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To any fund manager out there that truly believes you can beat the market, here is how you can sell me your fund: We agree on an index and a time frame. You gu

To any fund manager out there that truly believes you can beat the market, here is how you can sell me your fund: We agree on an index and a time frame. You guarantee me the same return as the index within that time frame. If you beat the index, you keep 90% of returns ABOVE the index (and I get 10%). We both win, and you win big. If you don't beat the index (within the time frame), you make up the difference (so I get the return to the index).

jppittma 2y ago
I feel like some creative use of beta could make this a very lucrative deal for a patient, but unscrupulous fund manager.
Findeton 2y ago
Fundsmith for example has beaten the market for a long time (not this year though). I can also mention another Spanish fund that I know: Tercio Capital. https://markets.ft.com/data/funds/tearsheet/charts?s=GB00B4Q5X527:GBP https://markets.ft.com/data/funds/tearsheet/charts?s=GB00B4Q... https://www.finect.com/fondos-inversion/ES0174115057-Cinvest_tercio_capital_b_fi https://www.finect.com/fondos-inversion/ES0174115057-Cinvest...
- cjblomqvist 2y ago
  There are some research (instead of cherry picking/anecdotes). I don't have any links right now but basically half of the funds lose compared to the index (by law of nature - averages and all that). Furthermore, taking fees into account, just a few percentages make anything more (over time) - which is probably within scope of randomness.
  - Findeton 2y ago
    In general hard working prudent value investors are able to beat the index. It's just that those are very few. I mean Buffet has done it for half a century, that's not a coincidence.
    - p_j_w 2y ago
      Given the statistics and number of investors involved, it seems like an absolute certainty that a few people would beat the index for the entirety of their lives simply by chance.
      - Findeton 2y ago
        Yes some people might do it by chance. Some other people, they do it by knowledge.
        sdenton4 2y ago
        Find me the one who knows they got there by chance alone... It's very easy to create a narrative around random movements. I expect that anyone who is ahead of the market creates such a narrative, and declare themselves a genius. And then half of the geniuses underperform each year, same as every year...
        p_j_w 2y ago
        How do you tell one from the other?
        Findeton 2y ago
        You learn enough about value investing to know who is actually following that framework and then you just hope it works. Note: it works.
    - cjblomqvist 2y ago
      Half will beat index by definition. The key is to beat it including the cost of beating - and we've also seen that the extra value have generally been captured by the fund managers - not the fund buyers.
abound 2y ago
An important component of a bet like this: you should base the win/lose calculation on returns after accounting for fees. The index fund likely has fees that are two orders of magnitude lower than the active fund. Otherwise, a random fund may beat a broad index just by chance. Warren Buffett's very similar bet was done this way.
Scarblac 2y ago
You won't have any guarantee that they will be able to make good on their promise and won't just go bankrupt.
bandyaboot 2y ago
You’re probably aware that no fund manager would accept your offer. But it doesn’t prove that they don’t think they can beat the market (as misguided as that belief might be), it just means they’re not willing to take on an absurd amount of risk to prove it.
- cjblomqvist 2y ago
  Exactly. No point being the one taking the risk - if the professionals don't dare take the risk then any non-professional (fund buyer) shouldn't either (under normal circumstances). PS. Furthermore, an accurate comparison is not beating the index, it's beating it enough to cover the salary/compensation of the fund manager + some (with less risk! Risk = cost!)
  - bandyaboot 2y ago
    Well I think many fund managers regularly take on risk to achieve higher returns. They just won’t take on 100% downside risk while being taxed 10% on the upside.
    - emacdona 2y ago
      I think this gets at a deeper point I'm trying to make. If you truly can consistently beat the market, you are already making a killing with your _own_ money. If you want to use _my_ money to place your bets (presumably b/c you want to leverage your market beating ability), I want a guarantee (because I'm more than happy to take the return of the index).
      - DistractionRect 2y ago
        I follow, essentially you're viewing it like a loan + interest + a minor stake in the venture. If the venture fails, you still expect to repaid loan + interest and your stake in the venture is worth $0. Unfortunately no one will agree to this as long as everyone else is willing to invest _and_ shoulder the risk
hhmc 2y ago
Why would anyone take the other side of this bet? It's an incredible financial instrument, that anyone on the buyside would buy in an instant (as formulated -- ignored fees/tcosts etc).
- stavros 2y ago
  If I can consistently make more than 10% on your money, I'll take the other side.
  - hhmc 2y ago
    If you can consistently make more than 10% you don’t need to hamstring yourself with this terrible deal, you can just get investment on typical terms.
    - stavros 2y ago
      If I can consistently make 30%, this terrible deal will make me 20%, whereas the typical terms of management fees will make me 5%.
      - swexbe 2y ago
        If you can consistently make 30%, a bank loan will make you 24%.
        stavros 2y ago
        Fair point. I don't know why BlackRock did it, then.
- stouset 2y ago
  > Why would anyone take the other side of this bet? People accept this bet every single day… when they buy actively-managed funds. Actually they accept a worse bet. Instead of taking 100% downside risk and being taxed on anything above the index, they’re taxed on both gains and losses. You’re right that it’s an incredible financial instrument. Actively-managed funds are extremely profitable… for fund managers, who get paid out of investors’ assets in bad years and also get to skim off the gains in good years.
paxys 2y ago
