"Why those highly paid pros do worse than a boring stock index fund"

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Taylor Larimore
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"Why those highly paid pros do worse than a boring stock index fund"

Post by Taylor Larimore »

Bogleheads:

Michael Edesess at MarketWatch has written an article explaining why professional investors do worse than a simple total market index fund:

https://www.marketwatch.com/story/why-t ... eid=yhoof2

Best wishes.
Taylor
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Re: "Why those highly paid pros do worse than a boring stock index fund"

Post by nedsaid »

Underperformance of active funds relative to index funds is due mostly to fees. The article also discusses smart beta.
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Re: "Why those highly paid pros do worse than a boring stock index fund"

Post by Rowan Oak »

The overarching reality is simple: Gross returns in the financial markets minus the costs of financial intermediation equal the net returns actually delivered to investors. Although truly staggering amounts of investment literature have been devoted to the widely understood EMH (the efficient market hypothesis), precious little has been devoted to what I call the CMH (the cost matters hypothesis). To explain the dire odds that investors face in their quest to beat the market, however, we don't need the EMH; we need only the CMH. No matter how efficient or inefficient markets may be, the returns earned by investors as a group must fall short of the market returns by precisely the amount of the aggregate costs they incur. It is the central fact of investing.

— John C. Bogle, The Relentless Rules of Humble Arithmetic, Financial Analysts Journal; November/December 2005
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Re: "Why those highly paid pros do worse than a boring stock index fund"

Post by nisiprius »

This is an impressively strong statement:
The mathematical methods of the finance field don’t help one bit, in spite of the fact that academic journals of finance are awash in it, one could accurately dismiss it as being all for show.
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Re: "Why those highly paid pros do worse than a boring stock index fund"

Post by alex_686 »

nedsaid wrote: Sat Oct 24, 2020 8:15 pm Underperformance of active funds relative to index funds is due mostly to fees. The article also discusses smart beta.
Which is why the title is false. The average active equity portfolio manager beats their index by 1.2%. There is a correlation between a portfolio manager’s compensation and their return. They do better, not worse.

That does nor mean you get to see that return. Fees, both explicit and implicit runs around 1.4%. There are other issues.
Former brokerage operations & mutual fund accountant. I hate risk, which is why I study and embrace it.
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Re: "Why those highly paid pros do worse than a boring stock index fund"

Post by Random Musings »

Perhaps those ivory tower geniuses could either a) go passive and be better off or b) tell their investing teams they have to pay them less so they can actually see some excess returns.

Otherwise, they are just negligent of handling their investments in the best manner. Worst case, there are shenanigans going on.

RM
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Re: "Why those highly paid pros do worse than a boring stock index fund"

Post by Ocean77 »

I'm sure they are doing just fine. For themselves.
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Re: "Why those highly paid pros do worse than a boring stock index fund"

Post by 000 »

While we're on the subject I'd like to share one of my biggest gripes with active funds (after fees): narrow focus.

I don't want a manager to find the best deals in, for example, small caps.

I want a manager to find the best deals wherever they are.

There are only a handful of funds of which I am aware like this. TRP Capital Appreciation is one I believe.
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Re: "Why those highly paid pros do worse than a boring stock index fund"

Post by nedsaid »

alex_686 wrote: Sat Oct 24, 2020 9:05 pm
nedsaid wrote: Sat Oct 24, 2020 8:15 pm Underperformance of active funds relative to index funds is due mostly to fees. The article also discusses smart beta.
Which is why the title is false. The average active equity portfolio manager beats their index by 1.2%. There is a correlation between a portfolio manager’s compensation and their return. They do better, not worse.

That does nor mean you get to see that return. Fees, both explicit and implicit runs around 1.4%. There are other issues.
Active management can work, if you get the fees low enough. I do question how the average active portfolio manager can beat their index by 1.2%, do you have a source? What I don't question is that good managers can beat the market but Alpha of just 0.2% or 0.3% a year isn't easy to generate.
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Re: "Why those highly paid pros do worse than a boring stock index fund"

Post by Peter G »

nedsaid wrote: Sat Oct 24, 2020 11:27 pm I do question how the average active portfolio manager can beat their index by 1.2%
Could a skewed distribution of returns produce such a result?
Could one imagine that 50% of all of those managers' returns in dollars, as a proportion of the sums invested must be more than if not equal to the index returns?
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Re: "Why those highly paid pros do worse than a boring stock index fund"

Post by nedsaid »

Peter G wrote: Sat Oct 24, 2020 11:53 pm
nedsaid wrote: Sat Oct 24, 2020 11:27 pm I do question how the average active portfolio manager can beat their index by 1.2%
Could a skewed distribution of returns produce such a result?
Could one imagine that 50% of all of those managers' returns in dollars, as a proportion of the sums invested must be more than if not equal to the index returns?
Beating the market has to be a zero sum gain. As a whole, investors in the stock market receive the market return minus whatever expenses. It is possible for some active investors to beat the market but that means that other active investors will trail the market. The other thing is that the competition has gotten better and the markets have been becoming more efficient. Stocks once were 90% owned by individuals and now it is 10%. Fewer suckers out there you can beat.
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Re: "Why those highly paid pros do worse than a boring stock index fund"

Post by criticalmass »

Conventional wisdom is that the diversified low cost index equity funds outperform their managed peers.

