Larry Swedroe: Skill Exists, But Not Enough

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Random Walker
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Larry Swedroe: Skill Exists, But Not Enough

Post by Random Walker » Wed Aug 22, 2018 10:24 am

https://www.etf.com/sections/index-inve ... not-enough

We all know that active management is a loser’s game for us investors, but that doesn’t mean that the pros on a Wall Street aren’t smart, skilled, and motivated. In fact there is a lot of evidence that active managers can generate excess returns gross of fees. We only earn net of fees though.

Larry reviews a study showing that active funds can generate alpha by exploiting earnings announcements. Unfortunately this is only true on a before fee basis. Moreover this ability is declining over time. Once again, exceptions to the efficient markets hypothesis, in the end, end up strengthening the hypothesis. The smart people capitalizing on market inefficiencies work to make the market more efficient for the rest of us.

Dave

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David Jay
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Re: Larry Swedroe: Skill Exists, But Not Enough

Post by David Jay » Wed Aug 22, 2018 10:26 am

I like Rick Ferri's construction: Alpha exists but it goes to the FA, not the investor.
Prediction is very difficult, especially about the future - Niels Bohr | To get the "risk premium", you really do have to take the risk - nisiprius

garlandwhizzer
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Re: Larry Swedroe: Skill Exists, But Not Enough

Post by garlandwhizzer » Wed Aug 22, 2018 11:50 am

Vanguard's Primecap Fund, VPMCX, is the best example that I know of that demonstrates long term consistent skill at outperformance. Since 11/1/1984 when it started more than 32 years ago it has averaged annual returns of 19.94%. At that rate your money more than doubles every 4 years on average. It has massively outperformed comparable and non-comparable indexes and factor funds as well. For example it has outperformed the darling of factor funds, DFSVX, Dimension's Small Cap Value Fund YTD, 1YR, 3YR, 5YR, 10YR, and since DFSVX's inception more than 25 years ago. VPMCX is a LC/MC growth fund, not where you might expect to find such outstanding long term results. Its outstanding results are not accounted for by factor analysis, rather a persistent and massive alpha. Its managers have been able to pick winning stocks and avoid big losers consistently over a very long time frame. It is the extremely rare exception to the rule that active management tends to be a long term loser to low cost indexes which is true for the overwhelming majority of active funds that attempt it.

Before you rush to buy it I should warn that it is closed to new investors in order to keep its asset base manageable and nimble. This is how Vanguard avoids the usual problem with active management--success eventually leads to failure due to asset bloat.

Garland Whizzer

marcopolo
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Re: Larry Swedroe: Skill Exists, But Not Enough

Post by marcopolo » Wed Aug 22, 2018 12:00 pm

Random Walker wrote:
Wed Aug 22, 2018 10:24 am
https://www.etf.com/sections/index-inve ... not-enough

We all know that active management is a loser’s game for us investors, but that doesn’t mean that the pros on a Wall Street aren’t smart, skilled, and motivated. In fact there is a lot of evidence that active managers can generate excess returns gross of fees. We only earn net of fees though.

Larry reviews a study showing that active funds can generate alpha by exploiting earnings announcements. Unfortunately this is only true on a before fee basis. Moreover this ability is declining over time. Once again, exceptions to the efficient markets hypothesis, in the end, end up strengthening the hypothesis. The smart people capitalizing on market inefficiencies work to make the market more efficient for the rest of us.

Dave
Interesting.

If this is true at the fund level, why would we expect it to be any different at the portfolio level, where an intelligent, well meaning, but expensive, advisor constructs a portfolio of diverse products (Factors, Alts, TIlts, etc.)?
Once in a while you get shown the light, in the strangest of places if you look at it right.

