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Asset Managers: The tide turns

154 points by dmmalam 11y ago

HappyTypist 11y ago
The article describes the paradox. The average fund manager will perform as well as the market, but they charge fees so the net return is less. If you think you are able to pick out better fund managers, then you should be picking stocks instead. If you're unable to pick stocks, what makes you think you're able to pick managers when you are working off opaque trades and even less information?
- jdoliner 11y ago
  That is a very elegant bit of deductive reasoning. It makes their demise seem inevitable.
- bambax 11y ago
  I'm not defending asset managers but your argument sounds specious: you only need to pick an asset manager once, whereas you need to pick stocks every day or several times a day. I can't fix my car but I can pick a garage based on reviews, etc.
  - nostrademons 11y ago
    You only need to pick a stock once too. Or at most, once per several years. If you're trading stocks every day you're doing it wrong. And you have a lot more information available about stocks than you do about fund managers.
    - TheLogothete 11y ago
      Are you serious? You need a PORTFOLIO of stocks. It is an ONGOING effort.
      - tormeh 11y ago
        Nah. Depends on whether you're in it for the average or the variance. If you're in it for the average you might as well pick an index fund.
        TheLogothete 11y ago
        Don't start with this condescending "nah" when you are going to make a qualification after that and exclude the very case we are discussing here.
        tormeh 11y ago
        Sorry, didn't know it had condescending connotations.
      - nostrademons 11y ago
        You need an information advantage to pick stocks. You need to have some reason to believe you have information that the rest of the market does not (or that the rest of the market is ignoring), which lets you better estimate the future profits of the company. And then you compare that against the market price, and if the market is being irrational, trade. If you have this, you can get by with a very small portfolio, often just a handful of stocks. And the only ongoing effort is to periodically re-evaluate whether the market has caught on to the information advantage that you're trading on. You do need to continue to keep informed, but daily trading is ridiculous. If you do not have this, you will lose your shirt regardless of how much you diversify.
        TheLogothete 11y ago
        >You need an information advantage Yeah, exactly my point. You need to spend >20 hours to research a single company and will chose to invest in 1 out of 10. Those are the optimistic numbers. So 5 stocks is 1000 hours. How many hours to learn how to do your due diligence? How many hours per month, every month to keep an eye on what is going on and optimize if necessary?
  - deleted 11y ago
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  - hkmurakami 11y ago
    Until the head asset manager you "hired" effectively retires and hands the reins to youngins without ever telling you what went down. I've seen this happen many times.
  - fsloth 11y ago
    "you need to pick stocks every day or several times a day." The usual advice for beginners is to revise ones portofolio between long intervals, say, once per year, record the specific reasons a purchase or sale was done, and progress with patience and not running after the market. Stocks with dividens provide an interest to ones investment regardless how their price evolves in day trading.
- mootothemax 11y ago
  I think ignorance also plays a part. For example, I myself thought that one of the reasons for going with a decent fund manager was access to e.g. IPOs at the discount price (+ inevitable fees) that the partner bank had access to. If you're not able to take advantage of such things, I really don't understand the appeal. (but then - having such large sums of money that I need help investing them would be quite a nice problem to have!)
- vostok 11y ago
  >If you think you are able to pick out better fund managers, then you should be picking stocks instead. I'm not sure this is right. You wouldn't say that you should be designing if you think you can hire a designer. There's no reason that hiring a good fund manager is different. For what it's worth, I'm not good at picking managers or picking stocks with my own money so I choose a parsimonious approach.
- onion2k 11y ago
  That only works if you believe the skills needed to choose a fund manager are the same skills needed to choose stocks. That's seems unlikely. If I've consistently picked terrible stocks for years, performing at 20% less than the market, and then I meet a fund manager who has has consistently performed at 20% above the market, are you suggesting I can't know whether or not he's better than me?
  - vehementi 11y ago
    Indeed - it's like saying if you can't identify good football players, you shouldn't go about choosing good coaches / managers.
  - lifeisstillgood 11y ago
    For the past few years, yes you can. For the next few...? Surely you have an idea why you picked stocks that seemed good ideas but were not. What was the missing piece of information you did not have or the missing model you were not using?
  - jib 11y ago
    Survivorship bias may hint at you not being able to. Whether stock picking is luck based or not, there are (almost) no fund managers currently working who performed 20% under the market over the last 5 years.
  - HappyTypist 11y ago
    Indeed. Past performance is a terrible indicator for future performance, especially for fund managers. A Morningstar study found that there is no correlation between historical performance and future performance, i.e. the top 25% of funds in one year was spread evenly across the spectrum in future years. This was after adjusting for survivorship bias. So, you cannot look at performance as an indicator.
- vehementi 11y ago
  Wouldn't the average fund manager only perform as well as the market if the market consisted only of fund managers? The definition of average here also needs qualification -- surely it's weighted by size of assets, so one huge, poorly performing fund manager should allow for the existence of many small market-beating ones. No?
  - deleted 11y ago
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  - HappyTypist 11y ago
    You are right, but it also follows that a huge poorly performing fund won't stay huge for long.