However, I've been keeping an eye on this fund: FKKSX "Federated Hermes Kaufmann Small Cap R." It has a whopping 1.37 ER (!!!)

Even with that hefty drag, it also seems to be doing very well across various time intervals, compared to small cap indexes, including Vanguard's index fund that uses a small cap index VSMAX. It performs well compared to S&P 500 Index VFIAX or Total Stock Market VTSAX too.

I don't have any holdings with FKKSX, but am curious about its performance relative to index funds.

Another interesting fund is Fidelity Contrafund, which has outperformed Vanguard & Fidelity total stock market funds for long periods of time. If you have access to the low cost version (K class) or the even lower cost non-fund Commingled Pool version (0.37 or 0.43 ER), then performance is even better.
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Re: "Why those highly paid pros do worse than a boring stock index fund"

Post by nedsaid »

criticalmass wrote: Sun Oct 25, 2020 12:08 am Conventional wisdom is that the diversified low cost index equity funds outperform their managed peers.

However, I've been keeping an eye on this fund: FKKSX "Federated Hermes Kaufmann Small Cap R." It has a whopping 1.37 ER (!!!)

Even with that hefty drag, it also seems to be doing very well across various time intervals, compared to small cap indexes, including Vanguard's index fund that uses a small cap index VSMAX. It performs well compared to S&P 500 Index VFIAX or Total Stock Market VTSAX too.

I don't have any holdings with FKKSX, but am curious about its performance relative to index funds.

Another interesting fund is Fidelity Contrafund, which has outperformed Vanguard & Fidelity total stock market funds for long periods of time. If you have access to the low cost version (K class) or the even lower cost non-fund Commingled Pool version (0.37 or 0.43 ER), then performance is even better.
Wow, I heard advertisements on the radio regarding the Kaufmann Fund over 20 years ago. Good to see that it is still around. Contrafund is another fund that has done well for a very long time. As I said, active management can work, even better odds of success with low expense ratios. What I will say is that there are relatively few active funds with these kind of long term track records.
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Re: "Why those highly paid pros do worse than a boring stock index fund"

Post by JBTX »

nedsaid wrote: Sun Oct 25, 2020 12:29 am
criticalmass wrote: Sun Oct 25, 2020 12:08 am Conventional wisdom is that the diversified low cost index equity funds outperform their managed peers.

However, I've been keeping an eye on this fund: FKKSX "Federated Hermes Kaufmann Small Cap R." It has a whopping 1.37 ER (!!!)

Even with that hefty drag, it also seems to be doing very well across various time intervals, compared to small cap indexes, including Vanguard's index fund that uses a small cap index VSMAX. It performs well compared to S&P 500 Index VFIAX or Total Stock Market VTSAX too.

I don't have any holdings with FKKSX, but am curious about its performance relative to index funds.

Another interesting fund is Fidelity Contrafund, which has outperformed Vanguard & Fidelity total stock market funds for long periods of time. If you have access to the low cost version (K class) or the even lower cost non-fund Commingled Pool version (0.37 or 0.43 ER), then performance is even better.
Wow, I heard advertisements on the radio regarding the Kaufmann Fund over 20 years ago. Good to see that it is still around. Contrafund is another fund that has done well for a very long time. As I said, active management can work, even better odds of success with low expense ratios. What I will say is that there are relatively few active funds with these kind of long term track records.
I had the Kaufmann fund for quite a number of years, mid 90's going forward. Morningstar has it at almost 2.0% expense ratio. Over the last 10 years it has slightly lagged mid cap growth index. I don't recall but I think I dumped it between the fees and it's growth flavor, and the fact that it started as small and became a mid cap.

I think if you look at contrafund for past 5-10 years it is close to the large cap growth index.

If you can outperform when small, then keep up with the market as you grow, you can always claim to have beat the index long term. If you don't outperform early on, close the fund and try again.
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Re: "Why those highly paid pros do worse than a boring stock index fund"

Post by Uncorrelated »

criticalmass wrote: Sun Oct 25, 2020 12:08 am Conventional wisdom is that the diversified low cost index equity funds outperform their managed peers.

