Shorting the actively managed mutual fund market

Discuss all general (i.e. non-personal) investing questions and issues, investing news, and theory.
Post Reply
somethingsomething
Posts: 1
Joined: Wed Apr 11, 2018 1:18 pm

Shorting the actively managed mutual fund market

Post by somethingsomething » Wed Apr 11, 2018 1:54 pm

Buying a total stock market index fund is essentially longing the entire stock market. This is a better idea than investing in actively managed mutual funds because, as a group, these funds fail to beat the market. And in fact, most mutual funds go out of business, which makes investing in them seem especially dangerous.

This leads me to wonder: instead of longing the entire stock market, why not short the entire actively managed mutual fund market? If it's true that actively managed mutual funds often fail, it seems like a good bet to short them. Maybe even using a strategy like shorting only the top 25 most active or speculative funds.

I realize that this isn't possible for an individual investor to do with mutual funds that are not traded on an exchange. But what about with actively managed ETFs? Or, alternatively, what about creating a fund which just shorts all of the individual securities in some actively managed mutual funds, with the appropriate weights? Has anyone ever tried this, and does it seem like a good strategy?

venkman
Posts: 669
Joined: Tue Mar 14, 2017 10:33 pm

Re: Shorting the actively managed mutual fund market

Post by venkman » Wed Apr 11, 2018 9:54 pm

Actively managed funds fail to beat the market AFTER COSTS. It's not that active managers are idiots--it's that they all have to compete against each other; and in the aggregate, they can't add enough value to overcome their extra trading costs and expense ratios. The performance of the underlying stocks held by active funds, on average, should come pretty close to matching the index.

snarlyjack
Posts: 780
Joined: Fri Aug 28, 2015 12:44 pm
Location: Montana

Re: Shorting the actively managed mutual fund market

Post by snarlyjack » Thu Apr 12, 2018 6:02 am

Somethingsomething,

Welcome to Bogleheads.

Your first post made me smile...
Listen to what Warren Buffett had to say about your question.

https://www.bing.com/videos/search?q=wa ... &FORM=VIRE

JohnDindex
Posts: 54
Joined: Wed Feb 07, 2018 10:59 am

Re: Shorting the actively managed mutual fund market

Post by JohnDindex » Thu Apr 12, 2018 6:20 am

somethingsomething wrote:
Wed Apr 11, 2018 1:54 pm
Buying a total stock market index fund is essentially longing the entire stock market. This is a better idea than investing in actively managed mutual funds because, as a group, these funds fail to beat the market. And in fact, most mutual funds go out of business, which makes investing in them seem especially dangerous.

This leads me to wonder: instead of longing the entire stock market, why not short the entire actively managed mutual fund market? If it's true that actively managed mutual funds often fail, it seems like a good bet to short them. Maybe even using a strategy like shorting only the top 25 most active or speculative funds.

I realize that this isn't possible for an individual investor to do with mutual funds that are not traded on an exchange. But what about with actively managed ETFs? Or, alternatively, what about creating a fund which just shorts all of the individual securities in some actively managed mutual funds, with the appropriate weights? Has anyone ever tried this, and does it seem like a good strategy?
Great idea, go short Trowe price and see how well that works out for you...

User avatar
ReformedSpender
Posts: 155
Joined: Fri Mar 16, 2018 1:24 pm
Location: Stone's Throw from Vanguard

Re: Shorting the actively managed mutual fund market

Post by ReformedSpender » Thu Apr 12, 2018 7:19 am

Beating the market or not, these funds still produce gains with the broader market when it rises or (in more cases than not) fall with the broader market when it falls.

To go short purely due to active management would be an epic losing battle imo. What criteria would you use to know which of the dozens of firms to short?

Good luck :beer
Last edited by ReformedSpender on Thu Apr 12, 2018 7:35 am, edited 1 time in total.
Market history shows that when there's economic blue sky, future returns are low, and when the economy is on the skids, future returns are high. The best fishing is done in the most stormy waters.