todayiamme 11y ago
>>> Technology also means that the strategies of active managers can be replicated at much lower cost. Take value managers, who claim to be able to beat the market by picking cheap shares. A computer program can comb the market for stocks that look cheap relative to their profits, asset values, or dividends; investors have no need to worry that the active manager might lose focus or change style. When it comes to choosing between asset markets, robo-advisers, using computer models, can help investors manage their wealth for a very low fee. Earlier this month Goldman Sachs, a big bank, became the latest big financial firm to buy one. <<< There is absolutely no doubt that an algorithm can outperform most asset managers using traditional strategies quite well, but their implied thesis is wrong. It is extremely unlikely that any system short of an AGI, no matter how sophisticated, will be able to displace all active managers. The reason behind that is that the best active managers try to build up positions by creating an informational edge. The very best ones are willing to do whatever it takes. Some have specialists analysing satellite imagery. Others are willing to snap up equity in private competitors of a company to check out their orderbook to predict the reality of the market before it can be reflected by the market. Or fund studies and do their own work. Whatever it takes. A really great example of this trend is the rise of activist hedge funds which work by shorting the market and exposing malfeasance at companies. Last year an activist hedge fund manager, Whitney Tilson, found out that the products of Lumber Liquidators was laced with a carcinogen. He had lab tests conducted, shorted the stock, announced his results publicly, and created a media campaign around it resulting in a tumble. http://seekingalpha.com/article/3019166-lumber-liquidators-is-evil http://seekingalpha.com/article/3019166-lumber-liquidators-i... It is extremely unlikely that any system could have replicated Tilson's work, because none of this data was online or existed somewhere that could be easily queried. At best these systems can trade far more effectively humans can with existing strategies, but that does not mean they can produce great returns, as they're operating upon the information the market already knows, as opposed to seeking out what isn't known. There are similar examples within commodities - there are firms that specialise in using satellite imagery to predict if OPEC has increased production or what the global yield of rice / wheat is going to be. (case in point http://www.bloomberg.com/news/features/2015-07-08/satellite-images-show-economies-growing-and-shrinking-in-real-time http://www.bloomberg.com/news/features/2015-07-08/satellite-... ) There is an arms race going on right now to know what the state of any economy will be before anyone else knows it. They will continue to specialise along this route by funding remote sensing companies, putting money into internet analytics to predict future usage patterns, and everything else they can think of before anyone else. Machines just can't compete - at least, for now.
nickff 11y ago
The article is describing something that Eugene Fama (winner of the prize for economics in the memory of Alfred Nobel,) described in a paper a few years ago (2010).[1] Fama and his co-author French found that there is no evidence that any active managers of mutual funds (or any other portfolio of exchange-traded equities) have above-average skill; as a result, some will perform better than the market, and others will perform worse, but none will predictably or reliably outperform the average, and they each take some fee. What this means is that since they all have about the same expected return, and have an expected outcome of under-performing the market by the amount of their fees (as those are subtracted from their expected average returns), you should simply invest in a portfolio with low transaction costs and low holding costs. [1] https://faculty.chicagobooth.edu/john.cochrane/teaching/35150_advanced_investments/Luck%20versus%20Skilll%20in%20the%20Cross%20Section%20of%20Mutual%20Fund%20Returns.pdf https://faculty.chicagobooth.edu/john.cochrane/teaching/3515...
- dsacco 11y ago
  >> Fama and his co-author French found that there is no evidence of active fund managers who perform better than average... The paper you linked by Fama and French doesn't support this assertion. In fact, it's incorrect, and the paper admits that there are outliers (however few) with consistent superior performance. From 1994 to 2014, Renaissance Technologies averaged a 71% return. From 1982 to 2012, Baupost averaged a 19% return. In the same time period the S&P 500 returned 7-8%. Even after fees, these managers easily beat the average for their clients. It's tempting to claim that there is no such thing as beating the market, especially if that belief aligns well with a corresponding set of political beliefs about Wall St. But it is inarguable that funds and managers like these exist, it's just a matter of admitting that it's extraordinarily difficult instead of impossible.
  - jacalata 11y ago
    You misquoted the grandparent to argue against a position he did not take.
  - pbreit 11y ago
    Who said it was impossible?
lifeisstillgood 11y ago
This may be a dumb question; but as I am looking for my next project, what is so hard about setting up a robo-adviser firm? Algorithm A : put $AGE % of funds into treasury bonds, put 85-$AGE % into index firm / ETF Algorithm B: err?
- hkmurakami 11y ago
  If that's literally all you do, I as a potential client should just go out and buy the underlying assets myself.
  - TheOtherHobbes 11y ago
    You could, but these things have potential value because they save time. Anyone can sit at a screen and pick stocks all day, and I'd guess most of people of average intelligence would do better than the markets given a few simple strategies - because most brokers seem happy to make more money from fees than from investment gains. But not many people want to do this. If you start selling a maintenance-free money machine, it's not going to be hard to get sales. Of course if enough people start using it, it stops working. But that's a different problem.
- crnt2 11y ago
