Hi Guys,
The persistence of market excess returns is so rare that it seems to be an illusion.
We constantly search for and mostly fail to discover the Holy Grail of investing. Sure, the law of large numbers sort of guarantees that a small percentage of individual stock pickers and mutual fund managers will generate excess returns relative to a carefully selected benchmark for a year or two. Statistics work to accomplish that outcome. But a major issue is top performance persistence over a longer measurement cycle. On that matter, it appears that the market experts and investment gurus consistently fall short of target goals.
The evidence in that regard is overwhelming. In a recent Wall Street Journal equity analyst survey of institutional entities, awards were granted to superior individual analysts. However, on average, the qualifying cohort as a group statistically underperformed appropriate Indices.
Decades ago, University of California professors reported that individual investors (most likely from the roles of Charles Schwab California clients) underperformed representative benchmarks when they published their findings in “Trading is Hazardous to Your Wealth” and “Boys will be Boys”. The authors of both studies are Brad Barber and Terrance Odean.
Year after year, the market research firm Dalbar annually reports in their Quantitative Analysis of Investor Behavior document that mutual fund investors poorly time the market; they underperform market rewards by a huge percentage. These ambitious traders sell funds that subsequently outperform their replacements. Successful timing is a treacherous business that eludes most investors.
More recently, Morningstar reinforces that same poor timing observation with their own analysis that reveals that individual investors are often late when buying top-ranked fund performers. That finding motivated Morningstar to add their Metals rating system (supposedly forward looking) to their Star rankings (admittedly a rearview mirror analysis). Time will test if the newer Metal ratings enhance the value of the Morningstar service.
At the guru level, CXO Advisory Group has collected accuracy prediction records for scores of famous market gurus over an extended timeframe. Once again, the value-added by these experts is highly questionable. Their accuracy typically ranges from just under 70 % to just over 20 %, with a cohort average that struggles to reach 50 %. That dubious record is no better than a fair coin toss.
A specific illustration of the limitations of self-proclaimed experts to even project market direction trends is provided by a recent CXO study. The study examined the market wisdom of financial newsletters monitored by Mark Hulbert. Hulbert has long reported that a vast majority of these newsletter gurus do not achieve Index-like returns.
Hulbert also likes to address market direction by a formulation that he calls his Hulbert Stock Newsletter Sentiment Index (HSNSI). He considers the HSNSI a contrarian’s signal. The composite newsletter judgments are interpreted as characteristically wrong. Here is the Link to the CXO statistical assessment of HSNSI:
http://www.cxoadvisory.com/3265/sentiment-indicators/mark-hulbert/#more-3265Anecdotally, I just returned from the Las Vegas MoneyShow conference. The selling of financial services and eloquent computer programs services are major components of that meeting. Access to computer programs that give the user a trading advantage with instantaneous data updates and sophisticated technical analyses tools supposedly award that investor with the edge that he needs for success in this field.
However, an economist at these sessions warned that the promises most likely exceed that which is delivered or deliverable. He cautioned to keep our hands away from our wallets. That was probably the best advice offered at the conference.
Hedge Fund structures have sold their services since the 1940s. According to common wisdom, Hedge Fund management is populated with the smartest, the inventive, and the most resourceful folks in the financial universe. Even under this purportedly superior management, the Hedge Fund survival rate is dismal.
The Federal Reserve has studied their hazard rate (their probability of failure). The Fed findings do not inspire confidence in the shrewdness of these Hedge fund managers. Their frequency of failure is high and their time to failure is short. Even these megastars of the investment world are victims to market vagaries and fail to successfully navigate it. Risky ventures generate high casualty rates.
Standard and Poor’s studies demonstrate the same expert shortcomings. S&P measures expert performance with their Standard & Poor's Indices Versus Active (SPIVA) studies and their Persistence Scorecard studies. They just released their mid-year Persistence Scorecard. Current results are generally inline with earlier findings. Here is the Link to that work:
http://www.spindices.com/assets/files/spiva/sp-persistence-scorecard-june-2012.pdfEnjoy this latest edition of the Persistence Scorecard. By delving just a little into the weeds of the S&P Persistence scorecard you will identify some fund categories that travel more persistent roads then others. The nuggets are waiting to be discovered with some digging.
At the broadest echelon of interpretation, the S&P Persistence scorecard constantly challenges the industry assertion that skill outcomes dominate over pure luck.
Once again, the current scorecard statistically shows that performance persistence over 3 and 5 year periods do not even match those expected from a normally distributed Bell curve by random chance alone. That’s sad. Why? Most likely these skillful and well trained fund managers can not overcome the drag of trading and management costs. As John Bogle never tires of reiterating, costs matter greatly. Luck is never a lady.
