Stock Pickers - Jason Zweig

[gerntz]

"Sorry, Stock Pickers: History Shows You Underperform in Bad Markets, Too"

"The odds of finding a stock picker who can do better in down markets have long been less than 50/50. The brief periods in which active managers did resoundingly better than the S&P 500 have tended to be times in which small stocks outperformed large. If you or your financial adviser think stock pickers will prevail in the next downturn, the evidence isn’t on your side."

https://blogs.wsj.com/moneybeat/201...ry-shows-you-underperform-in-bad-markets-too/

 

[Boho]

"Sorry, Stock Pickers: History Shows You Underperform in Bad Markets, Too"

"The odds of finding a stock picker who can do better in down markets have long been less than 50/50. The brief periods in which active managers did resoundingly better than the S&P 500 have tended to be times in which small stocks outperformed large. If you or your financial adviser think stock pickers will prevail in the next downturn, the evidence isn’t on your side."

https://blogs.wsj.com/moneybeat/201...ry-shows-you-underperform-in-bad-markets-too/

That means I'd put some effort into finding one rather than picking one at random.

 

[OldShooter]

That means I'd put some effort into finding one rather than picking one at random.

That's very logical, but it turns out to be impossible.

The proof is in the S&P Manager Persistence scorecards that are published semiannually. The conclusion is always the same, past performance does not predict future performance. A quick web search will yield as many of these as you care to read.

Here, also, is a video: https://famafrench.dimensional.com/videos/identifying-superior-managers.aspx It's only about 6 minutes; Kenneth French (of Fama/French fame) explains why your manager pick is always a random one.

Edit: This article (http://www.etf.com/sections/features/5678-new-fama-french-study-puts-managers-under-microscope.html) includes a link to the paper that Ken French mentions, Luck Versus Skill in the Cross Section of Mutual Fund Returns.

 

[OldShooter]

"Sorry, Stock Pickers: History Shows You Underperform in Bad Markets, Too" ...

Of course. This is just one aspect of the more general conclusion that stock picking is provably a losing strategy, particularly if one is hiring stock pickers/aka actively managed mutual funds.

The semiannual S&P SPIVA Scorecards always show the same thing: Active management loses. William Sharpe, in his 1991 paper The Arithmetic of Active Management explains why: https://web.stanford.edu/~wfsharpe/art/active/active.htm

Kenneth French (of Fama/French fame) also explains in a 5 minute video: https://famafrench.dimensional.com/videos/is-this-a-good-time-for-active-investing.aspx

 

[easysurfer]

Thanks. Interesting discussion.

Here's what I got from watching that 5 min video:

1. It's "always a pretty bad time for active management."

2. This is not a theory, but simple arithmetic (just addition).

3. Mr. French has a nice looking tie.

 

[Boho]

From the video: "my co-author Eugene Fama and I just finished a paper where we were trying to do exactly that, can we find among all of the US public equity mutual fund managers, can we identify some superior ability in the pool? We failed."

If they were looking for a manager who could outperform specifically in "bad markets" I bet they'd find one. I bet they were able to find better than average managers. I'd like to read that paper though, if it was published.

 

[OldShooter]

... If they were looking for a manager who could outperform specifically in "bad markets" I bet they'd find one. ...

All the data I have seen says that you'd lose your bet. If you have statistical data to the contrary (not anecdotes) I'd appreciate seeing it.

...I'd like to read that paper though, if it was published.

See the edit to my first post for the link. The paper is 43 pages and pretty dense. I'll admit to not having read the whole thing.

Really all we need to know is what SPIVA and the Manager Persistence scorecards tell us. We don't need academicians and we don't need theories. S&P has the statistical data and is giving it to us for free.

 

[easysurfer]

Might be a bad comparison, but I look at active investing like trying to come up with a winning system time and again betting on a race like the Kentucky Derby. Sure, you can make a winning bet but over time, odds are against you. Seems like someone can develop an unbeatable system but a race like the derby and stocks is not so much trying to guess numbers but human psychology -- good luck with that.

 

[Chuckanut]

There are a few who were good at picking the right stock. They stayed in an area they knew well. Michael Price was one. He invested in bankrupt and struggling companies that were selling well below the value of their assets. In my early days of investing I made, what was for me at that time, a "bundle' through his Mutual Shares fund.

He ended up selling the fund company to Franklin Templeton. That taught me the lesson that I could not simply hang my hat on the same stand as a great manager and forget about it.

 

[OldShooter]

Might be a bad comparison, but I look at active investing like trying to come up with a winning system time and again betting on a race like the Kentucky Derby. Sure, you can make a winning bet but over time, odds are against you. Seems like someone can develop an unbeatable system but a race like the derby and stocks is not so much trying to guess numbers but human psychology -- good luck with that.