  The difficult part is getting regulated, and raising money. Robo-advisers are subject to the same regulation as traditional asset managers - a regulatory burden which is only likely to increase over time. The legal fees associated with regulation are not cheap. Compounding the problem, a competitive robo-adviser needs to offer lower fees than a traditional asset manager. Probably they need to be in the 0.25-0.5% range, which means that for each $1m under management they are picking up $5,000 of revenue. Out of that they need to pay salaries, infrastructure costs, legal costs, rent, taxes etc. Let's be conservative and say that these costs are $2.5m per year. That means that a robo-advisor needs about $0.5bn under management before it begins to turn a profit. I don't think it's really suitable as a side project.
  - lifeisstillgood 11y ago
lordnacho 11y ago
Hedge fund guy here. There's an implicit assumption that return profile is what matters to the investor. It very often isn't. Quite often it's a simple cover-your-ass requirement. Gotta put my money somewhere, so anyone who isn't going to embarrass me is fine. Thus status quo. Second, strategies do exist that barely lose money ever. I've a friend who runs a strategy that has had 4 losing months out of 100. Certified by a fund administrator. Sounds too good to be true, so the fund stays small. Everyone's heard of negative skew so they stay away. There's also strategies that print money so regularly they don't need outside investment. You would be amazed at how simple it is. But I've actually reproduced this myself. You need some good execution to do it, but once it's up you don't need or want investors. If you get a bond like income stream, you might as well finance it like a bond. It's only stuff with low Sharpe where you need to share the risk. So what do you see then? A bunch of traditional managers doing their stock picking where the result doesn't matter too much, and some funds with some alpha that isn't stable.
- crnt2 11y ago
  There are strategies that rarely lose money and have a great risk-adjusted profile. But they are generally at least one of a) Not scalable (e.g. most intraday market-making or scalping strategies) b) Only available at a very high fee (think north of 3/30) c) Not available at any price (e.g. Renaissance Medallion, which has been closed to outside investors for 20+ years) So I'm not sure that it's particularly relevant to this discussion, which is about fee pressure on traditional, long-only asset managers.
  - lordnacho 11y ago
    Yeah, I went off on a tangent. The stuff ordinary guys do is very easily systematised by a machine. Problem is the "system" often doesn't do that well (looking at long period numbers, so you get long periods of non performance), so you're back to "trust me, I've done this" and then the guy with the nice marketing docs wins again. Or we'll see. It's a common idea that you might as well follow the market in some way, so maybe cheap will win this time.
  - paulpauper 11y ago
phelmig 11y ago
John C. Bogle, the founder of Vanguard (mentioned in the article) wrote a book called "The battle for the soul of capitalism" [1] where he describes his motivation to found Vanguard. In summary he sees that funds managers add little value but extract too much money from risk takers (=investors) and thereby turn capitalism up side down. Sounds like his thesis is winning. [1] http://www.amazon.com/Battle-Soul-Capitalism-John-Bogle/dp/0300119712 http://www.amazon.com/Battle-Soul-Capitalism-John-Bogle/dp/0...
- aczerepinski 11y ago
  Neither mutual funds nor hedge funds as a whole can match a low fee index like Vanguard. Of course there are individual outliers that outperform, but predicting which funds will win in the future is no easier than picking individual securities that will win in the future. It's becoming pretty clear that Buffett will win his 10-year bet that the Vanguard would beat what Protege Partners thought were the five best hedge funds. http://www.cnbc.com/2016/02/16/warren-buffett-slips-but-still-winning-epic-hedge-fund-bet.html http://www.cnbc.com/2016/02/16/warren-buffett-slips-but-stil... How many hundreds of millions will those five funds have earned for themselves while not beating the market?
- bradleyjg 11y ago
  It'll be interesting to see what the new equilibrium settles out to as more and more people index. It's pretty obvious everyone can't index and as more people do, there are more opportunities for smart money. But what form is that smart money going to mostly take? Large institutional investors -- pension funds, charitable endowments, sovereign wealth funds, etc. -- either investing directly or via outside money managers? Partnership style hedge funds? Family offices for ultra high net worth individuals? Or will the mass market long only mutual fund make a comeback?
xyzzy4 11y ago
All you have to do to make tons of money is buy UPRO (s&p 500 leveraged 3x) and sell it when the economy is at high risk of recession. If you chart it out historically since 60 years back it would make a fortune.
- btian 11y ago
  All you have to do to make tons of money is buy whatever stock that will rise by the most next week, and short sell stock that will tank the most next week. How to find out which stock will rise or tank next week is left as an exercise for the reader.
paulpauper 11y ago
Historically, consumer staples have much better risk-adjusted returns than any other sector. Buying and holding these stocks will beat active management and the S&P 500. Active management, despite their access to expensive Bloomberg terminals and other financial resources, by in large, are just as clueless as retail investors, but they have more money and make up the difference in fees. What does this prove? The fact that billionaires and hedge fund mangers – who have access unlimited data, who can buyout seats on the board of directors, and can even influence the news – are unable to beat the market but instead underperform it substantially, douses cold water on the popular belief that the markets are rigged, inefficient, or a scam. The biggest scam are these firms charging high fees for poor performance, but the market itself is not broken. Instead, the market has become more efficient than ever, benefiting index buyers and hurting those who think the are the next Warren Buffet.
- TheOtherHobbes 11y ago
  Your points are contradictory. If consumer staples regularly outperform other market sectors, markets can't possibly be efficient. If they were, there would no signal to extract from the noise. The whole idea that markets are "efficient" is specious nonsense anyway. If they were, they'd simply be a perfect random number generator. In fact billionaires do regularly outperform the market. Bill Gates has made far more money from investing than he did from Microsoft.
