Larry Swedroe: Evidence Of Shrinking Alpha

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Random Walker
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Larry Swedroe: Evidence Of Shrinking Alpha

Post by Random Walker » Fri Oct 06, 2017 9:16 am

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

Larry summarizes a couple of papers showing how the bright competitive people on Wall Street gobble up anomalies, making alpha disappear. He describes efficient markets and adaptive markets. It's best to behave as though markets are perfectly efficient. Good opportunity to recommend Larry's excellent book, The Incredible Shrinking Alpha.

Dave

staythecourse
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Re: Larry Swedroe: Evidence Of Shrinking Alpha

Post by staythecourse » Fri Oct 06, 2017 10:17 am

I have commented on this numerous times. It does not matter for the retail investor if we have efficient markets. They only thing they should care about is can one consistently exploit inefficiencies to produce alpha over at least a 1/2 of an investing lifetime (25 years) after accounting for fees, transaction costs, taxes, and inflation. If so then do it. If not then stick to the default which is passive, index investing.

The ONLY folks who should care about if markets are really efficient on mostly efficient are academics who are trying to publish.

Good luck.
"The stock market [fluctuation], therefore, is noise. A giant distraction from the business of investing.” | -Jack Bogle

AlphaLess
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Re: Larry Swedroe: Evidence Of Shrinking Alpha

Post by AlphaLess » Fri Oct 06, 2017 9:14 pm

staythecourse wrote:
Fri Oct 06, 2017 10:17 am
The ONLY folks who should care about if markets are really efficient on mostly efficient are academics who are trying to publish.
I respectfully disagree with this statement.

Even according to Vanguard, market efficiency has brought investment costs down.

E.g., see this: https://www.cnbc.com/2014/04/25/vanguar ... firms.html

For example, around 20 years ago, the Specialist firms on NYSE and other exchanges pocketed roughly $40B a year facilitating trading in stocks. Tiers of other market participants made markets efficient at other timescales, but they had to overcome the $40B in transaction costs paid to the Specialists.

Owning passive investments was not cheap: simply implementing the passive strategy would require higher transaction costs, and might also be subject to adverse selection.

So your passive investments had a tracking error (that lagged the benchmark), and you paid higher management fees.

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packer16
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Re: Larry Swedroe: Evidence Of Shrinking Alpha

Post by packer16 » Fri Oct 06, 2017 11:04 pm

What I find ironic is the approaches recommended by factor investors are as active as active management assuming by weighting some types of stocks over others you will create excess return or a better risk/return relationship that can be offered by standard index funds. IMO one unstated BH assumption is the market is the best average setter of prices & unless you know something the market does not you will not generate excess returns. What I find misleading is these factor approaches are couched in index-like language and use index like concepts to sell this form of active management. IMO when you dive into the implementation of factor investing there is more judgement required than standard value investing. Factor investing requires the investor to transform historical correlations with alot of noise in the data into specific implementations via stock weights. There are tons of variables & correlations many of which are random that you have to deal with to develop an investable strategy. Value investing, in contrast is much easier as you are estimating a cash flow or asset value of one specific asset whose economics you understand.

A rationale approach would be to assume the market weighted index has it right & unless you know something specific about a specific security stick with the market weighted index.

Packer
Buy cheap and something good might happen

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TD2626
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Re: Larry Swedroe: Evidence Of Shrinking Alpha

Post by TD2626 » Fri Oct 06, 2017 11:11 pm

I think that markets are fairly efficient over short time scales and very efficient over long time scales. Of course there are inefficiencies, as it still takes computers nanoseconds for computers to process information. However, new information is incorporated very quickly into the market.

The question is - where do the profits from exploiting inefficiencies go? Mostly to institutional arbitrageurs/prop traders/hedge funds? Or do individual retail investors, through retail mutual funds, have a shot at squeezing profit out of market inefficiencies? My guess is that profits from exploiting market inefficiencies go mostly to institutional specialist firms (arbitrageurs/prop traders) and there is little left for regular active mutual funds catering to retail investors.

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packer16
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Re: Larry Swedroe: Evidence Of Shrinking Alpha

Post by packer16 » Fri Oct 06, 2017 11:34 pm

What I have observed at the micro security selection level, is the largest winners are based upon trends the consensus has wrong. These types of factors cannot be programmed into a computer or quant screen. I will give you an example. In late 2013, there were some radio & TV stocks left for dead as their prices were 5x EV/EBITDA & 20% + FCF yields with debt yields in the mid single digits. Now there were 2 possible scenarios, either these stocks were going to recover to more historical levels of 10x EBITDA & 10% FCF yields or they were going to crash like newspapers. Now what institution was going to risk their capital on possible technology obsolescence story? Not very many & thus the opportunity. Also, given the diversified nature of mutual funds how many were going to invest enough to make a difference? Look at the mutual funds that try to do this & you will see the graveyard. A current example is the Fairholme fund. So IMO you can get alpha just not in diversified way. An interesting paradox.

Packer
Buy cheap and something good might happen

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