Here is a criticisim of active management I don't get

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sometimesinvestor
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Here is a criticisim of active management I don't get

Post by sometimesinvestor » Fri Aug 18, 2017 1:14 pm

http://www.etf.com/sections/index-inves ... nopaging=1


If I am an active manager who does not pick stocks as well as the best stock picker but am smart enough to in 2017 invest some percentage of my fund in european stocks that are doing well why should i not get credit for outperforming the large cap index.I know for a fact that in the 90s many international managers regularly outperformed the index by making the simple decision to underweight Japan. To me asset allocation is a skill that some fraction of active mangers will do better than me.

What am I missing?

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Re: Here isa criticisim of active management I don't get

Post by Dottie57 » Fri Aug 18, 2017 1:27 pm

sometimesinvestor wrote:
Fri Aug 18, 2017 1:14 pm
http://www.etf.com/sections/index-inves ... nopaging=1


If I am an active manager who does not pick stocks as well as the best stock picker but am smart enough to in 2017 invest some percentage of my fund in european stocks that are doing well why should i not get credit for outperforming the large cap index.I know for a fact that in the 90s many international managers regularly outperformed the index by making the simple decision to underweight Japan. To me asset allocation is a skill that some fraction of active mangers will do better than me.

What am I missing?
Problem is they are not consitently good year after year and you don't know which ones will succeed.

avalpert
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Re: Here isa criticisim of active management I don't get

Post by avalpert » Fri Aug 18, 2017 1:32 pm

It's simple, if he is allowing himself to select from the global set of securities to pick the areas he think will do best then his benchmark should be that universe - otherwise how are you fairly judging whether his asset allocation choices were in fact reflecting skillful choices.

Otherwise, why wouldn't everyone decide their benchmark index should be short term treasuries and credit their wise asset allocation choices for outperforming their self-chosen benchmark..

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Re: Here isa criticisim of active management I don't get

Post by welderwannabe » Fri Aug 18, 2017 1:36 pm

My beef is with high ER active funds. I invest in a couple of managed vanguard funds and so do many others here. Saying all active funds are bad is a gross oversimplification IMHO.
I am not an investment professional, but I did stay at a Holiday Inn Express last night.

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Re: Here isa criticisim of active management I don't get

Post by jbolden1517 » Fri Aug 18, 2017 6:27 pm

sometimesinvestor wrote:
Fri Aug 18, 2017 1:14 pm
http://www.etf.com/sections/index-inves ... nopaging=1


If I am an active manager who does not pick stocks as well as the best stock picker but am smart enough to in 2017 invest some percentage of my fund in european stocks that are doing well why should i not get credit for outperforming the large cap index.I know for a fact that in the 90s many international managers regularly outperformed the index by making the simple decision to underweight Japan. To me asset allocation is a skill that some fraction of active mangers will do better than me.

What am I missing?
I'd say the focus of the article is critiquing Carey Hall's claim that active outperformed passive in 5 out of 6 months. Essentially what he's saying is that active US large stock managers outperformed the US large stock index because they were holding non-USA stocks. This is sort of the mirror image of the argument regarding cash that happens quite frequently.

The stronger criticism is the Sharpe claim which asserts that all investors investment weighted in an index must get the aggregate performance of the index. Sharpe is more subtly wrong in that he ignores all the ways money can go sideways.

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Re: Here isa criticisim of active management I don't get

Post by venkman » Sat Aug 19, 2017 12:33 am

sometimesinvestor wrote:
Fri Aug 18, 2017 1:14 pm

If I am an active manager who does not pick stocks as well as the best stock picker but am smart enough to in 2017 invest some percentage of my fund in european stocks that are doing well why should i not get credit for outperforming the large cap index.I know for a fact that in the 90s many international managers regularly outperformed the index by making the simple decision to underweight Japan. To me asset allocation is a skill that some fraction of active mangers will do better than me.
If you're an active manager who has the purview to pick stocks from anywhere in the world, why shouldn't you get the blame for being invested mostly in American stocks at a time when European stocks were outperforming?

