my response to the Grantham interview on efficient markets

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my response to the Grantham interview on efficient markets

Post by larryswedroe »

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ddb
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Re: my response to the Grantham interview on efficient marke

Post by ddb »

Good blog post, Larry, but I'm surprised to see you quote Thaler!
As a final point about exploiting market inefficiencies, consider the following about University of Chicago professor Richard Thaler. Thaler is a leading behavioral finance theorist, who studies the very efficiencies Grantham is discussing. In a 2004 Wall Street Journal article, “he concedes that most of his retirement assets are held in index funds. And despite his research on market inefficiencies, he also concedes that ‘it is not easy to beat the market, and most people don’t.’”
I wonder why, then, Thaler is part of Fuller & Thaler Asset Management, which has the following statement directly on its home page:
Investors make mental mistakes that can cause stocks to be mispriced. Fuller & Thaler’s objective is to use our understanding of human decision making to find these mispriced stocks and earn superior returns.
None of us should be surprised that the two retail mutual funds managed by Fuller & Thaler (UBRLX and UBVLX are the institutional share-class versions) have underperformed the best-fit Vanguard funds over the past five years.

- DDB
"We have to encourage a return to traditional moral values. Most importantly, we have to promote general social concern, and less materialism in young people." - PB
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Post by richard »

Thanks for printing the data, which show GMO lagging basic Vanguard funds.
the real question for your investments is whether active managers can exploit inefficiencies and deliver higher returns after expenses
The other real question is whether, even if there are active managers who can beat the market, you can identify them in advance so that you can buy their funds and beat the market yourself.
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Re: my response to the Grantham interview on efficient marke

Post by bob90245 »

ddb wrote:I wonder why, then, Thaler is part of Fuller & Thaler Asset Management, which has the following statement directly on its home page:
Physician, heal thyself. Just goes to show, even behavioral economists, themselves, can suffer from overconfidence.
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Post by larryswedroe »

bob
Being cynical one might say Thaler KNOWS he is unlikely to beat the market but he makes a lot of money off of investors if he pretends he is likely to do so
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Re: my response to the Grantham interview on efficient marke

Post by saurabhec »

ddb wrote:None of us should be surprised that the two retail mutual funds managed by Fuller & Thaler (UBRLX and UBVLX are the institutional share-class versions) have underperformed the best-fit Vanguard funds over the past five years.

- DDB
In fairness his firm only sub-advises those funds, they have ~$75 million in AUM, which is probably not even 5% of the total funds managed by the firm.
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Post by dbonnett »

Vanguard makes the same claim for their active (quant) funds. Admit that it is difficult to beat the market and try anyway. John Bogle also mentioned his interest in active, low cost, low turnover funds.
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Post by uncleJohn »

Larry's point is well taken but.........

--perhaps a comparison over a longer time horizon is more appropriate given GMO Strategies do tend to lag in bull markets and then hold up better in down markets--exactly when investors need it the most. Furthermore, using the The GMO Global Balanced Asset Allocation Strategy (with more than 20 years of actual historical returns and whose record is clearly measured and available on their website) is probably a better proxy for the firm's full capabilities--not some randomly chosen specific asset classes.

I'm not saying they are the end-all of investment management. First Eagle and IVA are clearly more eclectic and successful managers but GMO is not a bad alternative in a closet-indexing comparison.

I understand the arguments for and against.....I'm just saying give a wee little credit where some is due. Heck--I only discovered them ten years ago, not 20, but they sure have saved me a TON of capital in the last decade.
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Post by larryswedroe »

unclejohn
The problem with that approach is the following

Succesful active management contains the seeds of its own destruction as new cash flows lead to higher trading costs and that increases hurdle of outperformance--one of the main reasons you don't see persistent outperformance----even if there is skill it gets overcome by costs

(See Jonathan Berk's excellent paper--The 5 Myths of Active Investing)
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Post by stratton »

A couple of years ago their global inflation linked bond fund couldn't have done a "better" job of getting low returns. They overweighted the countries that did the worst and underweighted the best performing ones. Trialed the benchmark by several points.

Paul
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Post by uncleJohn »

There is no doubt they are not perfect....however, the argument about size in the Global Balanced Allocation is nearly moot given the fund of funds structure of the fund.

