Any Monkey Can Beat the Market

[Rick Ferri]

Give a monkey enough darts and they’ll beat the market. So says a draft article by Research Affiliates highlighting the simulated results of 100 monkeys throwing darts at the stock pages in a newspaper. The average monkey outperformed the index by an average of 1.7 percent per year since 1964. That’s a lot of bananas!

Any Monkey Can Beat the Market

I think the Fama-French crowd will approve of this article.

Rick Ferri

[rustymutt]

How do they know that they have an average monkey, rather than a funky monkey?

[telemark]

I'm disappointed that the monkeys were only simulated. Maybe the real monkeys were all needed on typewriter duty?

[Rick Ferri]

Maybe the real monkeys were all needed on typewriter duty?

I resemble that remark!

Rick Ferri

[FinancialDave]

This is much like Malkiel's Random Walk experiment (using live people in this case) flipping coins to determine the direction of the market. Those that flipped 10 heads in a row were made the new investment advisors of the class -- ok so I made that last part up - you get the idea.

fd

[tetractys]

I'm disappointed that the monkeys were only simulated. Maybe the real monkeys were all needed on typewriter duty?

I see your point; it was probably out of necessity. Just how feasible would it be to train monkeys to throw darts, and would the trainers be able to trust said monkeys thereafter? -- Tet

[peppers]

Were the monkeys left-handed or right-handed? And was the sample of monkey throws enough data? Did the monkeys exhibit any tilt? We cannot have any bias.

[Rick Ferri]

Did the monkeys exhibit any tilt?

Well, you'll have to read the article to answer that question.

Rick Ferri

[peppers]

It would appear the monkeys have a preference for small bananas as opposed to the large bananas.

[baw703916]

Could they have beaten the market if the list of stock symbols were written in different sizes in proportion to the market caps?

[glock19]

I did not read the article but I strongly object to forcing monkeys to throw darts randomly. I sincerely hope no monkeys were harmed in conducting this study.

[NAVigator]

Sadly this experiment may never again be repeated. It is not because of the use of monkeys or a shortage of darts. Rather, a newspaper with printed stock pages is becoming exceedingly rare.

Jerry

[Call_Me_Op]

Doesn't this suggest that buying a holding a large group of randomly-selected stocks is better than using an index fund - as long as you can keep your trading cost very low?

[DaleMaley]

Some other dart board stories..............

Senator Thomas J. McIntyre of the Banking Committee, attached the stock market page to his dart board. The Senator then threw some darts at the dart board. It turned out the Senator's dart board stock selections beat almost all the mutual funds over the time period studied!!!!

In 1967, the editors of Forbes magazine also selected 28 stocks by throwing darts at a dart board. Their results also beat almost all of the professionally managed mutual funds!!!

[hafius500]

Give a monkey enough darts and they’ll beat the market. So says a draft article by Research Affiliates highlighting the simulated results of 100 monkeys throwing darts at the stock pages in a newspaper. The average monkey outperformed the index by an average of 1.7 percent per year since 1964. That’s a lot of bananas!

Any Monkey Can Beat the Market

I think the Fama-French crowd will approve of this article.

Rick Ferri

In their yet-to-be-published article, the company randomly selected 100 portfolios containing 30 stocks from a 1,000 stock universe. They repeated this processes every year, from 1964 to 2010, and tracked the results

If they chose a stock universe of the 1,000 largest stocks, how can the size effect explain the outperformance? I thought the size effect is concentrated among the smallest and most illiquid stocks.

If the size effect explains the outperformance, we should note that active or passive retail funds presumably cannot capture the (entire ?) size premium. E.g., active or passive micro-cap funds usually underperform their benchmark.

It also helped that the 30 stocks in the monkey portfolio were equally weighted by Research Affiliates. This technique reduced the average market cap relative to the cap weighted index and helped boost the return. In addition, equal weighting “tilted” the portfolio toward value stocks, which earned a higher return than growth stocks over the 1964 to 2011 period.

Furthermore, other factors could play a role. Recent rearch (*) found that factor exposure explains roughly 58% of the outperformance of a monthly rebalanced equal-weighted portfolio of SP500 stocks. 42% stem from rebalancing (contrarian strategy) (**). If the portfolio was rebalanced annually, the outperformance became statistically insignificant, although is was still positive (***).