I use two S&P reports (the SPIVA and the Persistence scorecards) to annually shift my portfolio incrementally. I like to contrast the present reports with the last few releases to see if any trends are being established or abandoned. It’s a dynamic world within the competing active and passive mutual fund management options.
The many references that I cited tell a consistent and disappointing story.
A formidable array of market experts, practicing professionals, and fortunetelling gurus fail to capture the economic winds beyond the accuracy level that a simple coin-toss can do. If these insiders really made truly independent judgments, from “The Wisdom of the Crowd” studies, one would anticipate a better outcome.
That does not occur because the total of expressed opinions are not independent assessments, but rather a produce of group-think. The experts invariably exchange their views before formulating their recommendations, thus diminishing the value of their forecasts by compromising its independence.
Whenever statistical data are used for explanatory purposes, non-mathematically inclined folks are often skeptical. The doubters tend to accept the premise that “the data were sufficiently tortured to secure a confession”. That does happen. To address that reservation, I specifically included a host of findings from studies conducted by a diverse set of financial institutions and professionals. It makes the posting much longer, but I hope more convincing.
On a personal level, numerous superstars often demonstrate their own market madness. John Maynard Keynes was the most influential economist of the 20th century and a successful market trader. Keynes became rich several times. Still, he did not foresee the Great Crash in the late 1920s and was nearly bankrupted by it.
Lord Keynes recovered and died a wealthy and renown economist. He wrongly said in 1926: “We will not have any more crashes in our time”. Even Worldly Philosophers of the first rank make investment missteps. There are many such personal stories of failure, redemption, and even failure again in some instances. Keynes equated the stock market to a casino or a game of chance, completely unpredictable.
The obvious bottom-line conclusion is that experts are just as prone to decision-making debacles and forecasting errors as the private investor is. The absence of persistent superior outcomes from these wide ranging surveys of money managers pervasively proves, that from a statistical perspective, luck trumps skill when making investment decisions. And luck fads quickly. Skilled financial managers are a myth except in very rare exceptional cases.
What to do? Be more self-reliant and trust yourself. It’s okay to seek and listen to the chorus of financial professionals. At bottom, that helps to establish a baseline. In the end however, you must make the final decisions. Most assuredly you are not the smartest or the best informed person in the room. But just as assuredly, you are the smartest and the best informed concerning your private circumstances, your goals, your current portfolio, your health, your risk aversion status, and your comfort zone.
So be your own decision maker and do not blindly accept the gospels preached by the assembly of false wizards. The record clearly does not support their exaggerated claims to fame.
But life and the marketplace goes on. Sadly, in my personal search for market guidance, from an early U2 song (in their Joshua Tree album): “ I still haven’t found what I’m looking for”. Perhaps it doesn’t exist, but I continue the march.
I encourage you to do the same. Stay the course; always run the race through the finish line in full stride.
Best Regards.
Comments
Always enjoy reading your interesting perspectives.
I'm afraid I don't know how to pick funds other than by past results.
I'm not privy to insider info on new products, who's closing what plants,
etc. I simply go by a fund having stayed in the top 25% of its class for the
past 1 yr, 3 yr, 5 yr, and if available, 10 yr periods (rolling periods). I reevaluate
quarterly and if the 1 year performance drops below 25%, I begin dc'ing out. I also "time" the market, using 200 day moving averages to trigger a dc-ing approach regardless of the rankings.
Looking at M* performance data for funds in the upper quarterile during those times, I find that my watch list contains about 100 funds (top 1/4 for those older than 5 years; a lesser number for older than 10 years (mainly because those were started between 5 and 10 years).
I'll give a list of FSCRX, funds I own in this category: PRNHX, PONDX, VILLX, PRMTX, LEXCX, AFSAX, VWINX, VFICX, MXXVX, FSCRX, PTSGX, MAPIX, PIPDX, PIXDX, and PETDX.
Because I am unable to pick funds in a better fashion, what am I missing? How would
you suggest that I pick funds?
Incidently, VFINX, VIGRX, and VTSMX are index funds in the top 1/4 in the5 year group.
Thanks for your comments
Zolta
Look at Paulson, who made one of the most successful bets of all time, then has had an awful couple of years since. Paulson didn't get stupid, but maybe after making one of the most successful bets in Wall Street history, investors in the funds - if given the opportunity - maybe should have seen the opportunity to take profits.
The issue with computer-driven trading is that you have hedge funds now literally trying to find prices of wheat in Babylon in order to get that edge over their competition. Hiring weathermen, physicists, etc. I don't think that many of these funds can't keep doing well, but when you are sending researchers to the ends of the Earth to find esoteric data, what's "the next step" when needed to get the edge again, when needed?