I'll give you this, the 250 or so bps of outperformance after fees over the last 20+ years is probably better explained by their asset allocation bets rather than manager skill at the security level....one might even argue (more successfully) that given bond outperformance relative topequities over the time mentioned--a slightly more conservative allocation won by default! --hence--no manager skill.
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Post by ddb »

uncleJohn wrote:GMO Strategies do tend to lag in bull markets and then hold up better in down markets--exactly when investors need it the most.
How long will this myth perpetuate. Here's a cut-and-paste of a post I made here on 05/06/09:
[Grantham's] firm, GMO, is the subadvisor for the Evergreen Asset Allocation Fund which is basically a go-anywhere type of fund where they can change the allocation at any time. Presently, the fund is ~50-60% in stocks. So, let's compare the fund (EAIFX, the least-expensive version of the fund) to a static mix of 30% Vanguard Total US Stock (VTSMX), 25% Vanguard Total Int'l Stock (VGTSX), and 45% Vanguard Short-Term Bond (VBISX) (under "Portfolio" column in below table) for the past five years through 2008-12-31, I assume that the passive static portfolio is rebalanced annually to the starting allocation.

Image

So, thanks to all of the things that were so obvious to Grantham beforehand, he managed to underperform a moderate-risk static allocation of index funds over the past five years, while taking on slightly more risk. And this is for the institutional share class for which no retail investor would qualify. Add the expenses of pricier share classes, and the results are even worse.
I am amused that your first two posts here are in defense of GMO - it's almost as if you search Google to look for negative comments about GMO, then joined the forum just for the purpose of propping them up. Definitely suspicious!

- DDB
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Re: my response to the Grantham interview on efficient marke

Post by jeffyscott »

larryswedroe wrote:the real question for your investments is whether active managers can exploit inefficiencies and deliver higher returns after expenses.
That is not my question with regard to GMO/Grantham. My question is do their "asset class forecasts" have value?

This: http://www.economist.com/finance/displa ... d=11870287

would appear to indicate that the answer just might be "yes".
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Re: my response to the Grantham interview on efficient marke

Post by ddb »

jeffyscott wrote:
larryswedroe wrote:the real question for your investments is whether active managers can exploit inefficiencies and deliver higher returns after expenses.
That is not my question with regard to GMO/Grantham. My question is do their "asset class forecasts" have value?

This: http://www.economist.com/finance/displa ... d=11870287

would appear to indicate that the answer just might be "yes".
Well, let's say that GMO's asset class forecasts have historically been somewhat accurate - they still haven't been able to use the information to deliver alpha to their investors over the past 5 years (as I kind of showed in the post above). So, if you can't use asset class forecasts to improve portfolio returns, then would you really say that the forecasts have value?

- DDB
"We have to encourage a return to traditional moral values. Most importantly, we have to promote general social concern, and less materialism in young people." - PB
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Re: my response to the Grantham interview on efficient marke

Post by jeffyscott »

ddb wrote: So, if you can't use asset class forecasts to improve portfolio returns...
Why do you make that assumption? Why wouldn't one who had adjusted their portfolio based on these forecasts have improved their returns?
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Re: my response to the Grantham interview on efficient marke

Post by ddb »

jeffyscott wrote:
ddb wrote: So, if you can't use asset class forecasts to improve portfolio returns...
Why do you make that assumption? Why wouldn't one who had adjusted their portfolio based on these forecasts have improved their returns?
What I'm saying is that even GMO was unable to use the information to improve portfolio performance.

Two issues here:

1. Can future returns be predicted?
2. If so, can you use predicted returns to improve performance?

I think the answer to (1) is no, which renders (2) irrelevant. But, GMO DID successfully predict returns (might be luck, might be skill), and was still unable to improve portfolio performance. So what makes you (general "you") think you will be different?

- DDB
"We have to encourage a return to traditional moral values. Most importantly, we have to promote general social concern, and less materialism in young people." - PB
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Re: my response to the Grantham interview on efficient marke

Post by Sunny Sarkar »

Getting a "broken link" message from the website. Says:
Oops... Blog Not Found

We're sorry, the blog you requested could not be found.
Broken Link

You might have used an out-dated bookmark or typed in that URL incorrectly
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Post by Adrian Nenu »

http://www.gurufocus.com/news.php?id=58284

Jeremy Grantham Morningstar Interview Videos

Just in case anyone missed it.

