9 ms·

How Many Mutual Funds Routinely Rout the Market? Zero

94 points by dcre 12y ago

betatim 12y ago
Can someone explain why they flip a coin twice per year per fund? The author wrote a second column (http://www.nytimes.com/2014/07/27/your-money/heads-or-tails-either-way-you-might-beat-a-stock-picker.html http://www.nytimes.com/2014/07/27/your-money/heads-or-tails-...) explaining how they came up with the number of funds that would outperform the market five years in a row. The reasoning goes like this: 2/2862 funds made it (or about 0.07% of funds). The author then says: If you assume a fund has a 50% chance of beating the market, and a 50% chance of falling behind then the chances of one beating the market five years in a row would be 0.5^(5 * 2). They just state that they flip a coin twice per year per fund (hence 0.5^10), can someone explain why?
- scottfr 12y ago
  "Beat the market" is misleading. In the article "beat the market" means be in the top 25% of the market, therefore equivalent to winning two coin flips each year.
ForHackernews 12y ago
Also worth noting, hedge funds (aka 'mutual funds for the extremely wealthy') typically under-perform the market: http://www.bloombergview.com/articles/2015-02-12/hedge-funds-underperform-as-investors-give-them-more-money http://www.bloombergview.com/articles/2015-02-12/hedge-funds...
ghettoCoder 12y ago
Nothing new here. Mutual funds are just a way for fund managers to charge inflated management fees for average to below average returns. Get a basic index fund and save the fees. The few years the managed funds beats the index funds will easily be offset by all the fees and other gotchas.
- walshemj 12y ago
  only problem with the index funds Is you have to buy the dogs in the index an active managed fund can get out of situations like the uk supermarkets and banks. I number of my actively managed investments did this so now an index fund will realistically always under perform this active fund.
  - dcre 12y ago
    The point is that those active funds mess it up so badly when the market is doing well that the performance of the index funds is still better over the long run.
  - gwern 12y ago
    > so now an index fund will realistically always under perform this active fund. So why don't they?
    - walshemj 12y ago
      Some do you just have to know what your doing and be prepared to invest against the market BKY LWY and TRY in the UK have done very very well for me over that last decade. many of my long term active investments have beaten the market over 10 years by over 100% you just need to look at the ones with 50-100 years track records Look at the average IT vs Unit trust vs bench mark
  - asr 12y ago
    The entire point of decades of research, and the above article, is that next to nobody can reliably tell you in advance which stocks are "the dogs." I'm glad for you, but if you want to convince me your active funds can reliably beat the market you would need to provide me a lot more data, as you are swimming upstream against a raging torrent of empirical research.
    - walshemj 12y ago
      Where do the Rothschilds keep their money not in Index funds but in actively managed IT's RIT Capital Partners has done very nicely. And Mr Buffet's investment company has beaten wall street for decades. You are believing all that advertising the index fund managers are putting out and your bank is aggressively selling you.
fideloper 12y ago
For those interested, Vanguard has some of the lowest cost unmanaged index funds. Unmanaged funds typically follow indexes and lose you the least in fees, which is useful for those to subscribe to this idea that no one beats the market in the long run, and thus invest mostly in index funds.
- thecopy 12y ago
  If you happen to live in Sweden, i would recommend Avanza Zero[0]. Swedish index fund with no fees at all, not even courtage. (I do not work for Avanza or have any affiliation) [0] https://www.avanza.se/vart-utbud/handel/avanza-zero.html https://www.avanza.se/vart-utbud/handel/avanza-zero.html
  - liugiul 12y ago
    Swede & Avanza customer checking in. Can definitely recommend them. If you reside and Sweden, make sure to open a ISK, not an Aktie- och Fondkonto (stock & fund account). Living in Germany and have not been able to find a bank with the same kind of service and reliability. Comdirect comes close, but not good enough for me to close my account with Avanza.
- JonFish85 12y ago
  If you want to be mildly outraged, compare your 401k program's S&P 500 tracking fund's fees with Vanguard's. Depending on your company, it can be more than 20x the cost, for a fund that requires minimal oversight.
  - gleenn 12y ago