However, I've been keeping an eye on this fund: FKKSX "Federated Hermes Kaufmann Small Cap R." It has a whopping 1.37 ER (!!!)

Even with that hefty drag, it also seems to be doing very well across various time intervals, compared to small cap indexes, including Vanguard's index fund that uses a small cap index VSMAX. It performs well compared to S&P 500 Index VFIAX or Total Stock Market VTSAX too.

I don't have any holdings with FKKSX, but am curious about its performance relative to index funds.

Another interesting fund is Fidelity Contrafund, which has outperformed Vanguard & Fidelity total stock market funds for long periods of time. If you have access to the low cost version (K class) or the even lower cost non-fund Commingled Pool version (0.37 or 0.43 ER), then performance is even better.
The performance of this fund, even after correcting for the expense ratio, is fully explained with a 3-factor regression.

Image

It appears to do well because it has a negative exposure to value, which has done poorly over the last 15 years. There is no evidence of actual management skill here, just what you would expect from random market gyrations.
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Re: "Why those highly paid pros do worse than a boring stock index fund"

Post by nedsaid »

JBTX wrote: Sun Oct 25, 2020 2:49 am
I had the Kaufmann fund for quite a number of years, mid 90's going forward. Morningstar has it at almost 2.0% expense ratio. Over the last 10 years it has slightly lagged mid cap growth index. I don't recall but I think I dumped it between the fees and it's growth flavor, and the fact that it started as small and became a mid cap.

I think if you look at contrafund for past 5-10 years it is close to the large cap growth index.

If you can outperform when small, then keep up with the market as you grow, you can always claim to have beat the index long term. If you don't outperform early on, close the fund and try again.
This is a problem that successful funds run into and that is asset bloat. Another fund with a similar history is American Century Ultra, which at one time was popular in 401(k) plans. Started as a Mid/Small-Cap fund, had one fantastic year and the money just rolled in. It is now a Large Cap Growth fund and after a disappointing stretch has now recovered some of its former glory.
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Re: "Why those highly paid pros do worse than a boring stock index fund"

Post by mr_brightside »

i believe greatly in indexing for the majority of one's holdings

but I still buy into the concept of active investing with experienced pros who 'stay in their lane' as long as the fees aren't ridiculous

in the not too distant future i may be doing a large-ish rollover and have my eye on putting a chunk of it in T. Rowe Price Blue Chip Growth

(have a little concern that Puglia is retiring in a bit but their bench seems pretty good ...)
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Re: "Why those highly paid pros do worse than a boring stock index fund"

Post by nedsaid »

I might be way ahead of my time but I have toyed with the idea of a 20%-40% active/60%-80% passive portfolio. The active portion would be low cost active funds such as what Vanguard offers or the low turnover/low cost factor type funds like DFA. Pretty much everyone doing their little part to keep the markets efficient. The odds for active to beat passive over the long term are not high but certainly greatly improved with low cost and lower turnover. Vanguard has good low cost active funds.
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Re: "Why those highly paid pros do worse than a boring stock index fund"

Post by criticalmass »

JBTX wrote: Sun Oct 25, 2020 2:49 am
criticalmass wrote: Sun Oct 25, 2020 12:08 am Conventional wisdom is that the diversified low cost index equity funds outperform their managed peers.

However, I've been keeping an eye on this fund: FKKSX "Federated Hermes Kaufmann Small Cap R." It has a whopping 1.37 ER (!!!)

Even with that hefty drag, it also seems to be doing very well across various time intervals, compared to small cap indexes, including Vanguard's index fund that uses a small cap index VSMAX. It performs well compared to S&P 500 Index VFIAX or Total Stock Market VTSAX too.

I don't have any holdings with FKKSX, but am curious about its performance relative to index funds.

Another interesting fund is Fidelity Contrafund, which has outperformed Vanguard & Fidelity total stock market funds for long periods of time. If you have access to the low cost version (K class) or the even lower cost non-fund Commingled Pool version (0.37 or 0.43 ER), then performance is even better.
I had the Kaufmann fund for quite a number of years, mid 90's going forward. Morningstar has it at almost 2.0% expense ratio. Over the last 10 years it has slightly lagged mid cap growth index. I don't recall but I think I dumped it between the fees and it's growth flavor, and the fact that it started as small and became a mid cap.
Morningstar shows the expense ratio as 1.370%. Regardless of ERs, I don't think it is fair to compare small cap FKKSX with the mid cap index. It makes more sense to compare FKKSX with small cap indexes.
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Re: "Why those highly paid pros do worse than a boring stock index fund"

Post by afan »

nedsaid wrote: Sun Oct 25, 2020 12:04 am The other thing is that the competition has gotten better and the markets have been becoming more efficient.
Do you know of data to support this?
How were they defining and measuring market efficiency?
The data on relative performance of active investors compared to indexes was compiled before index funds came into existence. In fact, these data were the motivation for creating the funds.