Adrian
anenu@tampabay.rr.com
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Post by uncleJohn »

Not sure what is suspicious about facts.....

ddb's comparison is selectively worse than Larry's....copied below is GIPS compliant performance of the strategy since inception (6/30/88) and net of all fees:

Average Annual Total Return (Net) in USD as of 05/31/2009

1 Year 3 Year 5 Year 10 Year Inception
Strategy -13.73 -0.21 4.52 7.05 9.73
Benchmark -21.77 -2.26 2.10 2.32 7.66
Value Added 8.04 2.05 2.42 4.73 2.07
Index -21.85 -2.24 2.10 2.13 7.84

And Risk Characteristics:

From 06/30/1988 Through 03/31/2009
Strategy Benchmark
Alpha 3.32 0.00
Beta 0.78 1.00
R-Squared 0.85 1.00
Sharpe Ratio 0.63 0.26

Just saying---compare apples to apple. I'll be the first to tell you that 95% of all active management is, indeed, doomed to failure. And I certainly did not identify GMO back in 1988 (only in 1999). I'm just saying that Jeremy Grantham is certainly worth listening to for his wisdom and experience. Heck, Bogle even referenced him in his 1999 Common Sense book.

Now--whether his forecasts will add value or not cannot be known in advance (by ddb or by Larry or by anyone for that matter). I certainly would not be betting the farm on their strategy, but---they are worth reading more than most things out there. Just another source of information making markets more efficient, not unlike Larry himself, this forum, or any other information source.
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Post by ddb »

uncleJohn wrote:Not sure what is suspicious about facts.....

ddb's comparison is selectively worse than Larry's....copied below is GIPS compliant performance of the strategy since inception (6/30/88 ) and net of all fees:

<performance and risk info suppressed>
UncleJohn:

Can you please provide more information about the data you posted? Specifically, a source, what you mean by "the strategy", what the benchmark is, etc.

Thanks!
DDB
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Re: my response to the Grantham interview on efficient marke

Post by diasurfer »

ddb wrote:But, GMO DID successfully predict returns (might be luck, might be skill), and was still unable to improve portfolio performance. So what makes you (general "you") think you will be different?

- DDB
Larry already gave us a reason this could be possible in this thread. In your 5 year performance numbers, GMO outperforms in 2004 and 2005, leading to ...
larryswedroe wrote: Succesful active management contains the seeds of its own destruction as new cash flows lead to higher trading costs and that increases hurdle of outperformance--one of the main reasons you don't see persistent outperformance----even if there is skill it gets overcome by costs
An individual using GMO's forecasts is not going to have this problem. Active managers face a different set of challenges that individuals using indices.

I'm not saying this is what happened, I'm just saying it's possible.
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Post by larryswedroe »

sunny
That problem should now be fixed
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Post by mbrasher1 »

larryswedroe wrote:unclejohn
Succesful active management contains the seeds of its own destruction as new cash flows lead to higher trading costs and that increases hurdle of outperformance--one of the main reasons you don't see persistent outperformance----even if there is skill it gets overcome by costs
I recall William Bernstein's description of the most storied mutual fund manager -- Peter Lynch. His tenure at Magellan started when the fund was the private investment vehicle for Fidelity's founder and his family. It was only opened to the public for 9 years. The best returns were to be found when it was small, obscure, and the average investor could not participate. When it was opened to the public and the Fidelity PR machine went to work, Magellan received huge inflows that Lynch was able to invest, but not as profitably as before, when he was mostly covering small caps. He barely beat the market during this time.

It is from the Four Pillars of Investing -- pages 91-3.
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Post by larryswedroe »

Re Lynch
If my memory serves his alpha when public was still large but was basically eroding as time went on and IMO he got out knowing the cash flows would likely swamp any alpha he could generate (assuming was skill)
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Post by gw »

larryswedroe wrote:bob
Being cynical one might say Thaler KNOWS he is unlikely to beat the market but he makes a lot of money off of investors if he pretends he is likely to do so
One hardly needs to be a cynic to reach that conclusion.

Good on ya, ddb.

(And nice blog post, Larry.)
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Post by uncleJohn »

ddb:

The information is available at GMO's website. Free registration, Strategies and Performance, Global Balanced Asset Allocation, Annual Returns and Risk Characteristics.