  - paulpauper 11y ago
    and some billionaire fortunes have been lost; in the end, you get the overall market performance. Maybe there is some excess. It would be interesting if there were a study about if stocks of companies by Forbes 400 members outperform stocks which don't have members. I said more efficient than ever. That doesn't mean 100% efficiency.
ssharp 11y ago
If you have a consumer facing service and you charge on a commission basis, the tide is turning for you. Asset managers can just get added to a list that already includes positions like real estate agents, insurance agents, car salespersons, etc. The problem is the inability for these people to continue to provide value against alternatives that justifies taking a commission. I don't think there's a line in the sand for when these jobs become obsolete but the slow crawl towards it has been happening for a while.
- eldavido 11y ago
  Two important factors you're leaving out: (1) Does the intermediary add value? Sometimes they do, by facilitating better market functioning. If I sell a house and a real estate agent has access to a better buyer pool than I do -- likely, as they've been doing it for a while -- then I benefit with a higher selling price and the agent gets a commission. The loser is the "deal hunter" buyer who sits at the low end of the market, looking for a "deal" due to something being mispriced. In some markets, e.g. public market trading and low-end insurance, it's easy to get the same benefits with a computer. On the higher end, however, like with complex business insurance, I'd gladly pay a middleman a few % to help me get through the complexity of picking out the right package, coverage, helping me think through the risks, etc. (2) Are people afraid of doing it themselves? When dealing with a large enough proportion of wealth, some people will demand assistance, even if very expensive. I see this dynamic all the time in real estate. Most people don't want the hassle of selling a house themselves and would rather, somewhat lazily, just have someone else deal with it.
Dowwie 11y ago
and to add insult to injury, investment managers are expected to pursue advanced designations such as the CFA, which takes years of hard work -- hundreds of hours of intense study and preparation perhaps the standards settings bodies such as the CFA Institute should share some of the responsibility
jdonaldson 11y ago
The return profile is not the end-all-be-all for an investment. There's different strategies for tax avoidance, income generation, and for handling inheritance situations. Most folks here are clever enough to work these out on their own, but the question is whether or not it's worth it for them to do so if a small portion of that money can pay someone to do it for them.
deleted 11y ago
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RockyMcNuts 11y ago
Active management is an overpriced, tough to beat affair, but if enough people invest passively, active management will regain the upper hand. Indexers herd, they reduce liquidity, they push up prices of stocks in the index, they increase volatility, initially smaller/less liquid stocks have prices pushed around irrationally, then bigger stocks. It starts to pay to do private equity, buy out cheap stocks, IPO them, get them back into the index universe, and sell them back to the indexers. Indexing is not a silver bullet, it's one strategy in a Nash-like equilibrium. Too much active investing, passive can match them at a lower cost and win...too much passive investing, mispricing arises and active investors can exploit passive investors. https://blogs.cfainstitute.org/investor/2016/02/02/active-investing-really-the-losers-game/ https://blogs.cfainstitute.org/investor/2016/02/02/active-in...
- deleted 11y ago
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- inthewoods 11y ago
  First question - "they reduce liquidity" - how? Second, I don't think anyone is arguing that active investing can beat potentially beat passive investing. The problems with active management vs. passive are: - Most active manager will continue to underperform (this year I believe it was north of 90%) - That it is just about impossible to predict which funds will be leaders - That the fees active managers require are too high relative to the lack of any real value The point of the article isn't that active management can't ever beat passive - it's that the fees on investing are coming down because most active management provides little value. So if active management is going to win, the fees may be compressed and that may change the industry.
pkulak 11y ago
Great podcast on this recently: http://www.npr.org/sections/money/2016/03/04/469247400/episode-688-brilliant-vs-boring http://www.npr.org/sections/money/2016/03/04/469247400/episo...
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iofj 11y ago
The article's basic assumptions are wrong. Money is flowing out of private investment, so they just assume it's flowing into index funds. However ... Index funds doesn't seem to be where it's going. SPY lost 15% or more in Feb, and then recovered to only be down 5.5%. Before that a similar thing happened around new year. The trend appears to be down (in the sense that the second massive drop fell to a lower level than the first, and doesn't appear to be recovering the level the first recovered to), and a lot of banks are saying that people should sell the recovery. And if you prefer non-technical arguments : stocks in the S&P 500 are trading at a GAAP EPS multiple of ~21. Whilst that is actually a bit of a drop from before, that's still a >98% percentile for the multiple. "Normal" multiple is 16, which would have the S&P 500 trading at ~1550, and generally if you believe in mean reversal you'd expect it to drop below that before improving. Additionally the fed is raising rates, and that has always resulted in stock market drops. And all of this is assuming there isn't something more serious happening (global shipping has dropped double digit percentages since last year, which would seem to indicate a very serious issue, especially in Asia). I'm thinking there is a general outflow out of the stock market entirely. Index funds and everything. I would even bet that private investments are dropping, partly because quite a bit of investment advisors are telling people to get out of the market.

