WSJ - Is Your Stockpicker Lucky or Good?

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matjen
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WSJ - Is Your Stockpicker Lucky or Good?

Post by matjen » Fri Nov 24, 2017 9:26 am

Behind a paywall but people can usually find ways around that.

A great article that shows the difficulty in selecting and sticking with a "star" manager. Once again it is Victor Haghani of LTCM fame that is providing the insight.
Victor Haghani, a co-founder of one of the best-known investment firms in history, says the most surprising thing is that people have great confidence that they can pick these super-talented fund managers. Currently the chief executive of Elm Partners, which espouses index investing for wealthy clients, Mr. Haghani will try to prove that to you with a simple test.

He and two colleagues told several hundred acquaintances who worked in finance that they would flip two coins, one that was normal and the other that was weighted so it came up heads 60% of the time. They asked the people how many flips it would take them to figure out, with a 95% confidence level, which one was the 60% coin. Told to give a “quick guess,” nearly a third said fewer than 10 flips, while the median response was 40. The correct answer is 143.
https://www.wsj.com/articles/is-your-st ... 1511519400
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livesoft
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Re: WSJ - Is Your Stockpicker Lucky or Good?

Post by livesoft » Fri Nov 24, 2017 9:53 am

That suggests that one wants to make a lot of transactions in order to determine if they are lucky or not.
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matjen
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Re: WSJ - Is Your Stockpicker Lucky or Good?

Post by matjen » Fri Nov 24, 2017 9:58 am

livesoft wrote:
Fri Nov 24, 2017 9:53 am
That suggests that one wants to make a lot of transactions in order to determine if they are lucky or not.
I think it is more of a "need" thing than a "want" thing.
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cinghiale
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Re: WSJ - Is Your Stockpicker Lucky or Good?

Post by cinghiale » Fri Nov 24, 2017 10:37 am

An example of Kahneman and Tversky’s tongue-in-cheek identification of “The Law of Small Numbers.” Most people are “innumerate” when it comes to probability and statistics, and do not realize how many items are needed in a sample for it to have any explanatory power.
One bias they found is that people tend to believe in “the law of small numbers”; that is, they tend to generalize from small amounts of data. So, for example, if a mutual fund manager has had three above-average years in a row, many people will conclude that the fund manager is better than average, even though this conclusion does not follow from such a small amount of data. Or if the first four tosses of a coin give, say, three heads, many people will believe that the next toss is likely to be tails. (From: http://www.econlib.org/library/Enc/bios/Kahneman.html)
The financial “services” industry depends on this lack of numeracy when advertising and pushing its wares.
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Wakefield1
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Re: WSJ - Is Your Stockpicker Lucky or Good?

Post by Wakefield1 » Fri Nov 24, 2017 10:43 am

livesoft wrote:
Fri Nov 24, 2017 9:53 am
That suggests that one wants to make a lot of transactions in order to determine if they are lucky or not.
And to make enough transactions to find out that you are not lucky may prove to be costly.

bogglehead125
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Re: WSJ - Is Your Stockpicker Lucky or Good?

Post by bogglehead125 » Fri Nov 24, 2017 10:47 am

In evaluating active mutual funds, retail investors are not tasked with finding weighted coins, but figuring out how weighted the coins actually are (do they outperform fees?!). This turns out to be comically harder. Estimating the bias of a coin to a sensitivity of 0.01 with 95% confidence requires 10,000 tosses (https://en.wikipedia.org/wiki/Checking_ ... in_is_fair)

garlandwhizzer
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Re: WSJ - Is Your Stockpicker Lucky or Good?

Post by garlandwhizzer » Fri Nov 24, 2017 12:45 pm

I think this raises an important point, the difficulty in separating luck from skill in terms of explaining past fund performance. Another hurdle is that past fund success often leads to future failure, not just from luck turning but also from performance chasing dollars accruing in huge volume to successful funds. At some point, the asset base to invest exceeds the available opportunities to generate alpha which is becoming a rarer and rarer commodity as time passes. This is what happened to Berkshire Hathaway, Magellan Fund, Janus Twenty Fund, etc., all of which were highly successful until they got overloaded with assets. Yet another problem is that equity markets go through cycles that last for years and alternate with each other. Sometimes, like in recent years, growth outperforms value. Growth and momentum funds have impressive performance in such times and assets flow that way after a few years or perhaps a decade of such gains. Often just after you've given up on value and bought into the hot growth/momentum fund, the market itself shifts its focus and value starts outperforming growth for years into the future.

Pickling the optimal fund for the future based on past results is so challenging that few consistently succeed. Hence, the appeal of either cap-weighted indexes which make no bets other than market weight, and of multi-factor funds or alternate funds that spread assets widely enough so that you always own some of whatever is working at the moment.

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livesoft
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Re: WSJ - Is Your Stockpicker Lucky or Good?

Post by livesoft » Fri Nov 24, 2017 12:49 pm

In general, using actively-managed funds and/or a high-fee stock picker / sales rep will not bankrupt most of the people that choose to do that. I would consider the relationship more parasitic than symbiotic, so the parasite doesn't want to kill off the host that feeds them. I mean, how long did that worm live in that NK soldier to get that big?
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Re: WSJ - Is Your Stockpicker Lucky or Good?

Post by GRP » Fri Nov 24, 2017 3:19 pm

livesoft wrote:
Fri Nov 24, 2017 12:49 pm
In general, using actively-managed funds and/or a high-fee stock picker / sales rep will not bankrupt most of the people that choose to do that. I would consider the relationship more parasitic than symbiotic, so the parasite doesn't want to kill off the host that feeds them. I mean, how long did that worm live in that NK soldier to get that big?
A gross... but appropriate analogy! :shock:

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