    My coworker at an old job did exactly that: found a matching Vanguard fund with nearly identical funds to our 401K. It had 1/6th the fees and that company lost a significant amount of my money. The tax benefits of the higher tax free cap for 401K's versus just having an IRA were definitely not made up for by how poorly my 401K's investments went. tl;dr: open an IRA, buy Vanguard
walshemj 12y ago
A number of the Big UK Investment trusts have been beating the FTSE 100 over the last 10 years or more I have Several of those as inventments.
- virmundi 12y ago
  Would you be so kind as to name them? I'm not knowledgeable about exchanges outside of the US.
  - walshemj 12y ago
    Lowland LWI Bankers BNKR and City Of London CTY
    - virmundi 12y ago
      Thank you. I'll look at those after Hellboy 2.
      - aswanson 12y ago
        ? This comment gave me the hardest laugh i've had in ages. Thanks.
- henrikschroder 12y ago
  Of course they have, that's the expected statistical outcome of thousands of funds. The problem is that 1) You were lucky in picking those, not prescient. 2) Their winning streak is a result of luck, not competence. Funds are a perfect example of survivorship bias in a zero-sum game. For someone to win at beating the index, someone else must lose, and losers are routinely eliminated. So when an investor presents funds for your choosing, you only get to see the lucky ones, a biased sample. Of course it looks like a great idea to invest in them!
  - walshemj 12y ago
    You do know that those funds have decades and some IT's cases century's of history behind them. The funds I mentioned have very good track records for 3 or 4 decades or more its just that they don't pay advisors fees or pander to tracking the "index" why do you think a number of very rich families have used active funds? If its good enough for Lord Rothschild its good enough for me.
nicholasdrake 12y ago
this is really shocking.
downandout 12y ago
The title of this article implies that no funds beat the market over time, and that isn't true. The study it is based on (which was done by S&P, a company that profits when people invest based upon their index) doesn't look at overall returns. It looks at whether any funds were in the top 25% for the last 5 consecutive years. The answer is no, but who cares? Profitable investing is far more about how right you are (when you are right) than how often you are right.
hyperbling 12y ago
nothing new here. the OP doesn't even mention anything about taxes, which shifts things even more in favor of index investing.
cs702 12y ago
Misleading statistic: "We selected the 25 percent of funds with the best returns over those 12 months — and then asked how many of those funds actually remained in the top quarter in each of the four succeeding 12-month periods through March 2014." The statistic that matters, as Warren Buffett and others have repeated again and again, is COMPOUND RETURN!!! Consider these two investment options. Option 1 outperforms 60% of the time (three out of five years), but Option 2 produces a greater compound gain: YEAR Option 1 Option 2 Year 1 8.0% 15.0% Year 2 8.0% 7.0% Year 3 8.0% 4.0% Year 4 8.0% 19.0% Year 5 8.0% 6.0% Total gain 46.9% 61.4% Compound/yr 8.0% 10.1% The study I'd love to see is one that finds out (1) whether there are actively managed funds that consistently produce better compound returns than the indices over five to 10 year periods, and (2) whether there are any unusual concentrations of long-term compound outperformance that cannot be explained by chance among those funds. For example, what if it turns out that only a small number of actively managed funds are consistent long-term outperformers but many of them claim to use the same investment methodology? That would be a very unusual concentration of long-term success. I'd love to see a study with that kind of analysis.
- liugiul 12y ago
  What if you start investing in a bad year then?
  - EliRivers 12y ago
    If you invested only at the peaks, right before crashes? Still works out great. http://awealthofcommonsense.com/worlds-worst-market-timer/ http://awealthofcommonsense.com/worlds-worst-market-timer/
    - dxhdr 12y ago
      http://www.acting-man.com/blog/media/2014/10/2-Nikkei-Long-term.gif http://www.acting-man.com/blog/media/2014/10/2-Nikkei-Long-t... Yes we're talking about the S&P500 but I'd like to point out that this isn't a general rule of markets; past performance does not guarantee future results. The S&P500 was at around 60 in 1960 and near 2000 today. It doesn't matter when you bought or at what intervals, money invested has performed well.
vilhelm_s 12y ago
