets forget about the dozen or so portfolios they were quacking about between the mid 90's and 2002, all of which flew into the ground nose first at mach 5.

 

[laurence]

Seriously, Clifp, have you read 4 pillars? It has lots and lots of crunchy data to chew on to support what's been said here. It includes some tracking of top performers year by year and how they did later on. As far as a secret cabal of market geniouses who consistently beat the market and hide from the public, well, we aren't going to find them, so why worry about it?

 

[cantlogin]

I have yet to see a mutual fund prospectus or study that starts of with. Fund manager
Steady Sam has a lifetime record of 18 years outperforming the market equaling the market 5 years and underperformed it by 3 year his lifetime average is +2.5%
He is backed up by two members of the fund team. Volatile Vicky who her 7 years money manage experience had crushed the market for 3 year by an average of 15% while under performing 4 year by an average of 5%. Finally we have Phenom Fred, who was top of his class at Sloan and during his 4 year at as assistant manager XYZ fund beat the market each year by an average of 8%.

Now what would be really interesting is to do a study of the top 100 Phenom Fred's and follow their career for the next 25 years. I beat that as group they'd crush the market. Of course the efficient market folks aren't interested in this stuff, because it is too hard.

I'll start off by admitting that I don’t have as much knowledge on the subject as many of the other posters. I have read “The Four Pillars”, Bogleheads and countless posts here.

If I understand your thinking on the above quote, I agree completely, but the fact that statements like that aren’t seen in prospectuses (spelling’s correct, I looked it up) or advertisements speaks with strength about the dearth of such evidence. It makes it tempting to conclude that such managers simply don’t exist.

 

[FinanceDude]

FinanceDude, thanks for the review link. I think that trashing Edesses just because he is preaching against what he used to practice is unfair. If nothing else, he speaks as a reformed "sinner." It's like if you were selecting a speaker to speak against alcohol or drug abuse at a public school: Whom would you believe more: a PhD stuffed shirt who'd never done any substance abuse, or someone who'd overcome an addiction and the bad things that go along with it?

I have read enough books from "experts" like him to know it's probably not a good read. The info may be intriguing, but not earth-shattering, like a Suze Orman book. Even better, I used to read with great humor about all the failed car salesmen that made money giving out the "secrets" to buying a new car at a great price.

But hey, some publishing house picked it up, right? To me, his book and the National Inquirer have the same credibility.

If you want REAL drama, pick up "The Wolf on Wall Sreet"............THAT is a scary true life account.........

 

[unclemick]

I have read enough books from "experts" like him to know it's probably not a good read. The info may be intriguing, but not earth-shattering, like a Suze Orman book. Even better, I used to read with great humor about all the failed car salesmen that made money giving out the "secrets" to buying a new car at a great price.

But hey, some publishing house picked it up, right? To me, his book and the National Inquirer have the same credibility.

If you want REAL drama, pick up "The Wolf on Wall Sreet"............THAT is a scary true life account.........

Don't read books!

It's male(usually), INCURABLE, and happens every generation. It can be managed though!

This time - after forty years of stock picking, I got a very nice Curmudgeon Certificate downloaded from this very forum.

And yes I just posted over at the Bogleheads forum.

Yes Gertrude - there will be a test!

heh heh heh - it's called life. Pssst - 1 in 6 odds of hitting the 'superstock' per Bernstein.

 

[FinanceDude]

Seriously, Clifp, have you read 4 pillars? It has lots and lots of crunchy data to chew on to support what's been said here. It includes some tracking of top performers year by year and how they did later on. As far as a secret cabal of market geniouses who consistently beat the market and hide from the public, well, we aren't going to find them, so why worry about it?

The only genius I know is Warren Buffett..........I think his 50 year investment average return is better than 20%............

Found the link, I waspretty close: http://www.berkshirehathaway.com/letters/2005ltr.pdf

 

[laurence]

The line I've heard is that Warren takes over companies and actively manages them, he's a "value added" input, and that's how he beat returns. I think is conglomeration is too big for that now, and that he now benefits from a value tilt (which we know about) and being such a sage that people follow his moves, thus being a self fulfilling prophesy. Look at his purchase of silver a couple years back. No doubt though, he's good.