(*)Why Does an Equal-Weighted Portfolio Outperform Value- and Price-Weighted Portfolios?
Yuliya Plyakha, Raman Uppal, Grigory Vilkov, October 16, 2012
(**)Financial Times - Award for contrarian strategists, By Sara Silver and Steve Johnson
You may try to google the title.

The trio’s analysis of a random selection of stocks from the S&P 500 over the past 40 years found an equal-weighted portfolio generated an annual return 271 basis points above that of a value-, or market capitalisation-weighted portfolio,..The paper concluded that 58 per cent of the outperformance vis a vis the value-weighted portfolio stemmed from an “excess systematic component” driven by the equally weighted portfolio’s greater exposure to smaller and value stocks, factors long shown to lead to outperformance over a cycle. The remaining 42 per cent stems from “alpha”, or excess returns generated by the monthly rebalancing required to maintain equal weights, which is a contrarian strategy involving buying the losers and selling the winners.

(***)Why Does an Equal-Weighted Portfolio Outperform Market Capitalization- and Price-Weighted Portfolios?

[Browser]

How have the monkeys done at cliff-diving?

[BBL]

I was hoping you would find a way to include the infinite monkey theorem as well. Maybe that was a bridge too far.

http://en.wikipedia.org/wiki/Infinite_monkey_theorem

[Rick Ferri]

The monkey business working paper is up on SSRN:

The Surprising 'Alpha' from Malkiel's Monkey and Upside-Down Strategies, Robert D. Arnott, Research Affiliates, LLC; Jason C. Hsu, Research Affiliates, LLC & University of California, Los Angeles - Anderson School of Business; Vitali Kalesnik, Research Affiliates LLC; Phil Tindall, affiliation not provided to SSRN. October 10, 2012

Rick Ferri

[SP-diceman]

The 5 Factor Model?

Market
Size
Value
Momentum
Monkeys

[Browser]

This paper was discussed several weeks ago.

http://www.bogleheads.org/forum/viewtopic.php?f=10&t=105171

[BBL]

The 5 Factor Model?

Market
Size
Value
Momentum
Monkeys

What's the pure Monkey play? How do I maximize my exposure to the Monkey factor? Can I go all-Monkey?

[baw703916]

Sadly this experiment may never again be repeated. It is not because of the use of monkeys or a shortage of darts. Rather, a newspaper with printed stock pages is becoming exceedingly rare.

Jerry

Good point, I don't want a monkey to start throwing darts at my computer screen!

[harland]

I want a chimp-designed portfolio. I hear they throw darts better than your average orangutan...

[Sbashore]

Maybe that's how MoneyChimp got its name.

[LazyNihilist]

Doesn't this suggest that buying a holding a large group of randomly-selected stocks is better than using an index fund - as long as you can keep your trading cost very low?

Very interesting...

[EternalOptimist]

It's not the picking that's so important, it's reliance on patience, persistence and perservance.

[More Please]

Dear Santa,
Please bring me a monkey for Christmas. I've been good (for the most part).

[Default User BR]

Dear Santa,
Please bring me a monkey for Christmas. I've been good (for the most part).

How about this one?


Brian

[Marjimmy]

So many trolls with their "monkey" business
+1 for the read

[arcticpineapplecorp.]

Maybe it's time for them to start a hedge fund...call it Three Wise Monkeys Hedge Fund. Their slogan could be: Monkey See, Monkey Do, just no monkeys flinging poo (except on the trading floor).

http://en.wikipedia.org/wiki/Three_wise_monkeys

[Leif Eriksen]

It sounds like you saying any monkey can beat the TSM advocates.

[pkcrafter]

Wait a minute. Stop the music!

First off there is this:

In their yet-to-be-published article, the company randomly selected 100 portfolios containing 30 stocks from a 1,000 stock universe. They repeated this processes every year, from 1964 to 2010, and tracked the results.

Ha-ha, they didn't actually use monkeys. They simulated monkeys!

The process replicated 100 monkeys throwing darts at the stock pages each year. Amazingly, on average, 98 of the 100 monkey portfolios beat the 1,000 stock capitalization weighted stock universe each year.

This is impossible.

From 1964 to 2011, the annualized return for the 1,000 stocks used by Research Affiliates was 9.7percent.

The other 970 stocks made up 60 percent by capitalization weight and their return was 10.5 percent annually.

If the highest possible return was 10.5 and the simulated monkeys outperformed the index by 1.7%, their average return was 11.4%. That is higher than the highest possible return, even if all small caps were chosen. There's some monkeyshines going here designed to make index investing look bad.