User avatar
nisiprius
Advisory Board
Posts: 36467
Joined: Thu Jul 26, 2007 9:33 am
Location: The terrestrial, globular, planetary hunk of matter, flattened at the poles, is my abode.--O. Henry

Re: Shorting the actively managed mutual fund market

Post by nisiprius » Thu Apr 12, 2018 7:32 am

There's a certain mental puzzle I've been trying to deal with. It is, basically, why not a contrarian strategy? If most investors underperform the market, why isn't it easy to "just" to do the opposite of what the crowd is doing? It sounds easy and of course contrarian investing has been around forever, and like everything else it doesn't seem to be any kind of magic answer, either.

I think the best answer I have for this currently is that the "opposite" of active management isn't doing the same thing active managers are doing, but in the opposite direction. The opposite of active management is staying the course.

For example, if you imagine some goal that is straight ahead of you, and a crowd of people who are stumbling along irregular paths toward that goal, the way to beat them is not to match them stumble for stumble but in the opposite direction. It's just to proceed slowly and steadily toward the goal in a straight line, departing from that line as little as possible. You will not be able to beat other people following the same strategy, but you will beat all of the people taking complicated routes trying to beat the straight line.
Last edited by nisiprius on Thu Apr 12, 2018 8:22 am, edited 1 time in total.
Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness; Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.

User avatar
JoMoney
Posts: 5556
Joined: Tue Jul 23, 2013 5:31 am

Re: Shorting the actively managed mutual fund market

Post by JoMoney » Thu Apr 12, 2018 7:46 am

It would likely cost you more than the 1.5% they underperform by to borrow the shares so you could short them.

If they paid a 2% dividend, it would cost you at least that much to be short.

Edit:
Looks like the aggregate of active managers aren't losing by as much as they used to, maybe only .50% to 1%
15-YEAR Annualized Return (SPIVA)
S&P Composite 1500 10.18%
All Domestic Funds (Asset Weighted) 9.56%
All Domestic Funds (Equal Weighted) 9.14%

Edit again, after re-reading OP, to add: Be sure you understand that a mutual fund closing because it failed to attract enough suckers customers doesn't mean the assets went to zero, they just didn't make as much as other options (like the broad index), and either returned the remainder to the owners or merged into a different fund.
Last edited by JoMoney on Thu Apr 12, 2018 8:06 am, edited 2 times in total.
"To achieve satisfactory investment results is easier than most people realize; to achieve superior results is harder than it looks." - Benjamin Graham

gips
Posts: 457
Joined: Mon May 13, 2013 5:42 pm

Re: Shorting the actively managed mutual fund market

Post by gips » Thu Apr 12, 2018 7:54 am

nisiprius wrote:
Thu Apr 12, 2018 7:32 am
There's a certain mental puzzle I've been trying to deal with. It is, basically, why not a contrarian strategy? If most investors underperform the market, why isn't it easy to "just" to do the opposite of what the crowd is doing?

I think the best answer I have for this currenty is that the "opposite" of active management isn't doing the same thing active managers are doing, but in the opposite direction. The opposite of active management is staying the course.

For example, if you imagine some goal that is straight ahead of you, and a crowd of people who are stumbling along irregular paths toward that goal, the way to beat them is not to match them stumble for stumble but in the opposite direction. It's just to proceed slowly and steadily toward the goal in a straight line, departing from that line as little as possible. You will not be able to beat other people following the same strategy, but you will beat all of the people taking complicated routes trying to beat the straight line.
I disagree on a couple of levels:
- the opposite of active management isn’t staying the course if by staying the course you mean don’t time the market. Many active managers have buy and hold strategies and stay the course with their own rigorous stock selection strategy.
- let’s pretend your next door neighbor trades individual names and times the market. Taking the opposite position of each trade from a probabilistic pov should outperform the index (ignoring implementation costs). The problem is that a sample size of one is very risky. But isn’t factor investing in out of favor stocks or industries a decent proxy for the contrarian view your expressing?