Transaction costs have come down, but if anything, this should have helped the active managers, who trade more.

Other than that, I don't know how one would even define more efficient.
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Re: "Why those highly paid pros do worse than a boring stock index fund"

Post by SteadyOne »

nisiprius wrote: Sat Oct 24, 2020 9:00 pm This is an impressively strong statement:
The mathematical methods of the finance field don’t help one bit, in spite of the fact that academic journals of finance are awash in it, one could accurately dismiss it as being all for show.
Nassim Taleb called all these models ‘second rate physics.’
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Re: "Why those highly paid pros do worse than a boring stock index fund"

Post by nedsaid »

afan wrote: Sun Oct 25, 2020 1:08 pm
nedsaid wrote: Sun Oct 25, 2020 12:04 am The other thing is that the competition has gotten better and the markets have been becoming more efficient.
Do you know of data to support this?
How were they defining and measuring market efficiency?
The data on relative performance of active investors compared to indexes was compiled before index funds came into existence. In fact, these data were the motivation for creating the funds.

Transaction costs have come down, but if anything, this should have helped the active managers, who trade more.

Other than that, I don't know how one would even define more efficient.
You could start with Larry Swedroe's Incredibly Shrinking Alpha, he has posted articles that discusses this, you don't necessarily have to buy the book to get the gist of his arguments. One indicator of market efficiency is the failure of the long/short 130/30 funds. It ought to be like shooting fish in a barrel being long the "good" stocks and short the "bad" ones but in real life it didn't work that way. Another clue are the tribulations of QSPIX, AQR Style Premia Alternative Fund, which had a promising start but which has since floundered. You also would think that as more assets are passively managed that you would see more active funds beating the benchmarks, I am pretty sure we aren't seeing this. Yet another line of evidence is that most Hedge Funds have rather mediocre returns.

Below is the link to Larry's article.

https://www.wealthmanagement.com/invest ... king-alpha
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Re: "Why those highly paid pros do worse than a boring stock index fund"

Post by JBTX »

nedsaid wrote: Sun Oct 25, 2020 11:12 am
JBTX wrote: Sun Oct 25, 2020 2:49 am
I had the Kaufmann fund for quite a number of years, mid 90's going forward. Morningstar has it at almost 2.0% expense ratio. Over the last 10 years it has slightly lagged mid cap growth index. I don't recall but I think I dumped it between the fees and it's growth flavor, and the fact that it started as small and became a mid cap.

I think if you look at contrafund for past 5-10 years it is close to the large cap growth index.

If you can outperform when small, then keep up with the market as you grow, you can always claim to have beat the index long term. If you don't outperform early on, close the fund and try again.
This is a problem that successful funds run into and that is asset bloat. Another fund with a similar history is American Century Ultra, which at one time was popular in 401(k) plans. Started as a Mid/Small-Cap fund, had one fantastic year and the money just rolled in. It is now a Large Cap Growth fund and after a disappointing stretch has now recovered some of its former glory.
Another fund I had in the 90s, along with several others of theirs, which I ultimately moved out of.
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Re: "Why those highly paid pros do worse than a boring stock index fund"

Post by nedsaid »

JBTX wrote: Sun Oct 25, 2020 3:03 pm
nedsaid wrote: Sun Oct 25, 2020 11:12 am
JBTX wrote: Sun Oct 25, 2020 2:49 am
I had the Kaufmann fund for quite a number of years, mid 90's going forward. Morningstar has it at almost 2.0% expense ratio. Over the last 10 years it has slightly lagged mid cap growth index. I don't recall but I think I dumped it between the fees and it's growth flavor, and the fact that it started as small and became a mid cap.

I think if you look at contrafund for past 5-10 years it is close to the large cap growth index.

If you can outperform when small, then keep up with the market as you grow, you can always claim to have beat the index long term. If you don't outperform early on, close the fund and try again.
This is a problem that successful funds run into and that is asset bloat. Another fund with a similar history is American Century Ultra, which at one time was popular in 401(k) plans. Started as a Mid/Small-Cap fund, had one fantastic year and the money just rolled in. It is now a Large Cap Growth fund and after a disappointing stretch has now recovered some of its former glory.
Another fund I had in the 90s, along with several others of theirs, which I ultimately moved out of.
Yes, those were the days. The 1990's were the hey day of the no-load mutual funds.
A fool and his money are good for business.
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Re: "Why those highly paid pros do worse than a boring stock index fund"

Post by JBTX »

nedsaid wrote: Sun Oct 25, 2020 3:21 pm
JBTX wrote: Sun Oct 25, 2020 3:03 pm
nedsaid wrote: Sun Oct 25, 2020 11:12 am
JBTX wrote: Sun Oct 25, 2020 2:49 am
I had the Kaufmann fund for quite a number of years, mid 90's going forward. Morningstar has it at almost 2.0% expense ratio. Over the last 10 years it has slightly lagged mid cap growth index. I don't recall but I think I dumped it between the fees and it's growth flavor, and the fact that it started as small and became a mid cap.

