larryswedroe wrote:Matt first, what I showed you in the returns data that if you ran a regression it would be virtually impossible for it to show alpha. Any value stocks they had in the selection would have had or should have had huge premiums. And any large stocks would also be okay. It is only the small growth stocks that might have led to negative results relative to the benchmark chosen.
Second, if they are truly skilled at active management and are not constrained by asset class then they certainly should beat the market if there are asset classes that did, like value. So their best ideas certainly should have added alpha
Either way the active story in this case anyway really falls apart
The stock picks underperformed the market by 13%. Meanwhile, Small Caps underperformed by 26% and Foreign Stock underperformed by 54%. So it is quite easy to imagine, say, a collection of stocks that is 70% Large Cap, 15% Small Cap, and 15% Foreign Stock. That portfolio would have been assumed to underperform by 12% based on factor analysis for a modestly negative alpha.
How about 50% Large Cap, 40% Small Cap, and 15% Foreign Stock - expected underperformance of 16%. This one would actually have a positive alpha.
40% Large Cap, 40% Small Cap, and 20% Foreign Stock? Expected underperformance of 21%. Huge alpha to only trail by 13%!
So I just showed that it is clearly possible that factor exposure is the cause of the poor performance. You should have the same testing requirements when the argument is in your favor or not, but instead you revert to rationalizing instead of relying on the data. I do not buy the argument that the "best idea" should beat the market regardless of market dynamics. Sometimes the absolute best values in the market decline in value while junk stocks go up (see the tech bubble). And I will just mention the obvious points that a 2-year timeframe is not sufficient to a) measure the success of a single investment or b) measure the success of an investment manager.
I'm also not convinced by the idea that a manager would necessarily put forward his best investment idea as his ideal contest idea. They have different purposes. For example, on the Morningstar Mutual Funds forum mutual fund picking contests, I placed #1 in 2008 and something like #4 in 2009. But I did not actually own any of the funds I selected for those contests because the nature of a contest is to stand out and win on the upside, while the nature of an investment is to both win AND not lose. Again, stock selection, portfolio management, and contest entry are all very different things and the success in one of the three is not necessarily correlated to the other two. I happen to be good at all three, but we can't expect the same of everyone.