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September 18, 2013
Illustration by Zohar Lazar
I have a quarter which, when flipped, is able to predict whether the stock market will go up or down that day. Fortunately I don't believe my quarter is smart, it's just that I flipped a bunch of them, and one came out right.
Similarly, no one seems to be able to predict the geniuses up front, whether they are individual investors or mutual fund operators.
Would anyone like to pay my quarter a 1% management fee?
Yes, tough to beat the market while indexing, unless it's valuation based. See FWDD.
I get a kick out of all the people who confidently state that it is nearly impossible to beat the markets.
I have been consistently beating the averages for eight years now. Granted it took about 10 years of persistence and obsessive study and practice but I now beat the averages by twice or three times. Over the eight years of this fund I am up 260%. One year was 100%, another 60%, last year was only 35%.
Am up 17% so far this year.
good luck to all you money "managers".
You ruined it by quoting Mauboussin. He is a joke. During the TMT bubble, he invented new valuation theories to justify comical valuation multiples for tech stocks. His work was always wrapped up in supercilious pseudo-academic frameworks. How he loved Enron! He has made a career out of taking academic research and rewriting it in a smart-arsed way as stock-broker research.
This was a fantastic article. I enjoyed the personal touch that you brought to the subject.
Unfortunately, there is an entire industry built up around the idea that "professional" asset managers can either add alpha or find others who can add alpha. As you note, there is no provable persistence of alpha - essentially they are selling you yesterday's lottery numbers and telling you that they will hit again tomorrow because they have in the past.
The real takeaway for individual investors is that the only way to add "value" or alpha is to reduce fees, tax consequences, and other costs as low as possible.
At the end of the day, truly creative investing as with any creative act is a really personal thing. The whole concept of alpha makes it seem like it's something you can replicate on a mass scale, but you can't, at least not entirely, b/c the greatest investors don't just leverage widely available knowledge, but they also leverage their personal experiences, judgments and intuitions. That is something that just can't be transferred from person to person. The difficult part is, before, you could approximate a great investor's performance by following their portfolio, stock by stock, but with high frequency guys, there's no more room there. They buy milliseconds after the smart money buy. So, it really is true i think, that you can't follow the leader, you have to blaze your own path, that's the only way to find true "alpha".
Nice article. I think pricing of risk is getting better but alpha will always exist as long as there is uncertainty. A good piece on the expectingreturns.com website examines the pitfalls of measuring managers against benchmarks. I think it's worth a read in the context of this article: http://expectingreturns.com/2013/10/06/winning-a-losers-game/
Dear Ms. Segal,
I'm a former journalist turned analyst at a leading mutual fund company.
Hats off to you for writing a truly thought-provoking and excellent article.
One of the reasons I left journalism - having worked for two of the country's leading news organizations - was that journalists , partly because of budget cuts, were no longer writing critical articles that made readers think.
You have done exactly this. Keep up the good work! I'm eagerly awaiting your future articles.
Our whole accounting apparatus is designed to give investors/analysts information about tangible assets. Meanwhile, 80% of the market value of S&P 500 firms and just over 50% of the market value of all publicly traded firms can be attributed to intangible assets. With everyone slicing and dicing the same 20% mound of information, finding alpha is like trying to squeeze water from a rock. The upstream indicators of corporate performance are comprised of intangibles such as corporate culture, customer perception of value, employee engagement levels, brand equity, innovation, quality of supplier relationships, management integrity, etc. Every person who has ever worked in or managed a company knows these ingredients really matter, but investors are rarely provided with reliable information about the health of these intangibles. Alpha isn't dead. It's been buried alive under a pile of information where few investors have bothered to look.
Very good article. The steady decline of the standard deviation of mutual funds' alpha returns is the most rational and irrefutable proof of the article's point.
But it is never mentioned in the debate about alpha that, as a group, fund managers have a great positive impact on capital allocation in the economy and on quoted companies' long term return on capital (in a less obvious way than private equity fund managers but on a much larger pool of capital). So their contribution to the economy goes well beyond alpha generation alone.
Patrice, fund manager
We're still measuring alpha the same way we did 40 years ago, with regressions & peer groups. Yet we've evolved from vacuum tube radios to Dick Tracy watches. There are more accurate and reliable methodologies for evaluating manager success or failure. Who knows, these methodologies might reveal more alpha than you think. Or not. The sell side runs this show, & it's afraid of accurate performance evaluation. Ever meet a manager below median?
Alpha is dead! Alpha by definition is a zero-sum game. If asset managers trade against each other, the average performer is expected to deliver index minus expenses. Investors will be much better off with index funds unless they have superior skills of picking managers. In reality, picking good managers can be another impossible task. The number of investment products are more than the number of stocks. It is hard to differentiate skills from luck, or a streak of luck.
The alpha in the future will be more likely from managing downside risks, instead of picking stocks. Traditional asset mangers normally manage against their benchmarks disregarding capital preservation for investors. That approach have proven to be ineffective during the financial crisis. It does not help investors achieving their goals when a manager outperformed a benchmark, which was down by 40%, by a few percentage points.
We need a new definition of alpha. Alpha should be defined against an investors' goal rather a market index.
You've written a fantastic article. If more investors (and advisors) admitted the fact you cogently lay out they would be much better off. Of course, there is too much money to be made in the (failed) pursuit of alpha.
This point is really beyond debate today. Look up the last 10 years of returns for college endowments or state pension plans -- the biggest investors with access to the best and most exclusive investment strategies in the world are unable to outperform simple balanced index fund portfolios, let alone allocations that tilt to smaller and more value-oriented stocks.
No, the only "alpha" left in today's market that isn't simply due to chance is the efficient delivery of exposure to priced sources of risk and return -- size, price, and profitability on the equity side and term and credit on the fixed side as well as the promotion of positive investor behavior by a qualified advisor so their clients earn the returns of their asset allocation and no less through poor timing moves. The 2 D's: "dimensions" of return and "discipline" are the only two differentiators in today's modern investment markets.
"I'm smarter than everyone else" has about as much creditability as the one-time view that success was preordained for Raiders QB Jamarcus Russell because he was more physically gifted than anyone else. The two had/have approximately the same outcome.
Thanks for reading, Michael! And thanks for pointing this out. We've changed the mistake.
Dear Ms. Segal:
I enjoyed reading your article, "Beating the Market has become Nearly Impossible." Thank you for the hard work.
Just one note. On page number 5, the CFA Designation is known as the "Chartered Financial Analyst" designation vs. in the article it is stated as "Certified."
As a CFA Charterholder, it is my duty to inform you of this. Hopefully, others have done the same.
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