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Re: Here isa criticisim of active management I don't get

Post by lack_ey » Sat Aug 19, 2017 12:59 am

They shouldn't get credit for incidental alpha over a benchmark owing to a persistent mismatch of typical exposures happening to cyclically swing in their favor. That's an issue of benchmarking or interpreting results.

But sure, if a manager makes a conscious market timing / allocation decision that improves results, that should count.

For example, an intermediate-term core bond fund manager typically owning about 60% corporate bonds shouldn't get credit for excess returns in a given year relative to the Bloomberg Barclays Aggregate, whenever corporate bonds beat government bonds / government-related MBS. Then in another year when credit risk does worse and then fund does worse relative to the benchmark, that's not really the manager's fault either. It's just that the benchmark is inappropriate.

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Re: Here isa criticisim of active management I don't get

Post by jbolden1517 » Sat Aug 19, 2017 4:33 am

lack_ey wrote:
Sat Aug 19, 2017 12:59 am
They shouldn't get credit for incidental alpha over a benchmark owing to a persistent mismatch of typical exposures happening to cyclically swing in their favor. That's an issue of benchmarking or interpreting results.

But sure, if a manager makes a conscious market timing / allocation decision that improves results, that should count.

For example, an intermediate-term core bond fund manager typically owning about 60% corporate bonds shouldn't get credit for excess returns in a given year relative to the Bloomberg Barclays Aggregate, whenever corporate bonds beat government bonds / government-related MBS. Then in another year when credit risk does worse and then fund does worse relative to the benchmark, that's not really the manager's fault either. It's just that the benchmark is inappropriate.
FWIW that example is extremely pertinent for retail investors. This is an example where different segments of the market hold vastly different portfolios. Foreign banks buy almost exclusively government debt, and tilt towards shorter durations. US mutual funds are almost 2/3rds corporate in their holdings and have an extra few years of duration of the index. In the aggregate mutual funds and pension funds are holding a non-market portfolio. We really need two distinct indexes reflecting the amount of leverage of the holders.

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Re: Here isa criticisim of active management I don't get

Post by z3r0c00l » Sat Aug 19, 2017 6:59 am

Yes why pay extra to have someone gamble with your money in ways that are both unsophisticated and not terribly likely to work in the long run? We could underweight or overweight Japan or Europe without the extra fee. Still not necessarily a smart idea, but it would be much cheaper. And then on top of it they will mislead new investors about their abilities. That's why it is an increasingly criticized practice that is fading in favor the index. Buying international a year ago might seem smart and prescient in hindsight now, but at the time it was nothing more than a guess.

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Re: Here isa criticisim of active management I don't get

Post by Top99% » Sat Aug 19, 2017 9:42 am

On the surface it often seems like it should be easy for an active investor to beat indices. Just start with an index allocation and remove the "bad stuff". The problem is the performance of the "bad stuff" isn't very predictable.
https://www.callan.com/wp-content/uploa ... d_2017.pdf brings this into clear focus.
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Re: Here isa criticisim of active management I don't get

Post by texasdiver » Sat Aug 19, 2017 3:53 pm

Top99% wrote:
Sat Aug 19, 2017 9:42 am
On the surface it often seems like it should be easy for an active investor to beat indices. Just start with an index allocation and remove the "bad stuff". The problem is the performance of the "bad stuff" isn't very predictable.
https://www.callan.com/wp-content/uploa ... d_2017.pdf brings this into clear focus.
And that assumption also presumes that the "bad stuff" hasn't already been accurately discounted in price by the market.

That said, I did hear an interesting news report on NPR which stated that Fortune 500 firms with female CEOs have substantially out-performed Fortune 500 firms that have male CEOs. So perhaps a fund that tilts towards female CEOs is in order.

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Re: Here is a criticisim of active management I don't get

Post by whodidntante » Sat Aug 19, 2017 4:09 pm

You're referring to tactical allocation. It is possible to outperform if your time horizon is long enough by looking at valuations and expected forward returns. The problem is that most investors think short term, and a mutual fund will often start to face redemptions before outperformance can be realized. In the shorter term momentum may be useful, but it is far from a guarantee of outperformance.
Last edited by whodidntante on Sat Aug 19, 2017 4:17 pm, edited 1 time in total.