154 points by dmmalam 11y ago

The article describes the paradox. The average fund manager will perform as well as the market, but they charge fees so the net return is less. If you think you are able to pick out better fund managers, then you should be picking stocks instead. If you're unable to pick stocks, what makes you think you're able to pick managers when you are working off opaque trades and even less information?

jdoliner 11y ago
That is a very elegant bit of deductive reasoning. It makes their demise seem inevitable.
bambax 11y ago
I'm not defending asset managers but your argument sounds specious: you only need to pick an asset manager once, whereas you need to pick stocks every day or several times a day. I can't fix my car but I can pick a garage based on reviews, etc.
- nostrademons 11y ago
  You only need to pick a stock once too. Or at most, once per several years. If you're trading stocks every day you're doing it wrong. And you have a lot more information available about stocks than you do about fund managers.
  - TheLogothete 11y ago
    Are you serious? You need a PORTFOLIO of stocks. It is an ONGOING effort.
    - tormeh 11y ago
      Nah. Depends on whether you're in it for the average or the variance. If you're in it for the average you might as well pick an index fund.
      - TheLogothete 11y ago
        Don't start with this condescending "nah" when you are going to make a qualification after that and exclude the very case we are discussing here.
        tormeh 11y ago
        Sorry, didn't know it had condescending connotations.
    - nostrademons 11y ago
      You need an information advantage to pick stocks. You need to have some reason to believe you have information that the rest of the market does not (or that the rest of the market is ignoring), which lets you better estimate the future profits of the company. And then you compare that against the market price, and if the market is being irrational, trade. If you have this, you can get by with a very small portfolio, often just a handful of stocks. And the only ongoing effort is to periodically re-evaluate whether the market has caught on to the information advantage that you're trading on. You do need to continue to keep informed, but daily trading is ridiculous. If you do not have this, you will lose your shirt regardless of how much you diversify.
      - TheLogothete 11y ago
        >You need an information advantage Yeah, exactly my point. You need to spend >20 hours to research a single company and will chose to invest in 1 out of 10. Those are the optimistic numbers. So 5 stocks is 1000 hours. How many hours to learn how to do your due diligence? How many hours per month, every month to keep an eye on what is going on and optimize if necessary?
- deleted 11y ago
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- hkmurakami 11y ago
  Until the head asset manager you "hired" effectively retires and hands the reins to youngins without ever telling you what went down. I've seen this happen many times.
- fsloth 11y ago
  "you need to pick stocks every day or several times a day." The usual advice for beginners is to revise ones portofolio between long intervals, say, once per year, record the specific reasons a purchase or sale was done, and progress with patience and not running after the market. Stocks with dividens provide an interest to ones investment regardless how their price evolves in day trading.
mootothemax 11y ago
I think ignorance also plays a part. For example, I myself thought that one of the reasons for going with a decent fund manager was access to e.g. IPOs at the discount price (+ inevitable fees) that the partner bank had access to. If you're not able to take advantage of such things, I really don't understand the appeal. (but then - having such large sums of money that I need help investing them would be quite a nice problem to have!)
vostok 11y ago
>If you think you are able to pick out better fund managers, then you should be picking stocks instead. I'm not sure this is right. You wouldn't say that you should be designing if you think you can hire a designer. There's no reason that hiring a good fund manager is different. For what it's worth, I'm not good at picking managers or picking stocks with my own money so I choose a parsimonious approach.
onion2k 11y ago
That only works if you believe the skills needed to choose a fund manager are the same skills needed to choose stocks. That's seems unlikely. If I've consistently picked terrible stocks for years, performing at 20% less than the market, and then I meet a fund manager who has has consistently performed at 20% above the market, are you suggesting I can't know whether or not he's better than me?
- vehementi 11y ago
  Indeed - it's like saying if you can't identify good football players, you shouldn't go about choosing good coaches / managers.
- lifeisstillgood 11y ago
  For the past few years, yes you can. For the next few...? Surely you have an idea why you picked stocks that seemed good ideas but were not. What was the missing piece of information you did not have or the missing model you were not using?
- jib 11y ago
  Survivorship bias may hint at you not being able to. Whether stock picking is luck based or not, there are (almost) no fund managers currently working who performed 20% under the market over the last 5 years.
- HappyTypist 11y ago
  Indeed. Past performance is a terrible indicator for future performance, especially for fund managers. A Morningstar study found that there is no correlation between historical performance and future performance, i.e. the top 25% of funds in one year was spread evenly across the spectrum in future years. This was after adjusting for survivorship bias. So, you cannot look at performance as an indicator.
vehementi 11y ago
Wouldn't the average fund manager only perform as well as the market if the market consisted only of fund managers? The definition of average here also needs qualification -- surely it's weighted by size of assets, so one huge, poorly performing fund manager should allow for the existence of many small market-beating ones. No?
- deleted 11y ago
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- HappyTypist 11y ago
  You are right, but it also follows that a huge poorly performing fund won't stay huge for long.