> In other words, if all of the managers of the 2,862 funds hadn’t bothered to try to pick stocks at all — if they had merely flipped coins — they would, as a group, probably have produced better numbers. Instead of two funds at the end of five years, basic probability theory tells us there should have been three. Um. You are trying to tell me that 2 instead of 3 is enough to reject the null hypothesis? I rather doubt it.
andrewmutz 12y ago
Actively managed funds struggle to beat the market over the long term. There's a lot of evidence that passive investing (i.e. just buying a low-fee index fund) is the way to go right now for most investors. The presence of active management, however, is good for the rest of us. Through their struggle to beat the market, they conduct extensive research that is used to better price public equities. Those better prices help the passive participants, since they pay roughly correct prices for the dividends they will be receiving.
lordnacho 12y ago
There's not much emphasis on risk in this article. If some fund returns the same as the market with less risk, that's arguably beating the market. If you can get leverage from anywhere (such as a mortgage) you can invest more in such a fund than you otherwise could and make more money.
- ndesaulniers 12y ago
  The term you're looking for is "efficient." Equal returns but lower risk means the fund or allocation is more efficient. http://en.wikipedia.org/wiki/Efficient_frontier http://en.wikipedia.org/wiki/Efficient_frontier
swalsh 12y ago
" The truth is that very few professional investors have actually managed to outperform the rising market consistently over those years." To be honest, the market has been performing so well I don't really care if my portfolio outperforms it. My index funds have been doing pretty well by themselves.
ghufran_syed 12y ago
For an interesting perspective by a guy who runs his own hedge fund, but also appears to have a lot of insight into his own performance and the way the market works, read "Fooled by Randomness" by Nassim Taleb
rifung 12y ago
Not that I would advocate for investing in actively managed funds, but my understanding is that part of the reason it's been very difficult to beat the market these past years is because stocks as a whole have been doing very well. At least for value investors like Warren Buffet, it seems they are more likely to be able to beat the market when it isn't so bearish, because that's when you'd be able to find stocks at good prices. It also appears that the reason stocks are doing so well recently is because of quantitative easing, although I'll admit I don't know much about the economy; this is just what I gather from reading articles. Still, if this is true then it's rather disturbing that the markets can be so heavily influenced by decisions which are arguably outside of a business's direct control.
spevak 12y ago
This article is extremely misleading about the statistics it presents. It claims that you could outperform the funds by investing in random stocks, but the probabilistic model presented in the "source" article (http://www.nytimes.com/2014/07/27/your-money/heads-or-tails-either-way-you-might-beat-a-stock-picker.html http://www.nytimes.com/2014/07/27/your-money/heads-or-tails-...) is a completely different system. It assumes that every 12 month period, there is a 1/4 chance of being in the top quartile of funds, which is an absurd assumption and also completely unrelated to modeling success of picking random stocks. Sure, there'd be a 1/4 chance of being in the upper quartile of other funds ALSO INVESTING RANDOMLY. But to say you'd have the same chances of beating other actively managed funds makes the assumption that all the other funds are not doing any better than random investment. Big surprise that the conclusion is that funds don't do any better than random investment.
- pessimizer 12y ago
  For this objection to be meaningful wouldn't the group of funds as a whole need to have outperformed the market as a whole? The average of the return of all stocks in the market is the same as the average of an infinite number of random samples from the market.
OisinMoran 12y ago
"Still, those two funds did manage to perform splendidly in that study. Their stubborn persistence at the top of the heap over that five-year period suggested that there was some hope for active fund managers. If they could do it, after all, others could, too." If the authors expected randomly picking stocks to churn out 3 mutual funds that beat the market 5 years in a row then this explanation is nonsense. Their "stubborn persistence" is just an empty narrative slapped over a blatant case of survivorship bias. This paragraph makes it seem like whoever wrote it didn't understand any of the rest of the article.