I think if you look at contrafund for past 5-10 years it is close to the large cap growth index.

If you can outperform when small, then keep up with the market as you grow, you can always claim to have beat the index long term. If you don't outperform early on, close the fund and try again.
This is a problem that successful funds run into and that is asset bloat. Another fund with a similar history is American Century Ultra, which at one time was popular in 401(k) plans. Started as a Mid/Small-Cap fund, had one fantastic year and the money just rolled in. It is now a Large Cap Growth fund and after a disappointing stretch has now recovered some of its former glory.
Another fund I had in the 90s, along with several others of theirs, which I ultimately moved out of.
Yes, those were the days. The 1990's were the hey day of the no-load mutual funds.
back in the day funds for me:

- Kaufmann
- 20th century (growth, discovery, international small cap)
- oberweis regular and microcap
- heartland value and microcap
- Templeton emerging markets (quite possibly the worst performing equity fund I ever had)
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Re: "Why those highly paid pros do worse than a boring stock index fund"

Post by afan »

nedsaid wrote: Sun Oct 25, 2020 2:02 pm
afan wrote: Sun Oct 25, 2020 1:08 pm
nedsaid wrote: Sun Oct 25, 2020 12:04 am The other thing is that the competition has gotten better and the markets have been becoming more efficient.
Do you know of data to support this?
How were they defining and measuring market efficiency?
The data on relative performance of active investors compared to indexes was compiled before index funds came into existence. In fact, these data were the motivation for creating the funds.

Transaction costs have come down, but if anything, this should have helped the active managers, who trade more.

Other than that, I don't know how one would even define more efficient.
You could start with Larry Swedroe's Incredibly Shrinking Alpha, he has posted articles that discusses this, you don't necessarily have to buy the book to get the gist of his arguments. One indicator of market efficiency is the failure of the long/short 130/30 funds. It ought to be like shooting fish in a barrel being long the "good" stocks and short the "bad" ones but in real life it didn't work that way. Another clue are the tribulations of QSPIX, AQR Style Premia Alternative Fund, which had a promising start but which has since floundered. You also would think that as more assets are passively managed that you would see more active funds beating the benchmarks, I am pretty sure we aren't seeing this. Yet another line of evidence is that most Hedge Funds have rather mediocre returns.

Below is the link to Larry's article.

https://www.wealthmanagement.com/invest ... king-alpha
These are a few of the innumerable papers that provide evidence of market efficiency.

I was more interested in the idea the the market has become "more" efficient over time.


Evidence that active managers underperform, alone, does not address a change over time. As far as I can tell, active managers have ALWAYS underperformed compared to the indexes. That is hardly new, or surprising.

But when academics talk of market efficiency, I don't know of any definition of a figure of merit one could use to compare market efficiency now to some time in the past.

Having advanced degrees and high intelligence among active managers does not tell us anything about market efficiency. Even approaching the question requires a huge amount of clean data. Free of the usual biases. Also requires accounting for multiple dimensions of risk. I don't know of any commonly accepted measure of the degree of efficiency, so I don't know how one could determine it to be higher or lower today.

Academics have been pointing out market efficiency for decades. That certainly is not new.
We don't know how to beat the market on a risk-adjusted basis, and we don't know anyone that does know either | --Swedroe | We assume that markets are efficient, that prices are right | --Fama
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Re: "Why those highly paid pros do worse than a boring stock index fund"

Post by nisiprius »

Similarly with what uncorrelated said, if you take risk into account, compared to an S&P 500 or Total Stock Market fund, the Federated Hermes Kaufmann Small Cap R (FKKSX) had meaningfully higher risk, in terms of both volatility (Stdev) and maximum drawdown. It only has the slightest advantage in terms of risk-adjusted return. Almost all of the extra return is just reward for additional risk taken.

Source

Image
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Re: "Why those highly paid pros do worse than a boring stock index fund"

Post by afan »

For example, 12 years ago Kenneth French titles his address as president of the American Finance Association "The Cost of Active Investing". He estimated the total amount of money spent annually on active management in the US and calculated how much more money investors would have collectively if they switched to index funds.

This was a new way of looking at it, aggregate across the entire economy, but the insight that active management is a losing strategy was well accepted decades before.

I just don't see a record of the old days when active management was effective to compare to today.