Where will they find the money to pay you if they lose?
- cess11 2y ago
  If they don't they'll enter bankruptcy proceedings and their assets get sold and divided between creditors.
otoburb 2y ago
Sounds similar to recently launched buffer ETF products, specifically BlackRock and Innovator that hedge 100% of downside while capping your upside across different time horizons indexed to the S&P500.[1] [1] https://www.bloomberg.com/news/articles/2024-07-01/blackrock-enters-booming-market-for-stock-etfs-with-a-100-hedge https://www.bloomberg.com/news/articles/2024-07-01/blackrock...
- dmurray 2y ago
  They don't guarantee you zero downside compared to investing in the index, though, but compared to putting your money under the mattress. It's relatively easy to achieve a return profile like these promise with some combination of Treasuries and index options (at least while Treasuries pay 5%!), and the ETFs are doing this kind of financial engineering rather than promising to beat the market through stock-picking skill.
ProjectArcturis 2y ago
The point of actively managed funds is not so much to "beat the market", it's to provide diversified returns via strategies that are uncorrelated with the market. On average, the S&P500 has returned about 7% annually. If I had a strategy that returned 5% on average but was totally uncorrelated with the S&P, then you'd get the best overall long-term returns (maximize the geometric average of annual returns) by investing in a combination of my strategy and the S&P.
- pipes 2y ago
  I find this really hard to believe. I could be wrong but all the alpha type funds don't seem to advertise themselves as this.
- dv_dt 2y ago
  Well then you could establish a simiar pay critera that beats the s&p 500 during recessionary moves of the index. Im guessing you wouldn't get many takers
  - trpotter72 2y ago
    Uncorrelated returns is the key here, not inverse.
    - dv_dt 2y ago
      So how would you quantify non-correlation? I mentioned recession events because thats a significant movement when you most want to avoid correlation.
- daedrdev 2y ago
  My impression though i that most of these firms are highly correlated with the market despite their attempts at otherwise
- dukeofdoom 2y ago
  Is the 7% post inflation?
financltravsty 2y ago
You are not an UHNW individual/institutional investor, so no "fund managers" of any note are going to waste their time on this wager. "Beating an index" is really easy. Up to $10MM you can choose most any financial instrument class in the U.S markets and have a good probability of finding alpha for a long time (that would beat the S&P500 18.40% YTD). Many proprietary trading firms, or market makers, or quantitative trading shops do this regularly. Discretionary and systematic funds? Usually not. If their processes worked consistently, they would have no need to take outside capital and deal with relationship management. They could simply use more leverage (not exactly, but simplified for the general reader). This is also ignoring the fact there are no details in TFA about actual portfolio compositions or returns -- i.e. this is a PR piece. If your NW is under <$100MM, you should be focusing on hyper-growth strategies -- and not mentally limiting yourself on what is basically financial propaganda.
- dkekenflxlf 2y ago
  ++1!!
- archagon 2y ago
  What are “hyper-growth strategies”?
  - financltravsty 2y ago
    Anything entrepreneurial where there are outsized rewards for amount of risk taken. I.e. not working a career unless it's necessary to build contacts or learn the "secret sauce" that you can leverage for the aforementioned
toomuchtodo 2y ago
https://longbets.org/362/ https://longbets.org/362/ > “Over a ten-year period commencing on January 1, 2008, and ending on December 31, 2017, the S&P 500 will outperform a portfolio of funds of hedge funds, when performance is measured on a basis net of fees, costs and expenses.” Predictor: Warren Buffett | Challenger: Protege Partners, LLC https://longnow.org/ideas/warren-buffett-wins-million-dollar-long-bet/ https://longnow.org/ideas/warren-buffett-wins-million-dollar... (“Warren Buffett Wins Multi-Million Dollar Long Bet”)
KMag 2y ago
Disclaimer, I work for a market-neutral fund, and have close friends high up in prop shops. Presuming all strategies have a curve of diminishing marginal returns as assets under management increase, you would not expect any fund accepting outside money to have expected returns beating the market, but you would expect many of them to have a combination of correlation to the market and expected returns that would make them an attractive component in a basket of broad index ETFs and market-neutral funds. (Assuming risk-adjusted returns are the utility function being optimized. If variance is their preferred risk metric, this results in optimizing Sharpe ratio via mean-variance optimization, MVO.) It's fair to assume that any fund manager is optimizing the sum of returns from their own personal investments in the fund plus fees from outside investors. They pick the place on the volume/risk-adjusted-returns curve that still keeps their fund attractive enough to outside investors, and maximizes their personal profits (personal returns plus fund fees). If that optimal point on the volume/risk-adjusted returns curve for their particular strategy is at a point where risk-adjusted returns beat the market, then they maximize their returns by either never accepting outside funds (prop shops) or by not accepting additional funds and gradually buying out their investors (such as RenTech's famous Medallion fund). So, (assuming diminishing marginal returns) it's not rational to simultaneously accept outside investment and beat the market on a risk-adjusted basis. I suspect that many market-neutral funds could reliably beat the market on a risk-adjusted basis, but their volume/risk-adjusted-returns curve shape and their fee structures make it optimal for them to operate at a point on that curve where their expected returns are below the market. Note that this rational self-interest optimization below market returns isn't bad for the investors. Under most fee structures, it ends up being close to maximizing total investor returns. Increasing percentage returns would mean kicking out some investors. RenTech's Medallion Fund and