On Benchmarks and the “Hardest Profession in the World”
Josh Brown points us to an interesting post discussing the difficulty of the investment profession and the fierce competition with benchmarks. The author states:
“Benchmarks are the most ferocious of competitors. They show up for work everyday. They never get sick. They don’t take vacation. They are always 100% invested so their results are continuously compounding. Most importantly, they’re not aware of their own performance. The S&P 500 will never enter the 4th quarter feeling it needs to really press to have good numbers for the year. Nor will it take December off to “lock in” a good year.”
It’s even more difficult than that. What is the S&P 500? The S&P 500 is essentially the biggest, baddest corporations that exist in the USA (and maybe the world). We’re talking about the 500 best companies out of millions. And that’s not even counting the ones that haven’t survived. Throw in the survivorship bias of the companies that have all failed over the years and the S&P 500 is the very best of the best. Better than the top 1 tenth of 1% of all companies alive. And every single day millions of investors step into the arena against this index, beat their chest and get crushed. That’s the beauty (and ugliness) of the market. Anyone is free to play the game, but be careful differentiating skill from luck. In this world there are a lot of lucky managers pawning their brief luck off as skill.
This doesn’t mean that fund managers can’t add value or that trying to manage money is a pointless endeavour (differentiation is a powerful allocation tool here). Far from it, but if you give me 500 plain vanilla “large cap blend” funds and compare them to the S&P 500 over a 30 year period the odds are overwhelmingly against them outperforming after taxes and fees. Competing with the S&P 500 on an even playing field is like stepping onto the golf course with Tiger Woods with no handicap. It’s almost always a bad idea. So beware those correlated benchmarks. They’ll kick your ass if you don’t know what you’re doing. Perhaps more importantly, beware the fund manager pawning off outperformance as skill. It’s not always the case.
Cullen Roche
Mr. Roche is the Founder of Orcam Financial Group, LLC. Orcam is a financial services firm offering research, private advisory, institutional consulting and educational services.
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7 Comments
Where’s the value add in fund management, Cullen? Can you elaborate. Because it seems like most fund managers are just copying an index, underperforming and walking away with the fees.
For some investors, such as older, retired or nearly retired investors, I think a case can be made to look at actively managed funds that have closely matched the performance of the S&P 500 with less volatility. I realize that those funds are hard to find and that past performance is no guarantee of future return.
Older investors often need to keep some assets positioned in equities, but don’t have 30 year time horizons.
Wouldn’t it be better to just hedge volatility?
One needs to differentiate between the difficulty in beating in a benchmark with the difficulty in being an investment professional. The former is indeed true, but the latter is not so clear. In fact, there are tens of thousands of portfolio managers, analysts, investment advisors, and brokers who utterly fail in beating the benchmark yet take home substantial compensation for themselves. Sounds like a fine way to make a living!
I have posted results of one trading strategy which beats every mutual fund performance ever existed and that too without any operating expense, except EOD prices:)
http://bubbleshort.blogspot.in/2012/08/some-research.html
Opinions awaited…
It’s not that hard to beat over the long run if you’re not a permabull. Simply hedge or move into bonds/cash when recessionary indicators are flashing red, or the market is highly overbought and overvalued.
The reason most managers can’t beat the S&P is because they are long-only permabulls who try to beat the market by “picking stocks” instead of just staying long the index and hedging when appropriate. Avoid those 50% drawdowns and your compounded returns start to look really nice.
I have come to the same insight. Remember Buffet’s rules nr. 1 and 2?