User avatar
nisiprius
Advisory Board
Posts: 36467
Joined: Thu Jul 26, 2007 9:33 am
Location: The terrestrial, globular, planetary hunk of matter, flattened at the poles, is my abode.--O. Henry

Re: Shorting the actively managed mutual fund market

Post by nisiprius » Thu Apr 12, 2018 8:26 am

gips wrote:
Thu Apr 12, 2018 7:54 am
...But isn’t factor investing in out of favor stocks or industries a decent proxy for the contrarian view your expressing?...
It is, and I have a great deal of skepticism about it. I don't do it myself. It is not anything "inspired by John C. Bogle." And despite confident statements in this forum, it isn't by any means a sure thing. To me, it is in the nature of a tenuous "well, there might be something to it--maybe, and then again maybe not."

There is very good evidence, e.g. in Morningstar's "investor returns" versus "fund returns," that most actual fund investors fail to achieve the "hypothetical growth" returns they would have achieved by staying the course in the fund. It's not at all clear what is really happening, nor why it isn't easy to do the opposite and outperform the fund return.
Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness; Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.

dumbmoney
Posts: 2278
Joined: Sun Mar 16, 2008 8:58 pm

Re: Shorting the actively managed mutual fund market

Post by dumbmoney » Thu Apr 12, 2018 11:09 am

The goal of most indexes is to imitate active managers (of a certain style) as a group. They do so imperfectly, but that's the general idea. So you can approximate doing the opposite of active managers by...shorting index funds.
Last edited by dumbmoney on Thu Apr 12, 2018 11:36 am, edited 2 times in total.
I am pleased to report that the invisible forces of destruction have been unmasked, marking a turning point chapter when the fraudulent and speculative winds are cast into the inferno of extinction.

dumbmoney
Posts: 2278
Joined: Sun Mar 16, 2008 8:58 pm

Re: Shorting the actively managed mutual fund market

Post by dumbmoney » Thu Apr 12, 2018 11:20 am

nisiprius wrote:
Thu Apr 12, 2018 8:26 am
There is very good evidence, e.g. in Morningstar's "investor returns" versus "fund returns," that most actual fund investors fail to achieve the "hypothetical growth" returns they would have achieved by staying the course in the fund. It's not at all clear what is really happening, nor why it isn't easy to do the opposite and outperform the fund return.
For one thing, everyone is following the same peculiar market timing strategy: invest when you can invest; don't invest when you can't invest. Just try doing the opposite. :-)
I am pleased to report that the invisible forces of destruction have been unmasked, marking a turning point chapter when the fraudulent and speculative winds are cast into the inferno of extinction.

Tanelorn
Posts: 1520
Joined: Thu May 01, 2014 9:35 pm

Re: Shorting the actively managed mutual fund market

Post by Tanelorn » Thu Apr 12, 2018 12:16 pm

It's not possible to short a mutual fund. You could short the public stock of an active asset manager firm, but they're the ones collecting those high fees so it's not clear you want to do that and their stock is only loosely related to the performance of their funds and more to do with their marketing success bringing in more fee-paying assets.
JoMoney wrote:
Thu Apr 12, 2018 7:46 am
If they paid a 2% dividend, it would cost you at least that much to be short.
But the fund price would drop by that 2%, so it wouldn't matter that you paid it, unless you think getting paid dividends from your mutual fund is "free money" and they don't drop afterwards.