many prop shops, and funds that are currently slowly buying out their investors seem to indicate there are at least some strategies where the optimal volume/returns trade-off is above market returns. You would expect all funds that are currently open to more outside investment to either be young and lacking capital or else have an optimal point on the volume/returns curve that is below market returns. Note that as previously mentioned, a simple mean-variance optimization on a basket would allocate funds to both index ETFs and market-neutral funds returning a bit under the market on average. It's entirely possible that both fund investors and fund managers are being perfectly rational. Of course, there are also plenty of people out there who fool themselves into thinking they know what they're doing. The world certainly isn't perfectly rational. I'm just saying that in a perfectly rational world, assuming (1) utility function of risk-adjusted-returns (e.g. Sharpe ratio, resulting in mean-variance-optimization) (2) declining marginal returns on investment, you would expect all funds accepting outside investors (except for young funds desperate for money) to under-perform the market in expected returns. Now, everyone talks about Sharpe ratio on the outside, but the particular risk models actually used internally by any fund are almost certainly not just variance of returns. I presume all funds simultaneously apply a mixture of commercially available risk models and internally developed risk models. Sharpe ratio is far from perfect, but it's a good least-common-denominator for discussion, and doesn't give away any secret sauce. Side note: it would be rational for someone to take you up on your proposal and simply use index futures to take a highly leveraged position on your benchmark index. As long as they had enough money to make you whole in the case of bad tracking error and large downturns, their expected returns would be large. However, you wouldn't be very smart to take such an agreement instead of just getting leverage yourself. This demonstrates why risk-adjusted returns are usually more important than expected returns.
HFguy 2y ago
There is a similar but different product (without the downside protection). A fund manager can replicate the index with derivatives and overlay their alpha on top of it. Google “alpha overlay” or “portable alpha” for more info. These types of products were more popular about 10-15 years ago. Firms typically charge just for the alpha for these strategies. You are asking for the manager to sell you an option.
- fooker 2y ago
  > You are asking for the manager to sell you an option. For free. This is why no one will agree. But if you price this as an option, and pay for the contract I can this working out.
deleted 2y ago
[deleted]
lumb63 2y ago
Something I don’t see talked about enough is the extent to which the rise of passive investing increases the extent to which passive investing is the best strategy. Passive investing is predicated entirely on either freeloading off of the decisions of actively managed portfolios, who will adjust the market prices of securities efficiently, therefore resulting in passively managed funds automatically owning the “best” stocks because the bad ones will fall out of the indices; or it is predicated on what is effectively a Ponzi scheme wherein if everyone passively invests the same, then that form of passive investing will yield the best returns. For analogy, consider school students trying to get all the questions right on the test. The first scenario is equivalent to one student studying hard to find the right answers. The rest of the class copies his answers and benefits from his efforts. The other scenario is no student trying hard, them all failing, but succeeding because the teacher curves the grades. Note that both of these scenarios, especially the second scenario, results in stock prices which become increasingly detached from the economic reality of companies in proportion to the extent to which passive investing becomes prevalent. For instance, assume stock XYZ is a bad investment but is in the S&P 500. If 90% of funds are actively managed, maybe they can sell a sufficiently large amount of it to push it out of the S&P 500 and save the passive investors from owning it. But if 90% of funds are passively managed, even if XYZ is hot garbage, the 10% of passively managed funds cannot possibly sell enough to make up for the fact that 90% of the market participants are indiscriminately buying a terrible stock. Passive investing breaks the market to some extent. The free market system is predicated on having rational participants, not zombie participants.
- hankchinaski 2y ago
  What you describe can be measured with return dispersion, as more people invest with passive index more opportunities arise for active investors. So they balance each other
deleted 2y ago
[deleted]
citizen_friend 2y ago
This sounds clever but many funds did exactly that. What’s your point? S&P + nvidia was better than just S&P over the last 5 years.
- Dylan16807 2y ago
  The challenge is to beat the market in the future and put your money behind that. Not to beat the market in the past. You're giving an example of beating the market in the past, which is not useful. You can do that with blind luck.
  - citizen_friend 2y ago
    Yep I’m just pointing out S&P. Or VTI anre not magic There are funds that beat them often. Is your claim they don’t exist? Or that you can’t find them.
    - Dylan16807 2y ago
      The claim is that there are no funds that can make a convincing argument that they will beat S&P. When you say funds did "exactly that", the "exactly that" you're talking about is not the thing OP is asking for. Taking on 90% of upside and 100% of downside is one way to make a convincing argument, and nobody does it. Let's make the dice analogy. You can't make a convincing argument that you will roll a 5, even though people roll 5 all the time. Talking about people that rolled 5 in the past is proving entirely the wrong point.
      - citizen_friend 2y ago
        I think we are talking past each other and it’s not worth continuing this discussion. The reason why no fund will take that deal is the market for investments is much more favorable to managers than that.
        Dylan16807 2y ago