Random Walker
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Re: Larry Swedroe: Skill Exists, But Not Enough

Post by Random Walker » Wed Aug 22, 2018 2:06 pm

marcopolo wrote:
Wed Aug 22, 2018 12:00 pm

If this is true at the fund level, why would we expect it to be any different at the portfolio level, where an intelligent, well meaning, but expensive, advisor constructs a portfolio of diverse products (Factors, Alts, TIlts, etc.)?
My first thought is that in the example of an active fund versus a passive fund, the passive baseline is stable, measurable, reproducible. When you extrapolate to the comparison of an investor going advisor route to investor going DIY route, your baseline becomes a hodgepodge of very different entities. Each DIY investor will have different abilities, use different funds, and display different behaviors. So the difference between the FA route and the DIY route, the “alpha”, will be different for each individual investor / advisor combination. One obvious example is a well behaved investor versus the opposite. The investor who would panic sell and abandon his plan will likely benefit far beyond the costs of using an advisor. A well behaved investor maybe not so much. A more subtle example might be the case of rebalancing and tax loss harvesting. Some individual investors may be able to do this in an efficient and cost effective manner on their own while many others are better off leaving it to an advisor.

The advisor “alpha” depends on the difference between what the investor can achieve on his own and the value added by the advisor. There is tremendous variability in both the advisors and the investors, making each potential alpha calculation unique.

marcopolo
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Re: Larry Swedroe: Skill Exists, But Not Enough

Post by marcopolo » Wed Aug 22, 2018 2:27 pm

Random Walker wrote:
Wed Aug 22, 2018 2:06 pm
marcopolo wrote:
Wed Aug 22, 2018 12:00 pm

If this is true at the fund level, why would we expect it to be any different at the portfolio level, where an intelligent, well meaning, but expensive, advisor constructs a portfolio of diverse products (Factors, Alts, TIlts, etc.)?
My first thought is that in the example of an active fund versus a passive fund, the passive baseline is stable, measurable, reproducible. When you extrapolate to the comparison of an investor going advisor route to investor going DIY route, your baseline becomes a hodgepodge of very different entities. Each DIY investor will have different abilities, use different funds, and display different behaviors. So the difference between the FA route and the DIY route, the “alpha”, will be different for each individual investor / advisor combination. One obvious example is a well behaved investor versus the opposite. The investor who would panic sell and abandon his plan will likely benefit far beyond the costs of using an advisor. A well behaved investor maybe not so much. A more subtle example might be the case of rebalancing and tax loss harvesting. Some individual investors may be able to do this in an efficient and cost effective manner on their own while many others are better off leaving it to an advisor.

The advisor “alpha” depends on the difference between what the investor can achieve on his own and the value added by the advisor. There is tremendous variability in both the advisors and the investors, making each potential alpha calculation unique.

Those are good points. But, wouldn't just about everything you said apply to mutual funds as well? There are many abysmally run funds, many mediocre funds, and a small number of good performing funds. Comparing them can lead very different alpha calculation, just as you describe above. So, to solve this problem, funds are usually compared to well defined passive index approach to see how well the fund delivers relative to that. Couldn't the same be done at the advisor level? Select a specific set of index funds to comprise a benchmark portfolio, and compare the risk-adjusted return of advisors relative to that to see if any alpha they deliver (relative to baseline portfolio) exceeds their costs.
Once in a while you get shown the light, in the strangest of places if you look at it right.

Random Walker
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Re: Larry Swedroe: Skill Exists, But Not Enough

Post by Random Walker » Wed Aug 22, 2018 3:20 pm

Marcopolo,
Yes, I agree with you. In fact, when I was pondering my own potential transition from DIY BH to advisor route I did those same sorts of calculations. I came up with guesstimates for excess returns from tilting, improved portfolio efficiency, better TLH than I’d do on my own, advantages of tax managed value funds, better investor behavior by me. I even added a factor for stuff I didn’t know that i didn’t know. In practice though, not much value derived from those mental gymnastics. The reason is that you end up comparing two completely different paths: different investment vehicles, a known history compared to an unknown alternative history, and likely a completely different AA. And each individual will place different values on the time saved going the advisor route.
People have asked me once or twice to compare my returns using advisor to my DIY VG portfolio, but the comparison is completely meaningless. My overall AA has changed dramatically under the influence of the advisor and I don’t know what changes I would have made on the alternative DIY path. One of the biggest functions of the advisor is to get the AA right to begin with. I don’t know if I would have taken as much risk off the table as I have if I had stayed on the DIY route.
An individual could make up a spreadsheet to look at the positives and negatives of going the advisor route versus DIY. Honestly though, the individual can choose variables to get whatever outcome he wants. I’m sure there was a ton of confirmation bias involved in my own decision making process.

Dave

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