It has always been a losing proposition.
We don't know how to beat the market on a risk-adjusted basis, and we don't know anyone that does know either | --Swedroe | We assume that markets are efficient, that prices are right | --Fama
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Re: "Why those highly paid pros do worse than a boring stock index fund"

Post by Taylor Larimore »

afan wrote: Sun Oct 25, 2020 3:42 pm For example, 12 years ago Kenneth French titles his address as president of the American Finance Association "The Cost of Active Investing". He estimated the total amount of money spent annually on active management in the US and calculated how much more money investors would have collectively if they switched to index funds.

This was a new way of looking at it, aggregate across the entire economy, but the insight that active management is a losing strategy was well accepted decades before.

I just don't see a record of the old days when active management was effective to compare to today.

It has always been a losing proposition.
Afan:

You are correct. Active management has always been a losing proposition. Nobel Laureate Wm. Sharpe explains:

The Arithmetic of Active Management

Best wishes
Taylor
Jack Bogle's Words of Wisdom: "Selecting funds that will significantly exceed market returns, a search in which hope springs eternal and in which past performance has proven of virtually no predictive value, is a loser’s game.”
"Simplicity is the master key to financial success." -- Jack Bogle
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abuss368
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Re: "Why those highly paid pros do worse than a boring stock index fund"

Post by abuss368 »

Taylor Larimore wrote: Tue Oct 20, 2020 2:28 pm Bogleheads:

Michael Edesess at MarketWatch has written an article explaining why professional investors do worse than a simple total market index fund:

https://www.marketwatch.com/story/why-t ... eid=yhoof2

Best wishes.
Taylor
Jack Bogle's Words of Wisdom: "Total market indexing is the gold standard. Anything else, like sector investing, is a dilution of that standard."
Hi Taylor -

I have learned this over the years for sure!

I can think of two excellent examples:

* Bill Miller of Legg Mason

* Bruce Berkowitz of Fairholme Funds
John C. Bogle: “Simplicity is the master key to financial success."
garlandwhizzer
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Re: "Why those highly paid pros do worse than a boring stock index fund"

Post by garlandwhizzer »

alex_686 wrote: ↑Sat Oct 24, 2020 9:05 pm

Underperformance of active funds relative to index funds is due mostly to fees. The article also discusses smart beta.
Which is why the title is false. The average active equity portfolio manager beats their index by 1.2%. There is a correlation between a portfolio manager’s compensation and their return. They do better, not worse.

Nedsaid replied:

That does nor mean you get to see that return. Fees, both explicit and implicit runs around 1.4%. There are other issues.
Active management can work, if you get the fees low enough. I do question how the average active portfolio manager can beat their index by 1.2%, do you have a source? What I don't question is that good managers can beat the market but Alpha of just 0.2% or 0.3% a year isn't easy to generate.
1+ to nedsaid's comments.

I simply do not believe the average active manager beats his appropriate index by 1.2% before fees regardless of what the article says. I would very much like to see the source of that article. As nedsaid wrote, alpha of 0.2% - 0.3% is difficult to achieve consistently for anyone. If there is such a source my suspicion is that it comes from someone with a financial interest in active management and that its content is based much more on marketing than on reliable facts. Regardless of that, after cost returns is the only thing that is important to investors. The active management fees allow those who create and market such funds to retire rather quickly and very comfortably, not the investors who buy the funds. Active management has to say something to stem the massive outflow of money from active management and into index funds. If active managers as a group truly outperformed the money flow would be going the other way. After sufficient exposure to high cost fund underperformance most of us learn that low cost broadly diversified index investing is a better option. Index investing isn't where most investors start. They start out trying to beat the market. They listen to active managers who yell, "Don't settle for average." William Sharpe at Stanford demonstrated the reliable mathematical fallacy of that argument and won the Nobel Prize.

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Re: "Why those highly paid pros do worse than a boring stock index fund"

Post by texasdiver »

alex_686 wrote: Sat Oct 24, 2020 9:05 pm
nedsaid wrote: Sat Oct 24, 2020 8:15 pm Underperformance of active funds relative to index funds is due mostly to fees. The article also discusses smart beta.
Which is why the title is false. The average active equity portfolio manager beats their index by 1.2%. There is a correlation between a portfolio manager’s compensation and their return. They do better, not worse.

That does nor mean you get to see that return. Fees, both explicit and implicit runs around 1.4%. There are other issues.
Do you have a source for this assertion? Is this one of those things where they ignore dividends in the index but not in the analysis of investment returns?

Because I seriously doubt that if we looked at the returns of all the actively managed mutual funds in a category, that the median fund on that list would exceed the index by 1.2 percent.
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Re: "Why those highly paid pros do worse than a boring stock index fund"

Post by alex_686 »

texasdiver wrote: Tue Oct 27, 2020 8:51 pm Do you have a source for this assertion? Is this one of those things where they ignore dividends in the index but not in the analysis of investment returns?