"Keynes equated the stock market to a casino or a game of chance, completely unpredictable. "
I've started to agree more with what Mark Cuban said recently, essentially comparing stocks that don't pay dividends to baseball cards.
"More recently, Morningstar reinforces that same poor timing observation with their own analysis that reveals that individual investors are often late when buying top-ranked fund performers. "
When Cramer went on Regis and Kelly and proclaimed CGM Focus to be his favorite fund, I thought that was it for that (and I thought it was rather interesting to sell the most volatile fund on the planet to that audience, but whatever.) Sure enough that was about it.
Hi Zolta,
Thanks for the kind words. I try to inform.
With regard to your specific question, I have no special market insights or uncommon market wisdom. I struggle like everyone else to secure market rewards plus just a little sugar in terms of excess returns. Sometimes I succeed; sometimes I fail to achieve this modest goal. I too have no access to insider-quality information.
I do not own a silver bullet; I suspect very few people of moderate wealth do. There are no secrets buried among us.
I compliment you on your portfolio construction methods. From my perspective, they are rock solid. I use similar techniques myself and have little to offer that might improve on your systematic approach. It is disciplined. That is more than half the battle.
Although our approaches share several similarities, I am genuinely humbled by the breath and scope of your dedication to portfolio management. My efforts pale by comparison. I no longer have the patience to monitor a hundred or so alternative fund options. That task overwhelms me.
From the mid-1950s through the early-1980s, I constantly screened and updated about 150 individual stock candidates to assemble an equity portfolio of roughly 30 positions. The 30-holdings target reflected my interpretation of portfolio diversification as envisioned from Harry Markowitz’s Portfolio Selection studies.
That was an arduous time-consuming task that I abandoned in the early-1980s in favor of a mutual fund dominated program. I have never regretted that decision; today, I do not own any individual stocks whatsoever. Investment decision-making is much easier now.
My current guidelines in fund selection are likely very similar to your rules. Here are a few (probably incomplete) criteria that I follow. In general, I apply a top-down technique and hire fund managers to supply the bottom-up details of the selection process.
I too measure past performance over a range of timeframes as a selection discriminator, the longer the better. I verify manager tenure with that specific fund. Cost containment is a paramount consideration; costs matter greatly, especially when intermediate-term returns are likely to be muted. A small fund size is better to foster agility. The fund family should be large enough to support a sizable and stable cadre of researchers. Also, it must be flexible enough in its policies to permit freedom of fund manager actions, especially to encourage a go-anywhere attitude. I am patient and allow my chosen funds years to test their mettle except under extraordinary circumstances.
I also use a 200-day market moving average to aid in adjusting my overarching portfolio asset allocation. Momentum persists, at least in the short-term (1 year or less by my standards). When making rare portfolio adjustments, I do so incrementally since uncertainty is always a residual restriction regardless of the confidence assigned to any indicator signal. False signals are traps for all traders.
I employ calendar study findings when making my infrequent trades. CXO Advisory Group provides excellent access to a number of such statistical studies that range from suggesting the most rewarding trading days for any given month to the benefits of considering the Presidential 4-year cycle when doing longer range planning. Please visit their site to explore calendar phenomena at:
http://www.cxoadvisory.com/calendar-effects/
Since I have a large, globally diversified portfolio, I also incorporate some broad economic indicators when making minor adjustments to my portfolio on an annual-like basis. The two most fundamental drivers to an established economy are population demographics and productivity growth. For the US, the current historical averages for those two influential factors are 1 % and 2 % per year, respectively. If the US exceeds those expectations, GDP growth rate and corporate profits will respond accordingly. The correlations are reliably positive and statistically tight.
I also loosely watch the Federal Reserve monetary policy trends and biases. I firmly believe in Milton Friedman’s famous statement that “Inflation is always and everywhere a monetary phenomenon.”
Finally I too am skeptical of both financial professionals and amateurs alike. We all are victims of overconfidence, and are more often wrong then right. When the investing public is all in, perhaps it is time to be at least partially out of the market. Public and professional sentiment is definitely a contrarian’s signal.
I make no claims to be more market-wiser than any other investor. I have suffered my fair share of bad investments. I hope I have learned from these experiences. Believe it or not, my bigger hope is that you avoid the missteps that I made and manage to sidestep a few negative outcomes.
I know you will not fail to do better since you are more fully prepared then I was way back in the distant past.
Unfortunately, I must wish you luck since, after over 5 decades of investing experience, my most compelling finding is that skill is a necessary, but not a sufficient, factor to guarantee successful investing. To some extent, we all must be somewhat lucky in this uncertain world.
I do wish you good luck and successful investing.