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Re: Here is a criticisim of active management I don't get

Post by Doc » Sat Aug 19, 2017 4:15 pm

jbolden1517 wrote:
Fri Aug 18, 2017 6:27 pm
The stronger criticism is the Sharpe claim which asserts that all investors investment weighted in an index must get the aggregate performance of the index. Sharpe is more subtly wrong in that he ignores all the ways money can go sideways.
Sharpe is not "wrong", he hedged.
William Sharpe wrote:If "active" and "passive" management styles are defined in sensible ways, it must be the case that

(1) before costs, the return on the average actively managed dollar will equal the return on the average passively managed dollar and

(2) after costs, the return on the average actively managed dollar will be less than the return on the average passively managed dollar
https://web.stanford.edu/~wfsharpe/art/ ... active.htm
A scientist looks for THE answer to a problem, an engineer looks for AN answer and lawyers ONLY have opinions. Investing is not a science.

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Re: Here is a criticisim of active management I don't get

Post by jbolden1517 » Sat Aug 19, 2017 5:09 pm

Doc wrote:
Sat Aug 19, 2017 4:15 pm
Sharpe is not "wrong", he hedged.
Don't agree he hedged:
A passive investor always holds every security from the market, with each represented in the same manner as in the market. Thus if security X represents 3 per cent of the value of the securities in the market, a passive investor's portfolio will have 3 per cent of its value invested in X. Equivalently, a passive manager will hold the same percentage of the total outstanding amount of each security in the market2.

An active investor is one who is not passive. His or her portfolio will differ from that of the passive managers at some or all times. Because active managers usually act on perceptions of mispricing, and because such misperceptions change relatively frequently, such managers tend to trade fairly frequently -- hence the term "active."
Over any specified time period, the market return will be a weighted average of the returns on the securities within the market, using beginning market values as weights. Each passive manager will obtain precisely the market return, before costs. From this, it follows (as the night from the day) that the return on the average actively managed dollar must equal the market return. Why? Because the market return must equal a weighted average of the returns on the passive and active segments of the market. If the first two returns are the same, the third must be also.


Notice his conflation of the market return and the return from investment for the participants in the market. That's the problem with Sharpe's formulation. It is subtle and it didn't matter much when indexing was one passive (using passive here as an antonym to control rather than active) minority trading system among many. It starts to matter much more as it becomes the dominant system. So yeah I think Sharpe is just plain wrong on this one.

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Re: Here isa criticisim of active management I don't get

Post by jbolden1517 » Sat Aug 19, 2017 5:11 pm

texasdiver wrote:
Sat Aug 19, 2017 3:53 pm
That said, I did hear an interesting news report on NPR which stated that Fortune 500 firms with female CEOs have substantially out-performed Fortune 500 firms that have male CEOs. So perhaps a fund that tilts towards female CEOs is in order.
You were kidding but it exists (as least as a robo investor equivalent of a mutual fund): https://www.motifinvesting.com/motifs/no-glass-ceilings

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Re: Here is a criticisim of active management I don't get

Post by JoMoney » Sat Aug 19, 2017 5:23 pm

sometimesinvestor wrote:
Fri Aug 18, 2017 1:14 pm
http://www.etf.com/sections/index-inves ... nopaging=1


If I am an active manager who does not pick stocks as well as the best stock picker but am smart enough to in 2017 invest some percentage of my fund in european stocks that are doing well why should i not get credit for outperforming the large cap index.I know for a fact that in the 90s many international managers regularly outperformed the index by making the simple decision to underweight Japan. To me asset allocation is a skill that some fraction of active mangers will do better than me.

What am I missing?
The problem though, is how do you as a active-fund picker know to pick the guy who under-weights Japan vs one who over-weights it? How do you distinguish from the "smart" allocator who knew to avoid Japan and will avoid the next big bust vs the lucky allocator who avoided Japan by chance with a faulty stopped clock ?
"To achieve satisfactory investment results is easier than most people realize; to achieve superior results is harder than it looks." - Benjamin Graham

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Re: Here is a criticisim of active management I don't get

Post by Doc » Sat Aug 19, 2017 5:27 pm

jbolden1517 wrote:
Sat Aug 19, 2017 5:09 pm
Notice his conflation of the market return and the return from investment for the participants in the market. That's the problem with Sharpe's formulation. It is subtle and it didn't matter much when indexing was one passive (using passive here as an antonym to control rather than active) minority trading system among many.
I'm not following. Say "defined in sensible ways" means the S&P 500 and active investors are confined to invest only in those 500 stocks and no one else can invest in them, then the average return of those active investors before costs do not equal the return of the index?