 

[FinanceDude]

The line I've heard is that Warren takes over companies and actively manages them, he's a "value added" input, and that's how he beat returns. I think is conglomeration is too big for that now, and that he now benefits from a value tilt (which we know about) and being such a sage that people follow his moves, thus being a self fulfilling prophesy. Look at his purchase of silver a couple years back. No doubt though, he's good.

I think he managed to control 10% of the world's supply of silver.........and THEN it leaked out that Buffett was buying up a lot of silver, the price went through the roof, and he got out pretty darn close to the top..........

He's got folks looking out for him..........I wonder if Congress is going to pass some big bill where they throw billions at the railroad companies because it's the cheapest way to ship freight..........Warren would make big money on that.............

 

[clifp]

Seriously, Clifp, have you read 4 pillars? It has lots and lots of crunchy data to chew on to support what's been said here. It includes some tracking of top performers year by year and how they did later on. As far as a secret cabal of market geniouses who consistently beat the market and hide from the public, well, we aren't going to find them, so why worry about it?

Yup read 4 Pillar (actually the library had it on audio tape only so I didn't get to see all the charts.) Speigel's Stocks for the Long Run, Random Walk down Wall Street, Bogle on Mutual Funds and bunch of others

I don't own 4 Pillar but I what remember Berstein tracking was the performance of certain mutual funds managed by big name guys. I could be wrong but seems to the performance tracking was only for a relatively short period of time a decade or so and included only a single fund. What about Peter Lynch or Bill Miller before Magellan or Leg Mason, anybody seen a study on their lifetime performance?

As we know the law of big numbers pretty much puts a cap on open ended mutual funds significantly outperforming the market for long periods of time.
A hot fund in a bull market gets a big inflow of funds which reduces performance, in a bear market and/or in year of underpeformance it suffers from a large outflow of which also hurt performance. Large mutual funds also generally have a team of assistant managers who probably have less stocking picking skill (or perhaps more) than the big name manager.

When I put all of these factors together and add in a sizable ER, it isn't
a shock that managed funds do so poorly and only a handful of funds outperform the averages over long periods of time. The question is do these results prove that stock picking is a fool errand as the efficient market theory people contend,or do they just prove that open managed mutual funds aren't a good investment vehicle?

It seems to me that something like WSJ long running dart portfolio vs the pros. (In which the Pros beat the darts by a small but measurable amount) are a better test of my contention that stock picking is skill and not equally distributed.

Maybe we should start one on the board?

 

[Nords]

The line I've heard is that Warren takes over companies and actively manages them, he's a "value added" input, and that's how he beat returns.

Most of the Berkshire Hathaway CEOs don't even meet each other outside of the annual meetings, and they usually call Buffett-- he rarely calls them.

There are only 19 employees in Berkshire's home office:
"Our federal return last year, we should add, ran to 9,386 pages. To handle this filing, state and foreign tax returns, a myriad of SEC requirements, and all of the other matters involved in running Berkshire, we have gone all the way up to 19 employees at World Headquarters. This crew occupies 9,708 square feet of space, and Charlie – at World Headquarters West in Los
Angeles – uses another 655 square feet. Our home-office payroll, including benefits and counting both locations, totaled $3,531,978 last year."

Here's their acquisition criteria:
"We are eager to hear from principals or their representatives about businesses that meet all of the following criteria:
(1) Large purchases (at least $75 million of pre-tax earnings unless the business will fit into one of our existing units),
(2) Demonstrated consistent earning power (future projections are of no interest to us, nor are “turnaround” situations),
(3) Businesses earning good returns on equity while employing little or no debt,
(4) Management in place (we can’t supply it),
(5) Simple businesses (if there’s lots of technology, we won’t understand it),
(6) An offering price (we don’t want to waste our time or that of the seller by talking, even preliminarily,
about a transaction when price is unknown).
The larger the company, the greater will be our interest: We would like to make an acquisition in the $5-20 billion range. We are not interested, however, in receiving suggestions about purchases we might make in the general stock market."

I think that his strength lies in finding companies run by good people with an estate-tax problem. They want to cash out or expand without giving up control, and they know that Buffett will allow them to solve both problems without bringing down a horde of consultants & assistants. In return they give him a good price.

As for stocks, he's generally a cheapskate or the stock has an exceptionally strong franchise. But stocks are a minority of Berkshire's holdings.