Hi Guys,
I was prompted to generate this submittal by a recent posting by MFOer Hank on a “beating the market” topic. Here is the internal Link to that stimulating article and subsequent MFO discussion:
http://www.mutualfundobserver.com/discussions-3/#/discussion/9538/beating-the-market-as-a-reachable-goalThis is a very worthwhile subject that deserves further attention. Here are some of my thoughts on the matter.
Skepticism is a necessary attribute when investing You are all familiar with the saying that a good man is hard to find. Well, a good, persistent mutual fund manager is even harder to find. However, they do exist in inadequate numbers.
Skepticism does not operate in a vacuum. It is, or should be, closely coupled to market price levels and recent pricing history. As the price of a candidate investment increases, the odds for additional gain diminishes and skepticism and caution should increase. When prices drop, any candidate purchase should become more attractive since the potential for fat
gains increases. Strangely enough, the typical investment crowd behaves otherwise. Following the herd is often a dangerous pathway when investing.
Two of the most durable and reliable investment rules are a regression to the mean pricing pull, and a supermarket shopper price discipline.
If an investment price has dramatically risen or a mutual fund manager has recorded a string of high profile returns, the most likely next outcome is that a reversal is increasingly likely. Supermarket shoppers search out and load up their carts when prices plummet to attractive lows. Investors frequently do not follow this common wisdom.
When investing, it is amazing how difficult it is to execute these practical considerations. To be a successful money wizard, a private investor must sometimes challenge the wisdom of the crowd and his herd-like instincts. The task is to identify when that “sometimes” is happening. Super investors, both past and present, recognize, understand, and exploit this “sometimes” event.
Among the approximately 7,000 mutual funds, it is an arduous chore to isolate superior managers. However, such a search will usually uncover a short list of these talented professionals. What is true today was equally true in yesteryear.
Past superinvestors included the likes of Ben Graham, Jesse Livermore, John Templeton, John Neff, and perhaps Peter Lynch. Even these investment heroes suffered repeating hard times and disappointment.
Livermore made millions and lost millions. Lynch outdistanced the market rewards by approximately an astounding 15 %, but in his later years his performance had a regression towards the mean slope. Templeton and Neff delivered oversized returns in the plus 3 % range relative to appropriate benchmarks. They too experienced sub-par years. Both of these superstars recorded excess positive returns about 70 % of the time in their long and storied careers. Persistence is a hard nut even at this elevated performance level.
Warren Buffett spans both the past and the present honor roll of traders. He provides an additional list of exceptional money managers in his appendix to the 4th revised edition of Benjamin Graham’s “Intelligent Investor” book. The title of the appendix, which is a reprint of an earlier speech, is titled “The Superinvestors of Graham and Doddsville”. Here is the Link to that often referenced Columbia University speech:
http://www4.gsb.columbia.edu/null?&exclusive=filemgr.download&file_id=522Buffett identifies a number of other investors (like Bill Ruane and Walter Schloss), all tutored by Graham, who generated superior outcomes for their clients. Buffett’s stuff is always an entertaining and informative read.
I also am addicted to John Templeton’s simple and persuasive insights. I particularly like his 16 investment rules. Here is a reference to that useful list that also includes some of his companion commentary:
https://www.franklintempleton.com/retail/pdf/home/splash_PUB/TL_R16_1207.pdfI am especially impressed by two quotes contained in his referenced document: “…success is a process of continually seeking answers to new questions.”, and “ By definition, you can’t outperform the market if you buy the market.” That’s good stuff.
Another dimension that establishes solid mutual fund management is the persistence of superior outperformance. The S&P Persistency Scorecard studies address this issue semi-annually. I frequently have provided references to their work. Here is a new Link to one assessment of their studies:
http://www.forbes.com/sites/johnwasik/2013/07/19/the-continuing-tall-tale-of-past-performance/The author summarizes his interpretation of the S&P findings as follows: “The skinny on persistence of performance is pretty straightforward. Only a handful of mutual funds that post top returns were able to stay on top. Of 703 funds surveyed by S&P that were sitting in the top 25-percent of all funds in March 2011, less than 5 percent were able to stay in the highest-returning group over three consecutive 12-months periods through March 2013.”
He also quotes from Larry Swedroe: “The evidence demonstrates that the one thing that is persistent is the lack of persistence in mutual fund performance — with the exception being that the worst performers tend to repeat, mostly because they have the highest expenses.”
In all cases, the powerful reversion to the mean pull exerts itself on all fund managers. It compromises persistency. Imagine a bell shaped fund excess returns chart. The vertical axis shows the number of funds for each level of excess returns depicted on the horizontal axis.
Because of expenses or perhaps because of bad stock choices, the peak of the fund numbers curve is on the negative side of neutral excess returns. The bell curve is skewed towards the negative results with some funds showing long negative excess return tails. The takeaway is that when the curve depicts a 10-year period, just about zero managers produce positive excess returns above the plus 4 % marker. It’s a tough world.
Here is a Link to a paper that addresses and summarizes the persistency issue. Its title is “The Truth about Money Managers”:
https://www.rwbaird.com/bolimages//Media/PDF/Whitepapers/Truth-About-Top-Performing-Money-Managers.pdfThis paper emphasizes that persistency tests must consider data sets beyond the 3-year time horizon. Its main thesis is that long-term patience is mandatory to secure above average market rewards. The long holding period is needed to withstand reversion to the mean perturbations over an entire investing career. Indeed, it is a tough and unforgiving world for the money management industry.
A few mutual funds are blessed with superstar status managers. Will their outsized performance persist? Who knows? But the odds are not attractive. Almost all serious research supports this bottom-line takeaway.
I suppose I will consider this submittal a failure if it did not inform and/or offend a few MFO participants. We all benefit from divergent perspectives. Therefore, your comments are fully encouraged. My purpose was to probe more deeply into the active mutual fund management controversy, its costs and benefits. I hope you folks find it just a little helpful.
Best Regards and Merry Christmas.