94 points by dcre 12y ago

Can someone explain why they flip a coin twice per year per fund? The author wrote a second column (http://www.nytimes.com/2014/07/27/your-money/heads-or-tails-either-way-you-might-beat-a-stock-picker.html http://www.nytimes.com/2014/07/27/your-money/heads-or-tails-...) explaining how they came up with the number of funds that would outperform the market five years in a row. The reasoning goes like this: 2/2862 funds made it (or about 0.07% of funds). The author then says: If you assume a fund has a 50% chance of beating the market, and a 50% chance of falling behind then the chances of one beating the market five years in a row would be 0.5^(5 * 2). They just state that they flip a coin twice per year per fund (hence 0.5^10), can someone explain why?

scottfr 12y ago
"Beat the market" is misleading. In the article "beat the market" means be in the top 25% of the market, therefore equivalent to winning two coin flips each year.

ForHackernews 12y ago

Also worth noting, hedge funds (aka 'mutual funds for the extremely wealthy') typically under-perform the market: http://www.bloombergview.com/articles/2015-02-12/hedge-funds-underperform-as-investors-give-them-more-money http://www.bloombergview.com/articles/2015-02-12/hedge-funds...

ghettoCoder 12y ago

Nothing new here. Mutual funds are just a way for fund managers to charge inflated management fees for average to below average returns. Get a basic index fund and save the fees. The few years the managed funds beats the index funds will easily be offset by all the fees and other gotchas.

walshemj 12y ago
only problem with the index funds Is you have to buy the dogs in the index an active managed fund can get out of situations like the uk supermarkets and banks. I number of my actively managed investments did this so now an index fund will realistically always under perform this active fund.
- dcre 12y ago
  The point is that those active funds mess it up so badly when the market is doing well that the performance of the index funds is still better over the long run.
- gwern 12y ago
  > so now an index fund will realistically always under perform this active fund. So why don't they?
  - walshemj 12y ago
    Some do you just have to know what your doing and be prepared to invest against the market BKY LWY and TRY in the UK have done very very well for me over that last decade. many of my long term active investments have beaten the market over 10 years by over 100% you just need to look at the ones with 50-100 years track records Look at the average IT vs Unit trust vs bench mark
- asr 12y ago
  The entire point of decades of research, and the above article, is that next to nobody can reliably tell you in advance which stocks are "the dogs." I'm glad for you, but if you want to convince me your active funds can reliably beat the market you would need to provide me a lot more data, as you are swimming upstream against a raging torrent of empirical research.
  - walshemj 12y ago
    Where do the Rothschilds keep their money not in Index funds but in actively managed IT's RIT Capital Partners has done very nicely. And Mr Buffet's investment company has beaten wall street for decades. You are believing all that advertising the index fund managers are putting out and your bank is aggressively selling you.

fideloper 12y ago

For those interested, Vanguard has some of the lowest cost unmanaged index funds. Unmanaged funds typically follow indexes and lose you the least in fees, which is useful for those to subscribe to this idea that no one beats the market in the long run, and thus invest mostly in index funds.