jppittma 2y ago

I feel like some creative use of beta could make this a very lucrative deal for a patient, but unscrupulous fund manager.

Findeton 2y ago

Fundsmith for example has beaten the market for a long time (not this year though). I can also mention another Spanish fund that I know: Tercio Capital. https://markets.ft.com/data/funds/tearsheet/charts?s=GB00B4Q5X527:GBP https://markets.ft.com/data/funds/tearsheet/charts?s=GB00B4Q... https://www.finect.com/fondos-inversion/ES0174115057-Cinvest_tercio_capital_b_fi https://www.finect.com/fondos-inversion/ES0174115057-Cinvest...

cjblomqvist 2y ago
There are some research (instead of cherry picking/anecdotes). I don't have any links right now but basically half of the funds lose compared to the index (by law of nature - averages and all that). Furthermore, taking fees into account, just a few percentages make anything more (over time) - which is probably within scope of randomness.
- Findeton 2y ago
  In general hard working prudent value investors are able to beat the index. It's just that those are very few. I mean Buffet has done it for half a century, that's not a coincidence.
  - p_j_w 2y ago
    Given the statistics and number of investors involved, it seems like an absolute certainty that a few people would beat the index for the entirety of their lives simply by chance.
    - Findeton 2y ago
      Yes some people might do it by chance. Some other people, they do it by knowledge.
      - sdenton4 2y ago
        Find me the one who knows they got there by chance alone... It's very easy to create a narrative around random movements. I expect that anyone who is ahead of the market creates such a narrative, and declare themselves a genius. And then half of the geniuses underperform each year, same as every year...
      - p_j_w 2y ago
        How do you tell one from the other?
        Findeton 2y ago
        You learn enough about value investing to know who is actually following that framework and then you just hope it works. Note: it works.
  - cjblomqvist 2y ago
    Half will beat index by definition. The key is to beat it including the cost of beating - and we've also seen that the extra value have generally been captured by the fund managers - not the fund buyers.

abound 2y ago

An important component of a bet like this: you should base the win/lose calculation on returns after accounting for fees. The index fund likely has fees that are two orders of magnitude lower than the active fund. Otherwise, a random fund may beat a broad index just by chance. Warren Buffett's very similar bet was done this way.