Been reading everything GMO has written for years now, along with Diehards, along with Larry, along with Rick, along with Bogle, along with Buffett, along wtih Peter Bernstein, along with Jean Marie Evelliard, along with Charles de Vaulx, along with French, along with Fama, along with Swenson, along with Marty Whitman, along with some others I don't care to mention.

Come to thing of it--I haven't missed much. And there is pretty much nothing I haven't seen or heard before.

Indexing will, no doubt, outperform 95% of active managers.
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Post by Robert T »

.
Personally, I don’t think Grantham uses an apples-to-apples comparison with his benchmark choice. For example – the stated benchmark for the GMO Global Balanced Asset Allocation fund is 65% MSCI ACWI:35% Barclays US Aggregate Bond. So he’s comparing a fund that has historically had a value tilt with a total market benchmark – then seems to call the difference (which has been about 2 percent per year since inception) GMO ‘value added’. IMO the GMO fund should be compared to a value tilted benchmark.

FWIW - if I compare my globally diversified small cap and value tilted 75:25 stock:bond index fund portfolio with a 75% MSCI ACWI:25% Barclays US Aggregate Bond benchmark since my portfolio inception at start of 2003, I get a 2.6% annualized out-performance. No ‘value-added’ or ‘alpha’ just a small-cap and value tilt – and the return difference disappears if compared to a similarly tilted benchmark.

Robert
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Post by larryswedroe »

this false benchmark issue is how so many have claimed outperformance over the years.
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Post by uncleJohn »

Larry and Robert,

The analysis about the benchmark is spot on. It is quite easy to look good if you change the benchmark to one's liking.

What do they say, "One man's alpha is another man's beta." : )

So if one did some real attribution analysis, he/she could argue that maybe the returns could have been replicated in a passive way.....maybe.....today.....maybe not starting in 1988. Again, the real point of my post wasn't so much about whether GMO owned the Holy Grail--just that there are infinitely worse things one could have done than to follow their asset allocation advice. And I still think he is worth reading, among others.
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Post by ddb »

uncleJohn wrote:Larry and Robert,

The analysis about the benchmark is spot on. It is quite easy to look good if you change the benchmark to one's liking.

What do they say, "One man's alpha is another man's beta." : )

So if one did some real attribution analysis, he/she could argue that maybe the returns could have been replicated in a passive way.....maybe.....today.....maybe not starting in 1988. Again, the real point of my post wasn't so much about whether GMO owned the Holy Grail--just that there are infinitely worse things one could have done than to follow their asset allocation advice. And I still think he is worth reading, among others.
I'm kind of at a loss for how to analyze their returns. I ran the monthly returns since July 1988 through a regression analysis against the FF 3-factor model, and the model was a terrible fit (R-squared of less than 0.2). When I shortened the time period to last 10 years and even last 5 years, the model was still a terrible fit. So where to go from there? I guess we could just look at simply the Sharpe ratio, but that's not very interesting!

Of course, even if somebody shows that there WAS outperformance, I'd attribute it to luck rather than skill, so maybe it's a pointless exercise!

- DDB
"We have to encourage a return to traditional moral values. Most importantly, we have to promote general social concern, and less materialism in young people." - PB
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Post by Russell »

Good morning!
ddb wrote: I'm kind of at a loss for how to analyze their returns. I ran the monthly returns since July 1988 through a regression analysis against the FF 3-factor model, and the model was a terrible fit (R-squared of less than 0.2).
I just updated my online FF tool with the annual data from 1989 through 2008 (a little coarser, I know) -- and it did alright. All are welcome to click and try it, but here's a summary of the results for a 1 and 3 factor fit:

Code: Select all

       1 factor            3 factor
       -------             -------
alpha  2.98 [+/-1.596]     2.44 [+/-1.434]
beta   0.48 [+/-0.080]     0.49 [+/-0.072]
hml    ----                0.13 [+/-0.089]
smb    ----                0.18 [+/-0.115]
r^2    0.665               0.765
The +/- are the standard errors -- as a reference, statisticians generally require results to be two standard errors away from zero to classify as significant.

Best, Russell
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Post by DP »

Hi,
That is not my question with regard to GMO/Grantham. My question is do their "asset class forecasts" have value?

This: http://www.economist.com/finan....d=11870287

would appear to indicate that the answer just might be "yes".
And this:
http://www.cxoadvisory.com/gurus/Grantham/
would appear to indicate the answer is probably no.