todayiamme 11y ago

>>> Technology also means that the strategies of active managers can be replicated at much lower cost. Take value managers, who claim to be able to beat the market by picking cheap shares. A computer program can comb the market for stocks that look cheap relative to their profits, asset values, or dividends; investors have no need to worry that the active manager might lose focus or change style. When it comes to choosing between asset markets, robo-advisers, using computer models, can help investors manage their wealth for a very low fee. Earlier this month Goldman Sachs, a big bank, became the latest big financial firm to buy one. <<< There is absolutely no doubt that an algorithm can outperform most asset managers using traditional strategies quite well, but their implied thesis is wrong. It is extremely unlikely that any system short of an AGI, no matter how sophisticated, will be able to displace all active managers. The reason behind that is that the best active managers try to build up positions by creating an informational edge. The very best ones are willing to do whatever it takes. Some have specialists analysing satellite imagery. Others are willing to snap up equity in private competitors of a company to check out their orderbook to predict the reality of the market before it can be reflected by the market. Or fund studies and do their own work. Whatever it takes. A really great example of this trend is the rise of activist hedge funds which work by shorting the market and exposing malfeasance at companies. Last year an activist hedge fund manager, Whitney Tilson, found out that the products of Lumber Liquidators was laced with a carcinogen. He had lab tests conducted, shorted the stock, announced his results publicly, and created a media campaign around it resulting in a tumble. http://seekingalpha.com/article/3019166-lumber-liquidators-is-evil http://seekingalpha.com/article/3019166-lumber-liquidators-i... It is extremely unlikely that any system could have replicated Tilson's work, because none of this data was online or existed somewhere that could be easily queried. At best these systems can trade far more effectively humans can with existing strategies, but that does not mean they can produce great returns, as they're operating upon the information the market already knows, as opposed to seeking out what isn't known. There are similar examples within commodities - there are firms that specialise in using satellite imagery to predict if OPEC has increased production or what the global yield of rice / wheat is going to be. (case in point http://www.bloomberg.com/news/features/2015-07-08/satellite-images-show-economies-growing-and-shrinking-in-real-time http://www.bloomberg.com/news/features/2015-07-08/satellite-... ) There is an arms race going on right now to know what the state of any economy will be before anyone else knows it. They will continue to specialise along this route by funding remote sensing companies, putting money into internet analytics to predict future usage patterns, and everything else they can think of before anyone else. Machines just can't compete - at least, for now.

nickff 11y ago

The article is describing something that Eugene Fama (winner of the prize for economics in the memory of Alfred Nobel,) described in a paper a few years ago (2010).[1] Fama and his co-author French found that there is no evidence that any active managers of mutual funds (or any other portfolio of exchange-traded equities) have above-average skill; as a result, some will perform better than the market, and others will perform worse, but none will predictably or reliably outperform the average, and they each take some fee. What this means is that since they all have about the same expected return, and have an expected outcome of under-performing the market by the amount of their fees (as those are subtracted from their expected average returns), you should simply invest in a portfolio with low transaction costs and low holding costs. [1] https://faculty.chicagobooth.edu/john.cochrane/teaching/35150_advanced_investments/Luck%20versus%20Skilll%20in%20the%20Cross%20Section%20of%20Mutual%20Fund%20Returns.pdf https://faculty.chicagobooth.edu/john.cochrane/teaching/3515...

dsacco 11y ago
>> Fama and his co-author French found that there is no evidence of active fund managers who perform better than average... The paper you linked by Fama and French doesn't support this assertion. In fact, it's incorrect, and the paper admits that there are outliers (however few) with consistent superior performance. From 1994 to 2014, Renaissance Technologies averaged a 71% return. From 1982 to 2012, Baupost averaged a 19% return. In the same time period the S&P 500 returned 7-8%. Even after fees, these managers easily beat the average for their clients. It's tempting to claim that there is no such thing as beating the market, especially if that belief aligns well with a corresponding set of political beliefs about Wall St. But it is inarguable that funds and managers like these exist, it's just a matter of admitting that it's extraordinarily difficult instead of impossible.
- jacalata 11y ago
  You misquoted the grandparent to argue against a position he did not take.
- pbreit 11y ago
  Who said it was impossible?

lifeisstillgood 11y ago

This may be a dumb question; but as I am looking for my next project, what is so hard about setting up a robo-adviser firm? Algorithm A : put $AGE % of funds into treasury bonds, put 85-$AGE % into index firm / ETF Algorithm B: err?

hkmurakami 11y ago
If that's literally all you do, I as a potential client should just go out and buy the underlying assets myself.
- TheOtherHobbes 11y ago
  You could, but these things have potential value because they save time. Anyone can sit at a screen and pick stocks all day, and I'd guess most of people of average intelligence would do better than the markets given a few simple strategies - because most brokers seem happy to make more money from fees than from investment gains. But not many people want to do this. If you start selling a maintenance-free money machine, it's not going to be hard to get sales. Of course if enough people start using it, it stops working. But that's a different problem.
crnt2 11y ago
The difficult part is getting regulated, and raising money. Robo-advisers are subject to the same regulation as traditional asset managers - a regulatory burden which is only likely to increase over time. The legal fees associated with regulation are not cheap. Compounding the problem, a competitive robo-adviser needs to offer lower fees than a traditional asset manager. Probably they need to be in the 0.25-0.5% range, which means that for each $1m under management they are picking up $5,000 of revenue. Out of that they need to pay salaries, infrastructure costs, legal costs, rent, taxes etc. Let's be conservative and say that these costs are $2.5m per year. That means that a robo-advisor needs about $0.5bn under management before it begins to turn a profit. I don't think it's really suitable as a side project.
- lifeisstillgood 11y ago