User avatar
JoMoney
Posts: 5556
Joined: Tue Jul 23, 2013 5:31 am

Re: Shorting the actively managed mutual fund market

Post by JoMoney » Thu Apr 12, 2018 12:25 pm

Tanelorn wrote:
Thu Apr 12, 2018 12:16 pm
It's not possible to short a mutual fund. You could short the public stock of an active asset manager firm, but they're the ones collecting those high fees so it's not clear you want to do that and their stock is only loosely related to the performance of their funds and more to do with their marketing success bringing in more fee-paying assets.
JoMoney wrote:
Thu Apr 12, 2018 7:46 am
If they paid a 2% dividend, it would cost you at least that much to be short.
But the fund price would drop by that 2%, so it wouldn't matter that you paid it, unless you think getting paid dividends from your mutual fund is "free money" and they don't drop afterwards.
Good point. I still believe it would likely cost more to borrow the funds-shares to sell short then the expected return....
"To achieve satisfactory investment results is easier than most people realize; to achieve superior results is harder than it looks." - Benjamin Graham

User avatar
David Jay
Posts: 5460
Joined: Mon Mar 30, 2015 5:54 am
Location: Michigan

Re: Shorting the actively managed mutual fund market

Post by David Jay » Thu Apr 12, 2018 12:30 pm

nisiprius wrote:
Thu Apr 12, 2018 7:32 am
There's a certain mental puzzle I've been trying to deal with. It is, basically, why not a contrarian strategy? If most investors underperform the market, why isn't it easy to "just" to do the opposite of what the crowd is doing? It sounds easy and of course contrarian investing has been around forever, and like everything else it doesn't seem to be any kind of magic answer, either.
While I can't figure out how to implement it, my strategy would be to short the Money Magazine (or Kiplingers, etc.) Top Ten funds from last year, so in January of 2018 (or whenever they announce) when they list the Top Ten performing funds of 2017, short those 10 funds. Every January liquidate and short the next year's "10 Best".
Prediction is very difficult, especially about the future - Niels Bohr | To get the "risk premium", you really do have to take the risk - nisiprius

aristotelian
Posts: 4594
Joined: Wed Jan 11, 2017 8:05 pm

Re: Shorting the actively managed mutual fund market

Post by aristotelian » Thu Apr 12, 2018 1:55 pm

A bet that the active fund will underperform the S&P is not the same as a short bet that the active fund will be negative. If the S&P goes up 30%, it is going to be very hard to find an active fund that returns negative. What you want is to somehow be able to bet the difference between the active fund(s) and the S&P, which is different than shorting the active fund(s). Not sure how you would do that.

That said, if you own the S&P, you are already profiting from all the active funds who are underperforming.

alex_686
Posts: 3739
Joined: Mon Feb 09, 2015 2:39 pm

Re: Shorting the actively managed mutual fund market

Post by alex_686 » Thu Apr 12, 2018 2:24 pm

aristotelian wrote:
Thu Apr 12, 2018 1:55 pm
A bet that the active fund will underperform the S&P is not the same as a short bet that the active fund will be negative. If the S&P goes up 30%, it is going to be very hard to find an active fund that returns negative. What you want is to somehow be able to bet the difference between the active fund(s) and the S&P, which is different than shorting the active fund(s). Not sure how you would do that.
You short the mutual fund, take the money and invest long in the underlying index. At that point you only care about relative performance, not absolute.

I have seen this done with a mutual fund once, about 20 years ago. It was fairly hard to borrow the mutual fund shares in order to short them.

dumbmoney
Posts: 2278
Joined: Sun Mar 16, 2008 8:58 pm

Re: Shorting the actively managed mutual fund market

Post by dumbmoney » Thu Apr 12, 2018 2:25 pm

Tanelorn wrote:
Thu Apr 12, 2018 12:16 pm
It's not possible to short a mutual fund.
You can short ETFs.

But I suppose if any were really juicy short targets, they would be hard (expensive) to borrow. It's interesting that fund managers tolerate this given that short sellers are earning fees that would otherwise go to the manager (maybe they don't have a choice).
I am pleased to report that the invisible forces of destruction have been unmasked, marking a turning point chapter when the fraudulent and speculative winds are cast into the inferno of extinction.