A number of his past predictions are listed, followed by results.
In summary, Jeremy Grantham has a track record for predicting U.S. stock market behavior that is a little below average. Confidence in this conclusion is very low.
FYI, there is a new book out:
The Myth of the Rational Markets; A History of Risk, Reward and Delusion on Wall Street by Justin Fox.

I haven't read it but understand that it descibes the Efficient Market Theory as a myth that is crumbling.

Frankly I agree that markets have inefficiencies, but I also very much agree with Larry's comment:
While the debate rages on about whether the markets are efficient, the real question for your investments is whether active managers can exploit inefficiencies and deliver higher returns after expenses.
The answer to this question is most often no.

Don
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Post by jeffyscott »

DP wrote:And this:
http://www.cxoadvisory.com/gurus/Grantham/
would appear to indicate the answer is probably no.

Once again, I will point out that that site is all about short-term results, this is not the purpose of their forecasts and has nothing to do with their forecasts. The forcasts are just a way of presenting relative valuations.

I agree with the proposition that the stack market is a voting machine in the short term, but a weighing machine in the long term. I'm not one to try to capitalize on the voting aspects, I prefer to wait around for the weighing to take place. So I have no interest or concerns with anyone's short term prediction ability.

Also I will point out that I do not think GMO has some special magic, they merely choose to put their assessment of valuations out there for the world to conveniently see. If Bill B. or Larry (who I understand both believe that one should estimate expected returns) were to do this, I'd look at whatever they presented as well, and I would expect that they would have similar conclusions to GMO, though they'd likely present them differently as they may not assume a return to average valuations in 7 years as GMO does.
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Post by peter71 »

Russell wrote:Good morning!
ddb wrote: I'm kind of at a loss for how to analyze their returns. I ran the monthly returns since July 1988 through a regression analysis against the FF 3-factor model, and the model was a terrible fit (R-squared of less than 0.2).
I just updated my online FF tool with the annual data from 1989 through 2008 (a little coarser, I know) -- and it did alright. All are welcome to click and try it, but here's a summary of the results for a 1 and 3 factor fit:

Code: Select all

       1 factor            3 factor
       -------             -------
alpha  2.98 [+/-1.596]     2.44 [+/-1.434]
beta   0.48 [+/-0.080]     0.49 [+/-0.072]
hml    ----                0.13 [+/-0.089]
smb    ----                0.18 [+/-0.115]
r^2    0.665               0.765
The +/- are the standard errors -- as a reference, statisticians generally require results to be two standard errors away from zero to classify as significant.

Best, Russell
Hmm . . . I give people credit for not responding "don't confuse strategy with outcomes," but to me the jury is still out on all of this stuff . . . I'll personally be surprised if, twenty years from now, the orthodoxy about small and value qua small and value (as opposed to illiquidity, skewness, and perhaps even behavior) hasn't been modified. :D

All best,
Pete
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to simplify........

Post by gadfly888 »

active mng't is a fraud

the mrkt. is always efficient and sometimes irrational

just read and re-read all of Mr. Swedroe's books-

financial media is financial marketing, not education

eat like a monkey and breathe rhythmically........


Gad-
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Post by Russell »

peter71 wrote: I'll personally be surprised if, twenty years from now, the orthodoxy about small and value qua small and value (as opposed to illiquidity, skewness, and perhaps even behavior) hasn't been modified. :D
Gotta agree with you there. Actually, after I wrote that applet, I e-mailed Chensheng Lu to see if he would be willing to share his illiquidity/coskewness data -- I was hoping to build a parallel program for data fitting with his factors . I think that e-mail just vanished into the ether -- I'll have to try him again....
The best material model for a cat is another, or preferably the same, cat. - A. Rosenblueth and N. Wiener (1945).
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Post by jeffyscott »

So you mean that we will soon see posts here saying something like: "why doesn't vanguard going create an illiquid high coskewed index fund?".
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Post by Rodc »

jeffyscott wrote:So you mean that we will soon see posts here saying something like: "why doesn't vanguard going create an illiquid high coskewed index fund?".
That was in the works until all the University endowment funds tanked this past year. :)
We live a world with knowledge of the future markets has less than one significant figure. And people will still and always demand answers to three significant digits.
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