lordnacho 11y ago

Hedge fund guy here. There's an implicit assumption that return profile is what matters to the investor. It very often isn't. Quite often it's a simple cover-your-ass requirement. Gotta put my money somewhere, so anyone who isn't going to embarrass me is fine. Thus status quo. Second, strategies do exist that barely lose money ever. I've a friend who runs a strategy that has had 4 losing months out of 100. Certified by a fund administrator. Sounds too good to be true, so the fund stays small. Everyone's heard of negative skew so they stay away. There's also strategies that print money so regularly they don't need outside investment. You would be amazed at how simple it is. But I've actually reproduced this myself. You need some good execution to do it, but once it's up you don't need or want investors. If you get a bond like income stream, you might as well finance it like a bond. It's only stuff with low Sharpe where you need to share the risk. So what do you see then? A bunch of traditional managers doing their stock picking where the result doesn't matter too much, and some funds with some alpha that isn't stable.

crnt2 11y ago
There are strategies that rarely lose money and have a great risk-adjusted profile. But they are generally at least one of a) Not scalable (e.g. most intraday market-making or scalping strategies) b) Only available at a very high fee (think north of 3/30) c) Not available at any price (e.g. Renaissance Medallion, which has been closed to outside investors for 20+ years) So I'm not sure that it's particularly relevant to this discussion, which is about fee pressure on traditional, long-only asset managers.
- lordnacho 11y ago
  Yeah, I went off on a tangent. The stuff ordinary guys do is very easily systematised by a machine. Problem is the "system" often doesn't do that well (looking at long period numbers, so you get long periods of non performance), so you're back to "trust me, I've done this" and then the guy with the nice marketing docs wins again. Or we'll see. It's a common idea that you might as well follow the market in some way, so maybe cheap will win this time.
- paulpauper 11y ago

phelmig 11y ago

John C. Bogle, the founder of Vanguard (mentioned in the article) wrote a book called "The battle for the soul of capitalism" [1] where he describes his motivation to found Vanguard. In summary he sees that funds managers add little value but extract too much money from risk takers (=investors) and thereby turn capitalism up side down. Sounds like his thesis is winning. [1] http://www.amazon.com/Battle-Soul-Capitalism-John-Bogle/dp/0300119712 http://www.amazon.com/Battle-Soul-Capitalism-John-Bogle/dp/0...

aczerepinski 11y ago
Neither mutual funds nor hedge funds as a whole can match a low fee index like Vanguard. Of course there are individual outliers that outperform, but predicting which funds will win in the future is no easier than picking individual securities that will win in the future. It's becoming pretty clear that Buffett will win his 10-year bet that the Vanguard would beat what Protege Partners thought were the five best hedge funds. http://www.cnbc.com/2016/02/16/warren-buffett-slips-but-still-winning-epic-hedge-fund-bet.html http://www.cnbc.com/2016/02/16/warren-buffett-slips-but-stil... How many hundreds of millions will those five funds have earned for themselves while not beating the market?
bradleyjg 11y ago
It'll be interesting to see what the new equilibrium settles out to as more and more people index. It's pretty obvious everyone can't index and as more people do, there are more opportunities for smart money. But what form is that smart money going to mostly take? Large institutional investors -- pension funds, charitable endowments, sovereign wealth funds, etc. -- either investing directly or via outside money managers? Partnership style hedge funds? Family offices for ultra high net worth individuals? Or will the mass market long only mutual fund make a comeback?

xyzzy4 11y ago

All you have to do to make tons of money is buy UPRO (s&p 500 leveraged 3x) and sell it when the economy is at high risk of recession. If you chart it out historically since 60 years back it would make a fortune.

btian 11y ago
All you have to do to make tons of money is buy whatever stock that will rise by the most next week, and short sell stock that will tank the most next week. How to find out which stock will rise or tank next week is left as an exercise for the reader.

paulpauper 11y ago

Historically, consumer staples have much better risk-adjusted returns than any other sector. Buying and holding these stocks will beat active management and the S&P 500. Active management, despite their access to expensive Bloomberg terminals and other financial resources, by in large, are just as clueless as retail investors, but they have more money and make up the difference in fees. What does this prove? The fact that billionaires and hedge fund mangers – who have access unlimited data, who can buyout seats on the board of directors, and can even influence the news – are unable to beat the market but instead underperform it substantially, douses cold water on the popular belief that the markets are rigged, inefficient, or a scam. The biggest scam are these firms charging high fees for poor performance, but the market itself is not broken. Instead, the market has become more efficient than ever, benefiting index buyers and hurting those who think the are the next Warren Buffet.