KSActuary
Posts: 379
Joined: Fri Jan 13, 2012 10:53 pm

Re: Shorting the actively managed mutual fund market

Post by KSActuary » Thu Apr 12, 2018 2:51 pm

Never thought I would run across this topic.

What you should be shorting is the investing consumer who gets the short end of the stick in this relationship.

User avatar
JoMoney
Posts: 5556
Joined: Tue Jul 23, 2013 5:31 am

Re: Shorting the actively managed mutual fund market

Post by JoMoney » Thu Apr 12, 2018 3:11 pm

Maybe someone can offer a long-short fund like the 130/30 funds, but short stock picker strategies and leveraged long S&P 500.... and then charge 2% ER :twisted:

... and then offer that fund as an ETF so it can be sold short :P
"To achieve satisfactory investment results is easier than most people realize; to achieve superior results is harder than it looks." - Benjamin Graham

venkman
Posts: 669
Joined: Tue Mar 14, 2017 10:33 pm

Re: Shorting the actively managed mutual fund market

Post by venkman » Thu Apr 12, 2018 10:16 pm

If you REALLY want to bet against active management....

Find a hedge fund manager. Let them pick a basket of hedge funds. Bet them a million dollars that the return on the S&P will beat the return on the hedge funds over the next 10 years.

To date, this strategy has a 100% success rate. :happy

redstar
Posts: 42
Joined: Thu Jul 13, 2017 11:15 pm

Re: Shorting the actively managed mutual fund market

Post by redstar » Fri Apr 13, 2018 12:10 am

alex_686 wrote:
Thu Apr 12, 2018 2:24 pm
aristotelian wrote:
Thu Apr 12, 2018 1:55 pm
A bet that the active fund will underperform the S&P is not the same as a short bet that the active fund will be negative. If the S&P goes up 30%, it is going to be very hard to find an active fund that returns negative. What you want is to somehow be able to bet the difference between the active fund(s) and the S&P, which is different than shorting the active fund(s). Not sure how you would do that.
You short the mutual fund, take the money and invest long in the underlying index. At that point you only care about relative performance, not absolute.

I have seen this done with a mutual fund once, about 20 years ago. It was fairly hard to borrow the mutual fund shares in order to short them.
The relative difference wouldn’t include the high fee that a mutual fund investor has to pay, right? So it isn’t exactly the opposite of being actively managed.

Tanelorn
Posts: 1520
Joined: Thu May 01, 2014 9:35 pm

Re: Shorting the actively managed mutual fund market

Post by Tanelorn » Fri Apr 13, 2018 6:04 am

dumbmoney wrote:
Thu Apr 12, 2018 2:25 pm
Tanelorn wrote:
Thu Apr 12, 2018 12:16 pm
It's not possible to short a mutual fund.
You can short ETFs.

But I suppose if any were really juicy short targets, they would be hard (expensive) to borrow. It's interesting that fund managers tolerate this given that short sellers are earning fees that would otherwise go to the manager (maybe they don't have a choice).
Yes, you can short ETFs. Most ETFs are not actively managed however, and most ETFs have relatively low fees. Yes, there are a few ETFs that are short targets and they can cost 5-10%/year to borrow which makes them unattractive for this purpose.

Tanelorn
Posts: 1520
Joined: Thu May 01, 2014 9:35 pm

Re: Shorting the actively managed mutual fund market

Post by Tanelorn » Fri Apr 13, 2018 6:11 am

alex_686 wrote:
Thu Apr 12, 2018 2:24 pm
You short the mutual fund, take the money and invest long in the underlying index. At that point you only care about relative performance, not absolute.
Yes, that's right. Let's say you find a fund you dislike (perhaps due to their hefty 2% management fee), you could short it somehow and for free, and you then invest long in the passive index version of whatever the fund's benchmark might be. Now you stand to earn a net 2%, plus more or less based on the success of the active manager. The problem is that you probably have to put up $1 for the short and another $1 for your long, so even if you make the 2% and it's nearly risk free, given your $2's invested that's only a 1%/year return. I can point you to a bank account for those returns and with a whole lot less trouble.
I have seen this done with a mutual fund once, about 20 years ago. It was fairly hard to borrow the mutual fund shares in order to short them.
Now you've got me curious. If you can remember a bit more about how and why this was done, I would be very interested.