Because I seriously doubt that if we looked at the returns of all the actively managed mutual funds in a category, that the median fund on that list would exceed the index by 1.2 percent.
I have collected many over the years. Here is a place to start: Challenging the Conventional Wisdom on Active Management: A Review of the Past 20 Years of Academic Literature on Actively Managed Mutual Funds

https://www.tandfonline.com/doi/full/10 ... 19.1628555

Note, there are many ways to cut the pie here. Some managers claim narrower focus than a broad index. Plus there are hedge funds, SEP accounts, etc.

As for the median, gross returns (before net) that is about what it has to be. Look at the cost structure of running a active fund, which is often north of 1%. Look at their long term history. They underperform their passive funds on a net basis, but not by 1%.
Former brokerage operations & mutual fund accountant. I hate risk, which is why I study and embrace it.
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Re: "Why those highly paid pros do worse than a boring stock index fund"

Post by rascott »

I have a couple active funds in my 401k that have very impressive track records back to the 80s. They are of course large cap growth funds (Contafund and Harbor Capital Appreciation). The 2nd one is very concentrated, only has about 56 holdings..... and has been blowing the doors off of even the LCG index in recent times.

Both these funds have relatively low ERs for active mgmt (0.6% or less) and are certainly tempting with their long track records.
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Re: "Why those highly paid pros do worse than a boring stock index fund"

Post by GoldenGoose »

If active funds are worse than passive index funds then what is better than 100% passive index funds?
alex_686
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Re: "Why those highly paid pros do worse than a boring stock index fund"

Post by alex_686 »

GoldenGoose wrote: Wed Oct 28, 2020 11:56 am If active funds are worse than passive index funds then what is better than 100% passive index funds?
I am assuming that this is a legitimate question.

Active funds are not automatically worse than passive funds. The problem is selecting a manager that will bring value greater than their fees. This is a forward looking processes and is darn hard. Having done this professionally I can say that the better use of your time is selecting individual stocks - more bang for your buck.

Next, not all indexes are of high quality. Some are actually second rate and have exploitable issues. The classic examples are small cap and emerging markets, and almost all bond indexes. Securities in indexes must be "investable", meaning that index funds can buy and sell large blocks of shares quickly. This eliminates large swaths of the investable universe from indexes. Skilled managers can do well here.

Lastly, you want to select a portfolio that maximizes your chances of meeting your goal. The standard 3 fund portfolio is a one size fits all and may not fit your perfectly. Note, the 3 fund portfolio is darn efficient and does a excellent job. You need to a pretty odd edge case out there - and they do exist.
Former brokerage operations & mutual fund accountant. I hate risk, which is why I study and embrace it.
GoldenGoose
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Re: "Why those highly paid pros do worse than a boring stock index fund"

Post by GoldenGoose »

@alex_686, why wouldn't it be a "legit" question. I and many others want to do better than the proverbial "average index return", but it seems everytime alternatives to the index investing are proposed, they are quick to be shot down because you can never beat index investing, according to some of the die-hard BH-ers on this forum.
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Re: "Why those highly paid pros do worse than a boring stock index fund"

Post by afan »

I may want a unicorn. That does not mean such creatures exist.

If you deviate from the market by holding active funds, you create the possibility of having different returns. These differences will reflect a combination of luck, good or bad, and expenses. The luck will be random and you may benefit or lose. The expenses will always be a negative factor. These effects compound. Day after day and year after year you are hoping to get lucky enough to overcome your expenses. The odds are that your active portfolio underperform the broad market index funds will increase as time goes by.

"The arithmetic of active management"
"Luck vs skill in the cross section of mutual fund returns"
And the cost of active management paper I cited above are good places to start if you want to read the objective data on this question.
We don't know how to beat the market on a risk-adjusted basis, and we don't know anyone that does know either | --Swedroe | We assume that markets are efficient, that prices are right | --Fama
alex_686
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Re: "Why those highly paid pros do worse than a boring stock index fund"

Post by alex_686 »

GoldenGoose wrote: Thu Oct 29, 2020 4:06 am @alex_686, why wouldn't it be a "legit" question. I and many others want to do better than the proverbial "average index return", but it seems everytime alternatives to the index investing are proposed, they are quick to be shot down because you can never beat index investing, according to some of the die-hard BH-ers on this forum.
I think that you have answered your own question. There are a few trolls on Bogleheads. I am one of the few Bogleheads that moderately advocates for advisors and active funds. Do-It-Yourself is not for everybody, active management can bring value.
Former brokerage operations & mutual fund accountant. I hate risk, which is why I study and embrace it.
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Re: "Why those highly paid pros do worse than a boring stock index fund"

Post by dml130 »

rascott wrote: Wed Oct 28, 2020 10:30 am I have a couple active funds in my 401k that have very impressive track records back to the 80s. They are of course large cap growth funds (Contafund and Harbor Capital Appreciation). The 2nd one is very concentrated, only has about 56 holdings..... and has been blowing the doors off of even the LCG index in recent times.

