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when someone picks active management over passive, they're betting THEIR MANAGER can beat the average. people invested in buffett's stock picking skill; how a

when someone picks active management over passive, they're betting THEIR MANAGER can beat the average. people invested in buffett's stock picking skill; how are they doing?

zardo 10y ago
Above average. Of course those people all made an above average choice in active management.
- cpncrunch 10y ago
  It's somewhat ironic that Buffett is using this analogy, as he made huge profits by being an active investor. You just need to be smarter than the average active investor, which in reality isn't very difficult. The best strategy seems to be to use value investing, which is how Buffett made his fortune. Buy undervalued stocks, then keep hold of them for the long-term (or at least, until they become overvalued, then sell some).
  - briHass 10y ago
    Right, you just buy low, and sell high. It's so simple, I don't know why everyone doesn't do it. In reality, there's nothing statistically inconsistent with a 5 sigma outlier like Buffett.
    - cpncrunch 10y ago
      I'm not sure what your point is. Yes, it is as simple as buy low, and Buffett is saying the same thing. The main point is that most people aren't smart or confident enough to be able to [a] determine which stocks are undervalued and [b] buck the herd instinct.
  - haliax 10y ago
    Isn't Buffett's case a bit different? He typically buys businesses outright, rather than making investments on the open market, so no passive investor (besides one in Berkshire Hathaway) could get those returns. Also, as I understand it, Berkshire gets to implement management changes (if it deems them necessary) as it wishes, since it owns whole companies, and so the improvements they see could also come from better management of a business rather than picking better businesses. So arguments about average or above average stock picking ability seem less relevant here. (It could well be that Buffett has average management-picking ability, but is one of a relatively small number of market participants who both can and do exercise it, thereby getting an outsize result.)
    - mistermann 10y ago
      Also, I believe he has bought a number of privately held business, which are almost always waaaaay cheaper (on a P/E basis for example) than publicly traded companies.
    - hyperpallium 10y ago
      He buys them outright now, but not when he was amassing his fortune.
    - drumdance 10y ago
      Buffett also benefits from having Charlie Munger at his side. Buffet gets most of the credit but Munger is also a world class investor. It's like if Steve Jobs and Bill Gates had worked together.
e12e 10y ago
What misses from the above analogy, is that if all of the "passive" half have a different random subset, then about half will by definition do "above average", and the other will do "below average". While in the "active group", less than half will do "above average" because they pay part of their gain to fund managers. So if you want to beat the market, your chances are still better in the passive group... Now, this doesn't take into account getting away with insider trading, of course. If you can get away with insider trading, then you can beat the market just fine.
- dragonwriter 10y ago
  > Now, this doesn't take into account getting away with insider trading, of course. More importantly, it also doesn't take into account that there are investment opportunities that are not as directly (i.e., without intermediary layers which extract some of the returns) available to passive investors, so that the passive/act groups aren't splitting the same universe of alternatives. (E.g., passively investing in any given index fund is on average better than actively investing restricted to stocks in that index, and you can probably even extend that to passively investing in index funds in generally being better than actively investing in investments that directly held by any combination of index funds, but not every investment vehicle in the market is directly held by index funds.)
- rifung 10y ago
  > half will by definition do "above average", and the other will do "below average" Is this really true? I think it's only true if you replace average with median (e.g. in [1,2,3,10] only 10 is above the average).
  - dragonwriter 10y ago
    "Average" can refer to the median, or any of the various means. Its often informally used to mean the arithmetic mean (but also often the median), but it doesn't explicitly mean either of those.
  - e12e 10y ago
    A very good point! I would say that it depends on what the distribution looks like, I wrote: > [I]f all of the "passive" half have a different random subset, then about half will by definition do "above average", and the other will do "below average". While in the "active group", less than half will do "above average" because they pay part of their gain to fund managers. So, if all the passive investors have pick a random "large enough" subset of stocks, one would expect the distribution to approach the normal distribution, with roughly half to either side of the arithmetic mean. Similarly, as you point out, on the "active" side, one might see more outliers - and perhaps the selection isn't really uniformly random. So, it would probably be a stretch to claim that half will be above average "by definition", even if one includes the expected distribution, while note perhaps entirely wrong.