Edit: Typo. Removed extraneous "10".
Last edited by Doc on Sat Aug 19, 2017 6:18 pm, edited 1 time in total.
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Re: Here is a criticisim of active management I don't get

Post by Jags4186 » Sat Aug 19, 2017 5:33 pm

sometimesinvestor wrote:
Fri Aug 18, 2017 1:14 pm
http://www.etf.com/sections/index-inves ... nopaging=1


If I am an active manager who does not pick stocks as well as the best stock picker but am smart enough to in 2017 invest some percentage of my fund in european stocks that are doing well why should i not get credit for outperforming the large cap index.I know for a fact that in the 90s many international managers regularly outperformed the index by making the simple decision to underweight Japan. To me asset allocation is a skill that some fraction of active mangers will do better than me.

What am I missing?
Come at it from this angle:

Your hypothetical advisor isn't outperforming the large cap index. He's underperforming the European index because he's underweighted the high performing European stock market. Why is he holding crummy US stocks?

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Re: Here is a criticisim of active management I don't get

Post by packer16 » Sat Aug 19, 2017 6:15 pm

The real question is what is the objective of the manager and his investable world. If he is a global investor his benchmark should be global if the objective is the US then a US benchmark is appropriate & he should not invest outside the US. This way he gets credit for overweighting countries if this works out & docked if the bet does not work out. It is a question of using the right benchmark. This is more complicated than it would as first appear. How do you deal with multinationals that generate more revenues and cash flow from overseas markets? There is also the issue of Large Cap US Funds buying ADRs.

So the critisism is valid but the author does not provide a reasonable benchmark solution so I do not know if his conclusion is correct.

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Re: Here is a criticisim of active management I don't get

Post by jbolden1517 » Sat Aug 19, 2017 6:39 pm

Doc wrote:
Sat Aug 19, 2017 5:27 pm
jbolden1517 wrote:
Sat Aug 19, 2017 5:09 pm
Notice his conflation of the market return and the return from investment for the participants in the market. That's the problem with Sharpe's formulation. It is subtle and it didn't matter much when indexing was one passive (using passive here as an antonym to control rather than active) minority trading system among many.
I'm not following. Say "defined in sensible ways" means the S&P 500 and active investors are confined to invest only in those 500 stocks and no one else can invest in them, then the average return of those active investors before costs do not equal the return of the index?
When you start talking non passive investors or investors engaging in radically different strategies they start having ways of earning returns quite different than the market return on their stock holdings. For example I use stock+option combinations to earn theta yield. The stock positions only exist as part of an arbitrage. If you just consider the stock buys and sells there is a problem that one side of the transaction didn't take place on the open market at market prices. Exclude the option and why am I buying stocks above market price or selling below market price? Worse for Sharpe's model I'm often selling stocks that don't exist yet but will come into existence in future months, Under Sharpe's definition where did I get them?

Or take a control investor whose position in a stock is to make sure that the new corporate head quarters is leasing from a building he owns. His return comes from the rental income not the stock.

Etc... He's grossly oversimplifying the market as if all stock floats were static and all investors were making their money capital gains and dividends. His model of the stock market is a spherical horse running in a frictionless world: https://en.wikipedia.org/wiki/Spherical_cow

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Re: Here is a criticisim of active management I don't get

Post by Doc » Sat Aug 19, 2017 6:48 pm

jbolden1517 wrote:
Sat Aug 19, 2017 6:39 pm
Etc... He's grossly oversimplifying the market as if all stock floats were static and all investors were making their money capital gains and dividends. His model of the stock market is a spherical horse running in a frictionless world:
I don't disagree. I just think he addressed (hedged) the idea in his "sensible ways" comment.
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Re: Here is a criticisim of active management I don't get

Post by nedsaid » Sat Aug 19, 2017 7:28 pm

sometimesinvestor wrote:
Fri Aug 18, 2017 1:14 pm
http://www.etf.com/sections/index-inves ... nopaging=1


If I am an active manager who does not pick stocks as well as the best stock picker but am smart enough to in 2017 invest some percentage of my fund in european stocks that are doing well why should i not get credit for outperforming the large cap index.I know for a fact that in the 90s many international managers regularly outperformed the index by making the simple decision to underweight Japan. To me asset allocation is a skill that some fraction of active mangers will do better than me.