I agree. I think active investing persists and will continue to persist due simply to human greed. If you think about it, we have 100,000 years of Darwinian selection that rewards greed. (Not in a pejorative sense, just as descriptive.) The greedy were the ones with the most food, hence better able to survive famine. The greedy were the ones that had the most wives, hence they made a larger contribution to the gene pool. More generally, the greedy ones were the evolutionary winners. IOW, we have been bred to be greedy.

So, to me this explains mass stupidity like the lottery and casinos. Hardly anyone believes that the odds are in their favor when gambling, but greed and optimism (also bred into us IMO) keep the lottery, the casinos, and the ponies(!) prosperous.

A second-order consequence of greed is the plethora of hucksters out there hawking their wares and working to gull the suckers. There is a huge amount of money involved. (Morgan Stanley's "Wealth Management" business is $3.5B and generates 22-25% profits.) This is true not only in active management but in "enabling" businesses like Money and Motley Fool, even the WSJ, Barrons, and Forbes. They purvey idiotic stories like "Five Stocks for the Trump Era" and "Good Bets in Penny Stocks." These are fun articles that stimulate the greed instinct. There are no fun articles to read about passive investing, so there would be no eyeballs either. And, as important, the active managers are the ones who support these enablers via advertising. So the enablers are on thin ice if they start telling the truth.

 

[OldShooter]

There are a few who were good at picking the right stock. ...

Good or lucky? The statisticians say that given the noise in the signal and not even 100 years of data (!) it is impossible to determine whether the successful managers are skillful or just lucky.

Bill Miller of Legg Mason is a poster child; he beat his benchmark for 15 years then blew up and over two years lost nearly everything he had gained. That's on a percentage basis. On a dollar basis, since his fund was much larger than in the beginning, I'm sure he went negative, losing far more dollars than he had ever gained.

Nassim Taleb's Fooled by Randomness is a worthwhile read.

 

[Boho]

See the edit to my first post for the link. The paper is 43 pages and pretty dense. I'll admit to not having read the whole thing.

The abstract says "If we add back the costs in fund expense ratios, there is evidence of inferior and superior performance (nonzero true [alpha]) in the extreme tails of the cross-section of mutual fund [alpha] estimates." That's what I figured - some funds outperform. I don't see anything about being unable to identify outperforming fund managers, but it's dense as you said.

I noted this too, though I've read about it before:

"...passive funds that tilt toward small stocks, or value stocks, or positive momentum stocks are likely to produce positive [alpha] estimates...Passive mutual funds that focus on momentum do not as yet exist, so we do not have estimates of trading costs for such funds."

 

[ERD50]

... " That's what I figured - some funds outperform. I don't see anything about being unable to identify outperforming fund managers, but it's dense as you said. ...

There's no trick to identifying the outperforming fund managers. But where is the data that says they will continue to outperform?

I recall seeing data that shows the winners tend toward being losers going forward, and a contrarian position may actually have some small alpha.

-ERD50

 

[DrRoy]

I recommend Jason's book "Your Money and Your Brain".

 

[OldShooter]

... That's what I figured - some funds outperform. ...

Absolutely right! It is the average of all stock pickers that underperforms by the amount of the fees, per Sharpe. If you look at the SPIVA report cards, IIRC about 1/3 of actively managed funds outperform in a given year. But the next year it is mostly different ones that outperform. And if you go out 15 years it is only a fraction of one percent of funds that have outperformed, net, at the end of the period. Essentially, the outperformance is statistically indistinguishable from luck.

Think 10,000 monkeys flipping coins. After 8 flips, about 40 of them will have flipped 100% heads. Genius? (10,000 is very roughly the number of mutual funds that exist.)

And, sadly, it is impossible to pick out the lucky monkeys (err .... active managers) ahead of time. So we are stuck, as French argues, with making random choices if we are trying to pick active managers. And, since the average active manager is a loser, our choices are also likely to be losers.

"...passive funds that tilt toward small stocks, or value stocks, or positive momentum stocks are likely to produce positive [alpha] estimates ...

Yes. That is basically the takeway from the Fama/French three factor model, based on many years of market history. It is also the basis of the DFA fund strategy. No surprise, since both Fama and French have been involved with the firm since its inception.

The issue here is that if everyone knows that overweighting small and value funds is wise, why don't we expect that their prices will be bid up and the predicted future advantage will not materialize?

Here is yet another video, 37 minutes this time, that is very worthwhile. Viewing just up to about 2:44 is good for a laugh, but later on Fama discusses the question of the small & value performance possibly being eliminated plus there is a lot of other good stuff: INVESTORS FROM THE MOON: FAMA | Top1000Funds.com

To be clear, I would love to find a system or a manager that could be statistically shown to be superior to passive investing. I am as greedy as the next guy. But I have not been able to find one. I tell people that I am so stupid that it took me over 25 years to finally figure out that no one in the investment business knows anything useful and to finally go to passive investing.