when someone picks active management over passive, they're betting THEIR MANAGER can beat the average. people invested in buffett's stock picking skill; how are they doing?

zardo 10y ago

Above average. Of course those people all made an above average choice in active management.

cpncrunch 10y ago
It's somewhat ironic that Buffett is using this analogy, as he made huge profits by being an active investor. You just need to be smarter than the average active investor, which in reality isn't very difficult. The best strategy seems to be to use value investing, which is how Buffett made his fortune. Buy undervalued stocks, then keep hold of them for the long-term (or at least, until they become overvalued, then sell some).
- briHass 10y ago
  Right, you just buy low, and sell high. It's so simple, I don't know why everyone doesn't do it. In reality, there's nothing statistically inconsistent with a 5 sigma outlier like Buffett.
  - cpncrunch 10y ago
    I'm not sure what your point is. Yes, it is as simple as buy low, and Buffett is saying the same thing. The main point is that most people aren't smart or confident enough to be able to [a] determine which stocks are undervalued and [b] buck the herd instinct.
- haliax 10y ago
  Isn't Buffett's case a bit different? He typically buys businesses outright, rather than making investments on the open market, so no passive investor (besides one in Berkshire Hathaway) could get those returns. Also, as I understand it, Berkshire gets to implement management changes (if it deems them necessary) as it wishes, since it owns whole companies, and so the improvements they see could also come from better management of a business rather than picking better businesses. So arguments about average or above average stock picking ability seem less relevant here. (It could well be that Buffett has average management-picking ability, but is one of a relatively small number of market participants who both can and do exercise it, thereby getting an outsize result.)
  - mistermann 10y ago
    Also, I believe he has bought a number of privately held business, which are almost always waaaaay cheaper (on a P/E basis for example) than publicly traded companies.
  - hyperpallium 10y ago
    He buys them outright now, but not when he was amassing his fortune.
  - drumdance 10y ago
    Buffett also benefits from having Charlie Munger at his side. Buffet gets most of the credit but Munger is also a world class investor. It's like if Steve Jobs and Bill Gates had worked together.

e12e 10y ago

What misses from the above analogy, is that if all of the "passive" half have a different random subset, then about half will by definition do "above average", and the other will do "below average". While in the "active group", less than half will do "above average" because they pay part of their gain to fund managers. So if you want to beat the market, your chances are still better in the passive group... Now, this doesn't take into account getting away with insider trading, of course. If you can get away with insider trading, then you can beat the market just fine.

dragonwriter 10y ago
> Now, this doesn't take into account getting away with insider trading, of course. More importantly, it also doesn't take into account that there are investment opportunities that are not as directly (i.e., without intermediary layers which extract some of the returns) available to passive investors, so that the passive/act groups aren't splitting the same universe of alternatives. (E.g., passively investing in any given index fund is on average better than actively investing restricted to stocks in that index, and you can probably even extend that to passively investing in index funds in generally being better than actively investing in investments that directly held by any combination of index funds, but not every investment vehicle in the market is directly held by index funds.)
rifung 10y ago
> half will by definition do "above average", and the other will do "below average" Is this really true? I think it's only true if you replace average with median (e.g. in [1,2,3,10] only 10 is above the average).
- dragonwriter 10y ago
  "Average" can refer to the median, or any of the various means. Its often informally used to mean the arithmetic mean (but also often the median), but it doesn't explicitly mean either of those.
- e12e 10y ago
  A very good point! I would say that it depends on what the distribution looks like, I wrote: > [I]f all of the "passive" half have a different random subset, then about half will by definition do "above average", and the other will do "below average". While in the "active group", less than half will do "above average" because they pay part of their gain to fund managers. So, if all the passive investors have pick a random "large enough" subset of stocks, one would expect the distribution to approach the normal distribution, with roughly half to either side of the arithmetic mean. Similarly, as you point out, on the "active" side, one might see more outliers - and perhaps the selection isn't really uniformly random. So, it would probably be a stretch to claim that half will be above average "by definition", even if one includes the expected distribution, while note perhaps entirely wrong.