Scarblac 2y ago

You won't have any guarantee that they will be able to make good on their promise and won't just go bankrupt.

bandyaboot 2y ago

You’re probably aware that no fund manager would accept your offer. But it doesn’t prove that they don’t think they can beat the market (as misguided as that belief might be), it just means they’re not willing to take on an absurd amount of risk to prove it.

cjblomqvist 2y ago
Exactly. No point being the one taking the risk - if the professionals don't dare take the risk then any non-professional (fund buyer) shouldn't either (under normal circumstances). PS. Furthermore, an accurate comparison is not beating the index, it's beating it enough to cover the salary/compensation of the fund manager + some (with less risk! Risk = cost!)
- bandyaboot 2y ago
  Well I think many fund managers regularly take on risk to achieve higher returns. They just won’t take on 100% downside risk while being taxed 10% on the upside.
  - emacdona 2y ago
    I think this gets at a deeper point I'm trying to make. If you truly can consistently beat the market, you are already making a killing with your _own_ money. If you want to use _my_ money to place your bets (presumably b/c you want to leverage your market beating ability), I want a guarantee (because I'm more than happy to take the return of the index).
    - DistractionRect 2y ago
      I follow, essentially you're viewing it like a loan + interest + a minor stake in the venture. If the venture fails, you still expect to repaid loan + interest and your stake in the venture is worth $0. Unfortunately no one will agree to this as long as everyone else is willing to invest _and_ shoulder the risk

hhmc 2y ago

Why would anyone take the other side of this bet? It's an incredible financial instrument, that anyone on the buyside would buy in an instant (as formulated -- ignored fees/tcosts etc).

stavros 2y ago
If I can consistently make more than 10% on your money, I'll take the other side.
- hhmc 2y ago
  If you can consistently make more than 10% you don’t need to hamstring yourself with this terrible deal, you can just get investment on typical terms.
  - stavros 2y ago
    If I can consistently make 30%, this terrible deal will make me 20%, whereas the typical terms of management fees will make me 5%.
    - swexbe 2y ago
      If you can consistently make 30%, a bank loan will make you 24%.
      - stavros 2y ago
        Fair point. I don't know why BlackRock did it, then.
stouset 2y ago
> Why would anyone take the other side of this bet? People accept this bet every single day… when they buy actively-managed funds. Actually they accept a worse bet. Instead of taking 100% downside risk and being taxed on anything above the index, they’re taxed on both gains and losses. You’re right that it’s an incredible financial instrument. Actively-managed funds are extremely profitable… for fund managers, who get paid out of investors’ assets in bad years and also get to skim off the gains in good years.

paxys 2y ago

Where will they find the money to pay you if they lose?

cess11 2y ago
If they don't they'll enter bankruptcy proceedings and their assets get sold and divided between creditors.

otoburb 2y ago

Sounds similar to recently launched buffer ETF products, specifically BlackRock and Innovator that hedge 100% of downside while capping your upside across different time horizons indexed to the S&P500.[1] [1] https://www.bloomberg.com/news/articles/2024-07-01/blackrock-enters-booming-market-for-stock-etfs-with-a-100-hedge https://www.bloomberg.com/news/articles/2024-07-01/blackrock...

dmurray 2y ago
They don't guarantee you zero downside compared to investing in the index, though, but compared to putting your money under the mattress. It's relatively easy to achieve a return profile like these promise with some combination of Treasuries and index options (at least while Treasuries pay 5%!), and the ETFs are doing this kind of financial engineering rather than promising to beat the market through stock-picking skill.