 

[easysurfer]

...
To be clear, I would love to find a system or a manager that could be statistically shown to be superior to passive investing. I am as greedy as the next guy. But I have not been able to find one. I tell people that I am so stupid that it took me over 25 years to finally figure out that no one in the investment business knows anything useful and to finally go to passive investing.

25 years is a long time before the light turned on. Chalk up another for one time skeptics make the best believers.

In other words ...

[SIZE=-1]If you're playing a poker game and you look around the table and and can't tell who the sucker is, it's you.[/SIZE] [SIZE=-1]

PAUL NEWMAN[/SIZE]

 

[youbet]

All this broad-brushed blasting of managed funds....... Yet some, like Vanguard Wellesley and Wellington, for example, have served their customers well for many years.


And I have 5% - 6% of my FIRE portfolio in individual equities that I actively trade that has served me well for the past decade or so........ from both a total return and an entertainments perspective.


Additionally, with the huge proliferation of indexes in existence today, it does seem the line between active and passive investing is becoming blurred. If one frequently trades 20 - 25 ETF's, all based on indexes, is that active or passive investing? All your money is in index funds. But you're a frequent trader and your funds are very focused.


Things might not be as black and white as they seem.

 

[Chuckanut]

All this broad-brushed blasting of managed funds....... Yet some, like Vanguard Wellesley and Wellington, for example, have served their customers well for many years.

Very true in regards to funds like Wellesley and Wellington.

So, what are these managed funds doing right in the eyes of their shareholders?

 

[Boho]

about 1/3 of actively managed funds outperform in a given year. But the next year it is mostly different ones that outperform. And if you go out 15 years it is only a fraction of one percent of funds that have outperformed, net, at the end of the period.

I've read things like that. It's not clear enough to me that it's bad to go with the best of recent years. A study that shows "this is what happens when you invest in this way..." gets my attention. Things like the above are just vaguely discouraging.

Trendiness may be the key. Things may change, like value not working any more despite it being shown to work in the long term (to me that means it works, but whatever) but the most recent high performing fund manager will obviously be doing something right. Maybe there's a big random element but I don't know that it's random enough to dismiss the possibility that someone is a good stock picker.

 

[OldShooter]

Re Wellesley and Wellington I have no data. If their owners are happy, good for them, but I would be interested to know how their equity returns compare to relevant benchmarks. The stats indicate that they probably underperform. Do you guys know what their equity performance is?

The proliferation of so-called "index" funds is simply hucksters at work. Most of them are really sector funds. Using sector funds with the word "index" in their names is not passive investing. It is just stock picking in sheeps' clothing. That said, one could argue that anything beyond investing in a total world stock fund (like VTWSX) is not passive investing, since one is effectively picking stocks. But the SPIVA results tell me that passively investing in major asset categories is going to be long-term successful compared to picking actively managed funds in the same categories. Investing in the "South China Sea Small Cap Index ETF" or the "Small Countries with 'R' in their Names Index ETF" will probably not be long-term successful.

Re "individual equities that I actively trade that has served me well for the past decade or so" -- congratulations! Have you measured your results against the Russell 3000 or the ACWI for the same period? If favorable, double congratulations. But the stats still say that, on average, casino players and amateur stock pickers are net losers. But some win.

Re "bashing" I guess my use of the word "huckster" could make me guilty, but the statistics are neutral. Compared to the market portfolio, active loses by the amount of its fees. That's as much a fact as gravity.

 

[OldShooter]

... It's not clear enough to me that it's bad to go with the best of recent years. ... the most recent high performing fund manager will obviously be doing something right. Maybe there's a big random element but I don't know that it's random enough to dismiss the possibility that someone is a good stock picker.

With respect, all I can say is that I don't think you've studied the subject thoroughly enough.

I recommend that you look at the video linked in my Post #3 above and read a few of the S&P Manager Persistence scorecards and the Fama/French results summarized in the link in #3 above.

OTOH if you do have statistical data to support your beliefs I would love to see it. As I have already said, I am as greedy as the next guy.

 

[youbet]

Re Wellesley and Wellington I have no data. .......... The stats indicate that they probably underperform.

I know you don't have the data, but you must have had something to make the statement that "they probably underperform."

That said, one could argue that anything beyond investing in a total world stock fund (like VTWSX) is not passive investing, since one is effectively picking stocks.

Is you strategy of being 100% VTWSX working out to your satisfaction?

! Have you measured your results against the Russell 3000 or the ACWI for the same period? If favorable, double congratulations.

Thanks! And it's fun too! I do it inside an IRA so no tax complications.