alex_686
Posts: 3739
Joined: Mon Feb 09, 2015 2:39 pm

Re: Shorting the actively managed mutual fund market

Post by alex_686 » Fri Apr 13, 2018 9:00 am

redstar wrote:
Fri Apr 13, 2018 12:10 am
The relative difference wouldn’t include the high fee that a mutual fund investor has to pay, right? So it isn’t exactly the opposite of being actively managed.
I might be missing the point you are trying to make. You are just shorting the shares. The expense ratio is embedded in the share price. The short performance is exactly the opposite of the long performance, expect for the dividends.

alex_686
Posts: 3739
Joined: Mon Feb 09, 2015 2:39 pm

Re: Shorting the actively managed mutual fund market

Post by alex_686 » Fri Apr 13, 2018 9:09 am

Tanelorn wrote:
Fri Apr 13, 2018 6:11 am
alex_686 wrote:
Thu Apr 12, 2018 2:24 pm
The problem is that you probably have to put up $1 for the short and another $1 for your long, so even if you make the 2% and it's nearly risk free, given your $2's invested that's only a 1%/year return. I can point you to a bank account for those returns and with a whole lot less trouble.
I have seen this done with a mutual fund once, about 20 years ago. It was fairly hard to borrow the mutual fund shares in order to short them.
Now you've got me curious. If you can remember a bit more about how and why this was done, I would be very interested.
You have the math wrong. You short a stock for $1, so you sell the stock and but $1 in your pocket. You then take that $1 and buy the long side. At this point your are market neutral. You are long $1, you are short $1. You then put up $.30 in Treasuries as margin collateral. All you need to do is put up $.30, so a 2% difference becomes a 6.66% return. This is a classic strategy. Nothing special about shorting mutual funds. I think it is bizarre but there you go.

20 years ago I worked in the back office of a high-end high-touch full service brokerage. We would do any stupid strategy that our clients asked us to do. They were paying us enough. I don't know why the person shorted the mutual funds. In most cases clients who shorted the market this way had a combination of arrogance, ego, and hatred and contempt for the current management.

It also meant that I had to handle every stupid expectation. I would get my recon report flagging short mutual fund positions which normally. Every other short mutual fund position was a mistake that needed to be cleaned up. Not this position. I also had to deal with physical certificates for a mutual fund. Lots of weird stuff.

User avatar
willthrill81
Posts: 5381
Joined: Thu Jan 26, 2017 3:17 pm
Location: USA

Re: Shorting the actively managed mutual fund market

Post by willthrill81 » Fri Apr 13, 2018 9:13 am

JoMoney wrote:
Thu Apr 12, 2018 7:46 am
It would likely cost you more than the 1.5% they underperform by to borrow the shares so you could short them.
:thumbsup Bingo!
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

mega317
Posts: 2554
Joined: Tue Apr 19, 2016 10:55 am

Re: Shorting the actively managed mutual fund market

Post by mega317 » Sat Apr 14, 2018 1:19 pm

venkman wrote:
Thu Apr 12, 2018 10:16 pm
If you REALLY want to bet against active management....

Find a hedge fund manager. Let them pick a basket of hedge funds. Bet them a million dollars that the return on the S&P will beat the return on the hedge funds over the next 10 years.

To date, this strategy has a 100% success rate. :happy
No hedge fund manager would take that bet because they know just as well as you do. People don't run hedge funds in order to eke ahead of the S&P over a long period of time....

Post Reply