Paul

[grabiner]

Wait a minute. Stop the music!

First off there is this:

In their yet-to-be-published article, the company randomly selected 100 portfolios containing 30 stocks from a 1,000 stock universe. They repeated this processes every year, from 1964 to 2010, and tracked the results.

Ha-ha, they didn't actually use monkeys. They simulated monkeys!

The process replicated 100 monkeys throwing darts at the stock pages each year. Amazingly, on average, 98 of the 100 monkey portfolios beat the 1,000 stock capitalization weighted stock universe each year.

This is impossible.

The monkeys were not cap-weighted; the average monkey picked an equally weighted portfolio, and since mid-cap stocks outperformed small-cap stocks, the monkeys had an advantage. And that also explains the following:

From 1964 to 2011, the annualized return for the 1,000 stocks used by Research Affiliates was 9.7 percent. The 30 largest companies in the 1000 made up about 40 percent of the capitalization weight, but their return was only 8.6 percent annually. The other 970 stocks made up 60 percent by capitalization weight and their return was 10.5 percent annually.

If the highest possible return was 10.5 and the simulated monkeys outperformed the index by 1.7%, their average return was 11.4%. That is higher than the highest possible return, even if all small caps were chosen.

The 10.5% return is still cap-weighted, but from the 970 stocks which were not the 30 largest. The true mid-cap stocks earned more than the large-but-not-giant stocks.

[Leif Eriksen]

Perhaps instead of S&D (Slice & Dice), we should call ourselves monkeys. I think we are closer to monkeys then our TSM relatives.

Hey, hey, we're the monkees
And people say we monkey around,
But we're too busy investing
To put anybody down.

[Cubsfan]

Real monkeys behave differently from virtual monkeys:

Monkey Theory Proven Wrong

by Brian Bernbaum
May 9, 2003

LONDON - Give an infinite number of monkeys an infinite number of typewriters, the theory goes, and they will eventually produce the works of Shakespeare.

Researchers at Plymouth University in England reported this week that primates left alone with a computer attacked the machine and failed to produce a single word.

A group of faculty and students in the university's media program left a computer in the monkey enclosure at Paignton Zoo in southwest England, home to six Sulawesi crested macaques. Then, they waited.

At first, said researcher Mike Phillips, “the lead male got a stone and started bashing the hell out of it.

“Another thing they were interested in was in defecating and urinating all over the keyboard,” added Phillips, who runs the university's Institute of Digital Arts and Technologies.

[pkcrafter]

Wait a minute. Stop the music!

First off there is this:

In their yet-to-be-published article, the company randomly selected 100 portfolios containing 30 stocks from a 1,000 stock universe. They repeated this processes every year, from 1964 to 2010, and tracked the results.

Ha-ha, they didn't actually use monkeys. They simulated monkeys!

The process replicated 100 monkeys throwing darts at the stock pages each year. Amazingly, on average, 98 of the 100 monkey portfolios beat the 1,000 stock capitalization weighted stock universe each year.

This is impossible.

The monkeys were not cap-weighted; the average monkey picked an equally weighted portfolio, and since mid-cap stocks outperformed small-cap stocks, the monkeys had an advantage. And that also explains the following:

From 1964 to 2011, the annualized return for the 1,000 stocks used by Research Affiliates was 9.7 percent. The 30 largest companies in the 1000 made up about 40 percent of the capitalization weight, but their return was only 8.6 percent annually. The other 970 stocks made up 60 percent by capitalization weight and their return was 10.5 percent annually.

If the highest possible return was 10.5 and the simulated monkeys outperformed the index by 1.7%, their average return was 11.4%. That is higher than the highest possible return, even if all small caps were chosen.

The 10.5% return is still cap-weighted, but from the 970 stocks which were not the 30 largest. The true mid-cap stocks earned more than the large-but-not-giant stocks.

David, thank you for enlightening me. Now I see RA was comparing Bananas and Oranges. I now also see the whole point of Arnott's article was to show how monkeys using a RA equal equal-weighted index could easily beat an inappropriate benchmark. This kind of comparison is pure monkey business.

Paul

[Rick Ferri]

Don't read to much into this. The article and the paper were written merely to help layman understand how historic small and value stock premiums have boosted the portfolio returns of active managers, i.e. the monkeys. Nothing more and nothing less.