Re "bashing" I guess my use of the word "huckster" could make me guilty, but the statistics are neutral. Compared to the market portfolio, active loses by the amount of its fees. That's as much a fact as gravity.

What you do do that seems irrational to me is make the assumption that all active investing and all passive investing are the same. That's not really the case, at least not to me. So your comments seem a bit too broad brushed to me.

But I respect your right to say what you want to say. I'm just pointing out that comparing active to passive in general terms is not too useful. For example, my largest holding, by far, is the Vanguard TSM fund. But I also find Wellesley handy and have a chunk of that in my wife's IRA. And, as mentioned, I enjoy holding and sometimes trading some individual stocks and bonds, although a single digit percentage of my portfolio.

It's just a bit less black and white for me.

 

[OldShooter]

I know you don't have the data, but you must have had something to make the statement that "they probably underperform." ...

Simply the SPIVA data that almost no actively managed equity funds outperform their benchmarks over the long haul. But that doesn't say that there are none. The real issue is that there's no way to spot the winners ahead of time. Only in the rear view mirror. Note, too that I am talking about only the equity portion of the funds, so with blended stock/bond funds the equity performance is harder to prise out.

& actually Vanguard's low fees would predict that their funds would do better than the pack. But still, SPIVA tells us that the equity component probably doesn't outperform over the long term.

Is you strategy of being 100% VTWSX working out to your satisfaction?

Actually we are basically 50% in total US market funds, 35% in total international market funds, and 15% in US small cap index funds. So some home country bias and some small cap tilt. It's been working fine for close to 15 years now. Last couple of years our results have slightly beat the ACWI and slightly underperformed the Russell 3000, exactly what one would expect with the home country bias and the recent strength of the dollar.

... What you do do that seems irrational to me is make the assumption that all active investing and all passive investing are the same. That's not really the case, at least not to me. So your comments seem a bit too broad brushed to me. ... It's just a bit less black and white for me.

Well, YMMV of course. My basic references are the S&P SPIVA and Manager Persistence reports. There is a lot of other stuff that can be talked about, like the efficient market hypothesis, behavioral economics, the CAPM model and the Fama/French three factor model, but really none of that matters. At the bottom we don't care why the market behaves the way it does. We just need to understand and deal with what is. IOW, the S&P reports tell me what time it is/actionable information. I don't care very much how the watch works.

 

[youbet]

. Note, too that I am talking about only the equity portion of the funds

We're talking about managed funds, including blended funds. Of the few actively managed funds I own, the equity/fixed blended funds like Wellesley are the most useful. Especially in the portfolios of not-investment-savvy relatives.

Actually we are basically 50% in total US market funds, 35% in total international market funds, and 15% in US small cap index funds. So some home country bias and some small cap tilt.

Wow. I thought you were going to say your were 100% total world market, cap weighted, a true indexer. Instead, here you are a real speculator shifting away from the total world index towards country and market cap slants. Many of us don't have the skills and know how to slice and dice to "pick-em" the way you do OldShooter!

Anyway, glad to hear you're not a true, 100% passive indexer but rather somewhere along the line stretching between active and passive.

Well, YMMV of course. .

Yep

 

[Boho]

With respect, all I can say is that I don't think you've studied the subject thoroughly enough.

I recommend that you look at the video linked in my Post #3 above and read a few of the S&P Manager Persistence scorecards and the Fama/French results summarized in the link in #3 above.

OTOH if you do have statistical data to support your beliefs I would love to see it. As I have already said, I am as greedy as the next guy.

The scorecard for June 2015 says "Out of the 682 domestic equity funds that were in the top quartile as of March 2013, come the end of March 2015, only 5.28% had managed to stay in that top quartile. Further, 3.95% of the large-cap funds, 5.26% of the mid-cap funds, and 4.67% of the small-cap funds remained in the top quartile."

It doesn't address beating or failing to beat the S&P (from the part I read) if you choose those funds. I don't have a statistics background but my interpretation is that if you're choosing a managed fund, you should consider the return from two years prior. Probably more so one year prior, which I don't think they mention. To me, it's another one of those vaguely discouraging things. I'm not sure what to make of it.

I read more of Luck versus Skill in the Cross-Section of Mutual Fund Returns. It says "On a practical level, our results on long-term performance say that true [alpha] in net returns to investors is negative for most if not all active funds, including funds with strongly positive [alpha] estimates for their entire histories." The "if not all" part makes it only vaguely discouraging. I can't discern whether they looked at funds with success in the past year or two or only total return over their lifetime. I guess if I scrutinized the entire paper and understood it I'd have my answer.

The paper also says "there are superior managers who enhance expected returns" and "only about 2.3% have [alpha] greater than 2.50% per year (about 0.21% per month) – before expenses." So, if any of those managers have expenses of 1%, you'd be ahead of the S&P with them, right?