ProjectArcturis 2y ago

The point of actively managed funds is not so much to "beat the market", it's to provide diversified returns via strategies that are uncorrelated with the market. On average, the S&P500 has returned about 7% annually. If I had a strategy that returned 5% on average but was totally uncorrelated with the S&P, then you'd get the best overall long-term returns (maximize the geometric average of annual returns) by investing in a combination of my strategy and the S&P.

pipes 2y ago
I find this really hard to believe. I could be wrong but all the alpha type funds don't seem to advertise themselves as this.
dv_dt 2y ago
Well then you could establish a simiar pay critera that beats the s&p 500 during recessionary moves of the index. Im guessing you wouldn't get many takers
- trpotter72 2y ago
  Uncorrelated returns is the key here, not inverse.
  - dv_dt 2y ago
    So how would you quantify non-correlation? I mentioned recession events because thats a significant movement when you most want to avoid correlation.
daedrdev 2y ago
My impression though i that most of these firms are highly correlated with the market despite their attempts at otherwise
dukeofdoom 2y ago
Is the 7% post inflation?

financltravsty 2y ago

You are not an UHNW individual/institutional investor, so no "fund managers" of any note are going to waste their time on this wager. "Beating an index" is really easy. Up to $10MM you can choose most any financial instrument class in the U.S markets and have a good probability of finding alpha for a long time (that would beat the S&P500 18.40% YTD). Many proprietary trading firms, or market makers, or quantitative trading shops do this regularly. Discretionary and systematic funds? Usually not. If their processes worked consistently, they would have no need to take outside capital and deal with relationship management. They could simply use more leverage (not exactly, but simplified for the general reader). This is also ignoring the fact there are no details in TFA about actual portfolio compositions or returns -- i.e. this is a PR piece. If your NW is under <$100MM, you should be focusing on hyper-growth strategies -- and not mentally limiting yourself on what is basically financial propaganda.

dkekenflxlf 2y ago
++1!!
archagon 2y ago
What are “hyper-growth strategies”?
- financltravsty 2y ago
  Anything entrepreneurial where there are outsized rewards for amount of risk taken. I.e. not working a career unless it's necessary to build contacts or learn the "secret sauce" that you can leverage for the aforementioned

toomuchtodo 2y ago

https://longbets.org/362/ https://longbets.org/362/ > “Over a ten-year period commencing on January 1, 2008, and ending on December 31, 2017, the S&P 500 will outperform a portfolio of funds of hedge funds, when performance is measured on a basis net of fees, costs and expenses.” Predictor: Warren Buffett | Challenger: Protege Partners, LLC https://longnow.org/ideas/warren-buffett-wins-million-dollar-long-bet/ https://longnow.org/ideas/warren-buffett-wins-million-dollar... (“Warren Buffett Wins Multi-Million Dollar Long Bet”)

KMag 2y ago

Disclaimer, I work for a market-neutral fund, and have close friends high up in prop shops. Presuming all strategies have a curve of diminishing marginal returns as assets under management increase, you would not expect any fund accepting outside money to have expected returns beating the market, but you would expect many of them to have a combination of correlation to the market and expected returns that would make them an attractive component in a basket of broad index ETFs and market-neutral funds. (Assuming risk-adjusted returns are the utility function being optimized. If variance is their preferred risk metric, this results in optimizing Sharpe ratio via mean-variance optimization, MVO.) It's fair to assume that any fund manager is optimizing the sum of returns from their own personal investments in the fund plus fees from outside investors. They pick the place on the volume/risk-adjusted-returns curve that still keeps their fund attractive enough to outside investors, and maximizes their personal profits (personal returns plus fund fees). If that optimal point on the volume/risk-adjusted returns curve for their particular strategy is at a point where risk-adjusted returns beat the market, then they maximize their returns by either never accepting outside funds (prop shops) or by not accepting additional funds and gradually buying out their investors (such as RenTech's famous Medallion fund). So, (assuming diminishing marginal returns) it's not rational to simultaneously accept outside investment and beat the market on a risk-adjusted basis. I suspect that many market-neutral funds could reliably beat the market on a risk-adjusted basis, but their volume/risk-adjusted-returns curve shape and their fee structures make it optimal for them to operate at a point on that curve where their expected returns are below the market. Note that this rational self-interest optimization below market returns isn't bad for the investors. Under most fee structures, it ends up being close to maximizing total investor returns. Increasing percentage returns would mean kicking out some investors. RenTech's Medallion Fund and many prop shops, and funds that are currently slowly buying out their investors seem to indicate there are at least some strategies where the optimal volume/returns trade-off is above market returns. You would expect all funds that are currently open to more outside investment to either be young and lacking capital or else have an optimal point on the volume/returns curve that is below market returns. Note that as previously mentioned, a simple mean-variance optimization on a basket would allocate funds to both index ETFs and market-neutral funds returning a bit under the market on average. It's entirely possible that both fund investors and fund managers are being perfectly rational. Of course, there are also plenty of people out there who fool themselves into thinking they know what they're doing. The world certainly isn't perfectly rational. I'm just saying that in a perfectly rational world, assuming (1) utility function of risk-adjusted-returns (e.g. Sharpe ratio, resulting in mean-variance-optimization) (2) declining marginal returns on investment, you would expect all funds accepting outside investors (except for young funds desperate for money) to under-perform the market in expected returns. Now, everyone talks about Sharpe ratio on the outside, but the particular risk models actually used internally by any fund are almost certainly not just variance of returns. I presume all funds simultaneously apply a mixture of commercially available risk models and internally developed risk models. Sharpe ratio is far from perfect, but it's a good least-common-denominator for discussion, and doesn't give away any secret sauce. Side note: it would be rational for someone to take you up on your proposal and simply use index futures to take a highly leveraged position on your benchmark index. As long as they had enough money to make you whole in the case of bad tracking error and large downturns, their expected returns would be large. However, you wouldn't be very smart to take such an agreement instead of just getting leverage yourself. This demonstrates why risk-adjusted returns are usually more important than expected returns.