TheOtherHobbes 11y ago
Your points are contradictory. If consumer staples regularly outperform other market sectors, markets can't possibly be efficient. If they were, there would no signal to extract from the noise. The whole idea that markets are "efficient" is specious nonsense anyway. If they were, they'd simply be a perfect random number generator. In fact billionaires do regularly outperform the market. Bill Gates has made far more money from investing than he did from Microsoft.
- paulpauper 11y ago
  and some billionaire fortunes have been lost; in the end, you get the overall market performance. Maybe there is some excess. It would be interesting if there were a study about if stocks of companies by Forbes 400 members outperform stocks which don't have members. I said more efficient than ever. That doesn't mean 100% efficiency.

ssharp 11y ago

If you have a consumer facing service and you charge on a commission basis, the tide is turning for you. Asset managers can just get added to a list that already includes positions like real estate agents, insurance agents, car salespersons, etc. The problem is the inability for these people to continue to provide value against alternatives that justifies taking a commission. I don't think there's a line in the sand for when these jobs become obsolete but the slow crawl towards it has been happening for a while.

eldavido 11y ago
Two important factors you're leaving out: (1) Does the intermediary add value? Sometimes they do, by facilitating better market functioning. If I sell a house and a real estate agent has access to a better buyer pool than I do -- likely, as they've been doing it for a while -- then I benefit with a higher selling price and the agent gets a commission. The loser is the "deal hunter" buyer who sits at the low end of the market, looking for a "deal" due to something being mispriced. In some markets, e.g. public market trading and low-end insurance, it's easy to get the same benefits with a computer. On the higher end, however, like with complex business insurance, I'd gladly pay a middleman a few % to help me get through the complexity of picking out the right package, coverage, helping me think through the risks, etc. (2) Are people afraid of doing it themselves? When dealing with a large enough proportion of wealth, some people will demand assistance, even if very expensive. I see this dynamic all the time in real estate. Most people don't want the hassle of selling a house themselves and would rather, somewhat lazily, just have someone else deal with it.

Dowwie 11y ago

and to add insult to injury, investment managers are expected to pursue advanced designations such as the CFA, which takes years of hard work -- hundreds of hours of intense study and preparation perhaps the standards settings bodies such as the CFA Institute should share some of the responsibility

jdonaldson 11y ago

The return profile is not the end-all-be-all for an investment. There's different strategies for tax avoidance, income generation, and for handling inheritance situations. Most folks here are clever enough to work these out on their own, but the question is whether or not it's worth it for them to do so if a small portion of that money can pay someone to do it for them.

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RockyMcNuts 11y ago

Active management is an overpriced, tough to beat affair, but if enough people invest passively, active management will regain the upper hand. Indexers herd, they reduce liquidity, they push up prices of stocks in the index, they increase volatility, initially smaller/less liquid stocks have prices pushed around irrationally, then bigger stocks. It starts to pay to do private equity, buy out cheap stocks, IPO them, get them back into the index universe, and sell them back to the indexers. Indexing is not a silver bullet, it's one strategy in a Nash-like equilibrium. Too much active investing, passive can match them at a lower cost and win...too much passive investing, mispricing arises and active investors can exploit passive investors. https://blogs.cfainstitute.org/investor/2016/02/02/active-investing-really-the-losers-game/ https://blogs.cfainstitute.org/investor/2016/02/02/active-in...

deleted 11y ago
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inthewoods 11y ago
First question - "they reduce liquidity" - how? Second, I don't think anyone is arguing that active investing can beat potentially beat passive investing. The problems with active management vs. passive are: - Most active manager will continue to underperform (this year I believe it was north of 90%) - That it is just about impossible to predict which funds will be leaders - That the fees active managers require are too high relative to the lack of any real value The point of the article isn't that active management can't ever beat passive - it's that the fees on investing are coming down because most active management provides little value. So if active management is going to win, the fees may be compressed and that may change the industry.

pkulak 11y ago

Great podcast on this recently: http://www.npr.org/sections/money/2016/03/04/469247400/episode-688-brilliant-vs-boring http://www.npr.org/sections/money/2016/03/04/469247400/episo...

endurancerobot 11y ago

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iofj 11y ago

The article's basic assumptions are wrong. Money is flowing out of private investment, so they just assume it's flowing into index funds. However ... Index funds doesn't seem to be where it's going. SPY lost 15% or more in Feb, and then recovered to only be down 5.5%. Before that a similar thing happened around new year. The trend appears to be down (in the sense that the second massive drop fell to a lower level than the first, and doesn't appear to be recovering the level the first recovered to), and a lot of banks are saying that people should sell the recovery. And if you prefer non-technical arguments : stocks in the S&P 500 are trading at a GAAP EPS multiple of ~21. Whilst that is actually a bit of a drop from before, that's still a >98% percentile for the multiple. "Normal" multiple is 16, which would have the S&P 500 trading at ~1550, and generally if you believe in mean reversal you'd expect it to drop below that before improving. Additionally the fed is raising rates, and that has always resulted in stock market drops. And all of this is assuming there isn't something more serious happening (global shipping has dropped double digit percentages since last year, which would seem to indicate a very serious issue, especially in Asia). I'm thinking there is a general outflow out of the stock market entirely. Index funds and everything. I would even bet that private investments are dropping, partly because quite a bit of investment advisors are telling people to get out of the market.