It was a different investment community forty years ago. In that hazy past, the odds were that individual investors were mostly trading with each other.
In that yesteryear, private investors executed 70 % of the daily trading volume; institutions accounted for the remaining 30 %. The science or art of investing was very primitive; it was basically dumb, weak money exchanging stocks with equally dumb, weak money. There were remarkable exceptions; these exceptions quickly became rich (and sometimes poor again cyclically).
Today, that structure has been completely reversed and turned on its head. Now the bulk of the trading (like 70 %) is done by smart, strong institutional money. As an individual investor, it is highly likely that if you are trading some equity position, an institution is taking the other side of that gamble.
That trading partner poses a significant threat. Over time, he has become relatively and absolutely a more powerful opponent. His advantages are manifested by his composite unbounded financial resources, his unfettered timeline, his formal educational background dominated by top-tier MBA graduates, his mathematical sophistication especially in the statistical and operations research arenas, his unlimited research time commitment, his supercomputer access, and his sheer numbers.
The institutional participant is a daunting challenge to private investors. It is not a fair or a level playing field. It is something like the championship Baltimore Ravens professional football team competing against a ragtag group of tag football high school part-time players. The outcome is basically predetermined.
In the early 1990s, Peter Lynch published his blockbuster best seller “Beating the Street”. He projected that the “average Joe” could tame the excesses of Wall Street. Lynch ended that exceptional tutorial with 25 Golden Rules for superior investment outcomes. However, even at that earlier date, the private investor was becoming overmatched by the resources and skills of the institutional giants.
Even the legendary Peter Lynch magic was eroding. His major outsized performance was registered in the late-1970s to the mid-1980s. In that glorious period, his firm permitted him to participate in the inefficient small company and foreign company marketplaces. He invested so broadly and prolifically that it was said that Lynch never saw an investment opportunity that he did not like. But the times turned against him in the late-1980s, and he struggled to generate market-like rewards for his now excessively large client base. He salvaged his reputation by retiring in 1990 at age 46 after a few very mediocre years.
Interestingly, Jeff Vinik, Fidelity managements replacement for the departing Lynch, was soon summarily fired in 1996 when he attempted an ill-fated timing rotation to bond positions. Even as early as the 1990s, the major investment houses were clamping down on the freedom of choice prerogatives that were afforded earlier superstars like Peter Lynch. Vinik eventually recovered while launching and managing a highly profitable Hedge Fund operation. He currently owns a host of professional sports franchises around the world.
That’s spectacular success, even for a Jersey-boy. It does prove a major point. Rare as they likely are, active investing can have huge paydays.
But, there has been a sea change that has made the task far tougher for today’s amateurs, semi-pros, and even full time professionals. Everyone is substantially smarter, better informed, and can react with computer-like lightening speed.
The global statistics collected at places like Morningstar, Dalbar, and Standard and Poor’s demonstrate just how demanding it now is for the part-time investor to produce excess returns above market Index averages. When reviewed in total, these data sets are dismal for the individual investor. On average, we investors recover only about one-third of the returns that the mutual funds that service us deliver. We are pitiful in our entry-exit timing maneuvers. The marketplace is essentially a winning institutional game now.
I recognize there will always be a few highly skilled, insightful, and lucky souls who will outperform the dominating monoliths. They will be rare birds indeed. There are so many smart, informed, and talented financial outlets nowadays competing for the golden ring that they tend to neutralize one another.
They cancel each other out, quickly negating any momentary advantage, and deliver sub-par performance to their customers because of the continuous frictional cost to compete so energetically. Costs are like a hole in a water bucket; it’s a constant drain to wealth accumulation under all circumstances.
So, currently, my takeaway is that it is nearly impossible to “Beat the Street”. That’s just not going to happen for most of us.
But some segment of us will persistently try. Many current MFO members are in this camp. What is the game plan, the strategy, and most importantly, the prospects for this brave band of fearless warriors? Let me invent a likely generic profile to explore the issue for comparative purposes.
The committed private active investor is middle aged with a college degree. He is smart, dedicated, motivated, and industrious. He exchanges ideas on websites like MFO, accesses Morningstar for needed mutual fund data, and probably visits sites like Pony Express Bob to identify momentum attractive candidate funds for consideration. He likely deploys technical analyses using charts to guide perhaps a sector rotational strategy. It is a time-consuming struggle to access and absorb the mountainous pile of data available. Constant attention is necessary. Decision making is a lonely process.
Given the dominance of institutional investors these days, his competition is probably an institutional giant. Perhaps it’s a Boston behemoth, perhaps one of Chicago’s monsters of the midway, or perhaps it’s a team from the illustrious New York Genius network. Surviving against that cohort is hazardous duty. Given their many advantages, the odds of outwitting and outplaying these fierce and tireless opponents must approach zero. And adding the heavy burden of costs into the equation only deepens the challenge.
Given today’s environment and the lineup of market participants, what Peter Lynch interpreted as an individual investor advantage has morphed into a decided disadvantage. Currently, an active private investor is definitely playing a Loser’s game.
Why fight the tape? Since smart institutional investors engage to neutralize one another, an increasing number pf this elite club are joining the passive investment universe. Their numbers will swell in the future. It is doubtful that these numbers will ever penetrate the 50 % level, since institutional warriors enjoy the hunt and the profit incentives too much. That’s all goodness because active market participants are necessary to supply the requisite market pricing mechanism. Pricing competition keeps the marketplace roughly efficient.
Indexing is a reasonable solution to this dilemma for individual investors. It guarantees just short of market rewards if the low cost and low trading disciplines as advocated and practiced by outfits like Vanguard are followed. Even Warren Buffett has acknowledged the wisdom of this approach for most investors.
I encourage you to seriously consider the passive Index option for a more comfortable retirement. Although I currently own a mixed bag of actively managed and passively managed mutual funds/ETFs in my portfolio, I am slowly switching to more and more low cost passive holdings. Portfolio management need never be a overly simple either/or decision; compromise is a useful tool to reduce risk.
So it might well be time to step away, not to smell the roses, but to readdress your portfolio mix. The accumulating evidence overwhelmingly demonstrate a participant sea change and a slowly developing tsunami of institutional investors flooding towards the Index option. Recognize those perturbations and respond to your own special interpretations of those factoids. The institutions are making smarter decisions these days; just look at their profit margins
Certainly there will always be winning active investors who produce outsized market returns. Jeff Vinik is one such wizard. But there will also be lottery winners too. The key is to forecast these winners and their persistence. That’s a Herculean chore. Fat chance on accomplishing it.
Talk to you guys further down the road.