What am I missing?
The problem is that you are comparing apples to oranges. If your manager is adding European stocks to an otherwise US Large Cap portfolio, the benchmark should be a blended index weighted by the actual proportions invested. The blended index would consist of a European Index and the S&P 500. For example, if 20% of his investments are in Europe, the blended index should be 20% European Index and 80% S&P 500. This is the best way to see if any outperformance is due to the selection of asset classes or in his skill in picking individual securities.

Yes, I am aware that a lot of International Stock fund managers beat the International Indexes handily simply by avoiding Japan during the 1990's. Also, so-called Large Cap funds have increased performance by investing in Mid/Small-Cap stocks. In the early 1990's, I noticed that many of my "domestic" stock funds had a healthy slice of foreign stocks in them. There are tricks to juicing performance but they don't always work.
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Re: Here is a criticisim of active management I don't get

Post by jbolden1517 » Sat Aug 19, 2017 7:35 pm

Doc wrote:
Sat Aug 19, 2017 6:48 pm
jbolden1517 wrote:
Sat Aug 19, 2017 6:39 pm
Etc... He's grossly oversimplifying the market as if all stock floats were static and all investors were making their money capital gains and dividends. His model of the stock market is a spherical horse running in a frictionless world:
I don't disagree. I just think he addressed (hedged) the idea in his "sensible ways" comment.
The problem is his argument completely falls apart for those investors making money sideways. As the percentage of indexing (including quasi-indexing) increases anti-indexing strategies (anti-float trading strategies) become more effective for control and arbitrage investors. His argument crucially depends on this never being able to happen.

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Re: Here is a criticisim of active management I don't get

Post by Doc » Sat Aug 19, 2017 7:52 pm

jbolden1517 wrote:
Sat Aug 19, 2017 7:35 pm
Doc wrote:
Sat Aug 19, 2017 6:48 pm
jbolden1517 wrote:
Sat Aug 19, 2017 6:39 pm
Etc... He's grossly oversimplifying the market as if all stock floats were static and all investors were making their money capital gains and dividends. His model of the stock market is a spherical horse running in a frictionless world:
I don't disagree. I just think he addressed (hedged) the idea in his "sensible ways" comment.
The problem is his argument completely falls apart for those investors making money sideways. As the percentage of indexing (including quasi-indexing) increases anti-indexing strategies (anti-float trading strategies) become more effective for control and arbitrage investors. His argument crucially depends on this never being able to happen.
OK. But that's what I interpreted "sensible ways" to mean. Of course we have a long time gap in the discussion.


If you are correct I have a BIG problem not with the active/passive debate but the whole efficient market hypothesis and I don't want to accept that.

Buy gold?
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Re: Here is a criticisim of active management I don't get

Post by jbolden1517 » Sat Aug 19, 2017 8:15 pm

Doc wrote:
Sat Aug 19, 2017 7:52 pm
OK. But that's what I interpreted "sensible ways" to mean. Of course we have a long time gap in the discussion.

If you are correct I have a BIG problem not with the active/passive debate but the whole efficient market hypothesis and I don't want to accept that.

Buy gold?
His latest book makes similar claims so I'd say this reflects his current opinion. As far as EMH, not sure what you mean there are a lot of versions of EMH around. I don't believe in the EMH mainly because the evidence contradicts it and in practice it makes too many contradictory claims about pricing.

However the examples I just gave are pretty pro-EMH. There exist insiders who are going to be get shares months from now. Via the options market they are transmitting to market participants like me that they are going to aggressive sell when they do. Via the arbitrage those future sales are already priced in, and quite literally will have no impact on future price when they happen. Can't get any more pro-EMH than that example :D

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