Both these funds have relatively low ERs for active mgmt (0.6% or less) and are certainly tempting with their long track records.
Looks to me like the Harbor Capital Fund is pretty similar to qqq, though just eyeballing the 10 year performance, it looks like it might lag qqq's performance a bit.

I do like the idea of mutual funds and have a couple, but (as noted in this thread), it seems like most of the time the opportunity to beat the market doesn't pan out in practice.

At least for those who are tempted to try it, it's a less risky endeavor than stock picking on your own, for the majority of people.
GoldenGoose
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Re: "Why those highly paid pros do worse than a boring stock index fund"

Post by GoldenGoose »

afan wrote: Thu Oct 29, 2020 6:07 am I may want a unicorn. That does not mean such creatures exist.

If you deviate from the market by holding active funds, you create the possibility of having different returns. These differences will reflect a combination of luck, good or bad, and expenses. The luck will be random and you may benefit or lose. The expenses will always be a negative factor. These effects compound. Day after day and year after year you are hoping to get lucky enough to overcome your expenses. The odds are that your active portfolio underperform the broad market index funds will increase as time goes by.

"The arithmetic of active management"
"Luck vs skill in the cross section of mutual fund returns"
And the cost of active management paper I cited above are good places to start if you want to read the objective data on this question.
No question here reg active vs passive and how fees and churning more than likely sink the return of active as compared to passive. And the higher risk you take the more luck involves. No doubt. Just want to know if there is an investing strategy that has a more than 60% or higher chance of beating that assuming return of passive index investing.
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Re: "Why those highly paid pros do worse than a boring stock index fund"

Post by garlandwhizzer »

GoldenGoose wrote:

Just want to know if there is an investing strategy that has a more than 60% or higher chance of beating that assuming return of passive index investing.
If you find that, please share it with us on the Forum. It's safe to say that many are looking for such a strategy and very few are finding it. If many attempt such strategies it is very likely that a small percentage will succeed. A random distribution of results produces both winners and losers. For those that do succeed in outperforming cheap passive investing over a given time frame, two further questions emerge. One, was that success just luck rather than skill? Two, is it reproducible going forward as both the market and the economy change and evolve?

Odds of finding a consistent long term winner and overcoming the increased costs of a non-passive approach are slim but not zero. If you're playing the probabilities it makes sense to go with passive. If you're confident that you have some special insight in excess of the market's insight, you can give it a try but keep in mind that most who choose that path wind up underperforming.

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afan
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Re: "Why those highly paid pros do worse than a boring stock index fund"

Post by afan »

GoldenGoose wrote: Fri Oct 30, 2020 7:36 am
afan wrote: Thu Oct 29, 2020 6:07 am I may want a unicorn. That does not mean such creatures exist.

If you deviate from the market by holding active funds, you create the possibility of having different returns. These differences will reflect a combination of luck, good or bad, and expenses. The luck will be random and you may benefit or lose. The expenses will always be a negative factor. These effects compound. Day after day and year after year you are hoping to get lucky enough to overcome your expenses. The odds are that your active portfolio underperform the broad market index funds will increase as time goes by.

"The arithmetic of active management"
"Luck vs skill in the cross section of mutual fund returns"
And the cost of active management paper I cited above are good places to start if you want to read the objective data on this question.

No question here reg active vs passive and how fees and churning more than likely sink the return of active as compared to passive. And the higher risk you take the more luck involves. No doubt. Just want to know if there is an investing strategy that has a more than 60% or higher chance of beating that assuming return of passive index investing.
For a while, people thought they could beat the market on a nominal basis, before accounting for risk, by tilting toward small cap value. That has not worked for a long time now. No one knows whether it was just a string of luck that ran out, a compensation for risk but the risk has declined, or whether it was really a reliable anomaly.

It never worked when adjusting for risk.

Since the deviations from the market return are due to chance, you are asking whether there is a way to produce a 60% chance of making a coin come up heads. "Not with a fair coin."

If you can get some legal inside information, convince someone to pay you more for stocks than they are selling in the market or otherwise move the odds in your favor, then maybe you can get that 60% chance.

If you can get people to pay you 1% of assets to try to beat the market, then you make money on the fees, even if your investments underperform.

Absent those advantages, then no. There is no reliable way to beat a fair coin.
We don't know how to beat the market on a risk-adjusted basis, and we don't know anyone that does know either | --Swedroe | We assume that markets are efficient, that prices are right | --Fama
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