HFguy 2y ago

There is a similar but different product (without the downside protection). A fund manager can replicate the index with derivatives and overlay their alpha on top of it. Google “alpha overlay” or “portable alpha” for more info. These types of products were more popular about 10-15 years ago. Firms typically charge just for the alpha for these strategies. You are asking for the manager to sell you an option.

fooker 2y ago
> You are asking for the manager to sell you an option. For free. This is why no one will agree. But if you price this as an option, and pay for the contract I can this working out.

deleted 2y ago

[deleted]

lumb63 2y ago

Something I don’t see talked about enough is the extent to which the rise of passive investing increases the extent to which passive investing is the best strategy. Passive investing is predicated entirely on either freeloading off of the decisions of actively managed portfolios, who will adjust the market prices of securities efficiently, therefore resulting in passively managed funds automatically owning the “best” stocks because the bad ones will fall out of the indices; or it is predicated on what is effectively a Ponzi scheme wherein if everyone passively invests the same, then that form of passive investing will yield the best returns. For analogy, consider school students trying to get all the questions right on the test. The first scenario is equivalent to one student studying hard to find the right answers. The rest of the class copies his answers and benefits from his efforts. The other scenario is no student trying hard, them all failing, but succeeding because the teacher curves the grades. Note that both of these scenarios, especially the second scenario, results in stock prices which become increasingly detached from the economic reality of companies in proportion to the extent to which passive investing becomes prevalent. For instance, assume stock XYZ is a bad investment but is in the S&P 500. If 90% of funds are actively managed, maybe they can sell a sufficiently large amount of it to push it out of the S&P 500 and save the passive investors from owning it. But if 90% of funds are passively managed, even if XYZ is hot garbage, the 10% of passively managed funds cannot possibly sell enough to make up for the fact that 90% of the market participants are indiscriminately buying a terrible stock. Passive investing breaks the market to some extent. The free market system is predicated on having rational participants, not zombie participants.

hankchinaski 2y ago
What you describe can be measured with return dispersion, as more people invest with passive index more opportunities arise for active investors. So they balance each other

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citizen_friend 2y ago

This sounds clever but many funds did exactly that. What’s your point? S&P + nvidia was better than just S&P over the last 5 years.

Dylan16807 2y ago
The challenge is to beat the market in the future and put your money behind that. Not to beat the market in the past. You're giving an example of beating the market in the past, which is not useful. You can do that with blind luck.
- citizen_friend 2y ago
  Yep I’m just pointing out S&P. Or VTI anre not magic There are funds that beat them often. Is your claim they don’t exist? Or that you can’t find them.
  - Dylan16807 2y ago
    The claim is that there are no funds that can make a convincing argument that they will beat S&P. When you say funds did "exactly that", the "exactly that" you're talking about is not the thing OP is asking for. Taking on 90% of upside and 100% of downside is one way to make a convincing argument, and nobody does it. Let's make the dice analogy. You can't make a convincing argument that you will roll a 5, even though people roll 5 all the time. Talking about people that rolled 5 in the past is proving entirely the wrong point.
    - citizen_friend 2y ago
      I think we are talking past each other and it’s not worth continuing this discussion. The reason why no fund will take that deal is the market for investments is much more favorable to managers than that.
      - Dylan16807 2y ago