thecopy 12y ago
If you happen to live in Sweden, i would recommend Avanza Zero[0]. Swedish index fund with no fees at all, not even courtage. (I do not work for Avanza or have any affiliation) [0] https://www.avanza.se/vart-utbud/handel/avanza-zero.html https://www.avanza.se/vart-utbud/handel/avanza-zero.html
- liugiul 12y ago
  Swede & Avanza customer checking in. Can definitely recommend them. If you reside and Sweden, make sure to open a ISK, not an Aktie- och Fondkonto (stock & fund account). Living in Germany and have not been able to find a bank with the same kind of service and reliability. Comdirect comes close, but not good enough for me to close my account with Avanza.
JonFish85 12y ago
If you want to be mildly outraged, compare your 401k program's S&P 500 tracking fund's fees with Vanguard's. Depending on your company, it can be more than 20x the cost, for a fund that requires minimal oversight.
- gleenn 12y ago
  My coworker at an old job did exactly that: found a matching Vanguard fund with nearly identical funds to our 401K. It had 1/6th the fees and that company lost a significant amount of my money. The tax benefits of the higher tax free cap for 401K's versus just having an IRA were definitely not made up for by how poorly my 401K's investments went. tl;dr: open an IRA, buy Vanguard

walshemj 12y ago

A number of the Big UK Investment trusts have been beating the FTSE 100 over the last 10 years or more I have Several of those as inventments.

virmundi 12y ago
Would you be so kind as to name them? I'm not knowledgeable about exchanges outside of the US.
- walshemj 12y ago
  Lowland LWI Bankers BNKR and City Of London CTY
  - virmundi 12y ago
    Thank you. I'll look at those after Hellboy 2.
    - aswanson 12y ago
      ? This comment gave me the hardest laugh i've had in ages. Thanks.
henrikschroder 12y ago
Of course they have, that's the expected statistical outcome of thousands of funds. The problem is that 1) You were lucky in picking those, not prescient. 2) Their winning streak is a result of luck, not competence. Funds are a perfect example of survivorship bias in a zero-sum game. For someone to win at beating the index, someone else must lose, and losers are routinely eliminated. So when an investor presents funds for your choosing, you only get to see the lucky ones, a biased sample. Of course it looks like a great idea to invest in them!
- walshemj 12y ago
  You do know that those funds have decades and some IT's cases century's of history behind them. The funds I mentioned have very good track records for 3 or 4 decades or more its just that they don't pay advisors fees or pander to tracking the "index" why do you think a number of very rich families have used active funds? If its good enough for Lord Rothschild its good enough for me.

nicholasdrake 12y ago

this is really shocking.

downandout 12y ago

The title of this article implies that no funds beat the market over time, and that isn't true. The study it is based on (which was done by S&P, a company that profits when people invest based upon their index) doesn't look at overall returns. It looks at whether any funds were in the top 25% for the last 5 consecutive years. The answer is no, but who cares? Profitable investing is far more about how right you are (when you are right) than how often you are right.

hyperbling 12y ago

nothing new here. the OP doesn't even mention anything about taxes, which shifts things even more in favor of index investing.

cs702 12y ago

Misleading statistic: "We selected the 25 percent of funds with the best returns over those 12 months — and then asked how many of those funds actually remained in the top quarter in each of the four succeeding 12-month periods through March 2014." The statistic that matters, as Warren Buffett and others have repeated again and again, is COMPOUND RETURN!!! Consider these two investment options. Option 1 outperforms 60% of the time (three out of five years), but Option 2 produces a greater compound gain: YEAR Option 1 Option 2 Year 1 8.0% 15.0% Year 2 8.0% 7.0% Year 3 8.0% 4.0% Year 4 8.0% 19.0% Year 5 8.0% 6.0% Total gain 46.9% 61.4% Compound/yr 8.0% 10.1% The study I'd love to see is one that finds out (1) whether there are actively managed funds that consistently produce better compound returns than the indices over five to 10 year periods, and (2) whether there are any unusual concentrations of long-term compound outperformance that cannot be explained by chance among those funds. For example, what if it turns out that only a small number of actively managed funds are consistent long-term outperformers but many of them claim to use the same investment methodology? That would be a very unusual concentration of long-term success. I'd love to see a study with that kind of analysis.

liugiul 12y ago
What if you start investing in a bad year then?
- EliRivers 12y ago
  If you invested only at the peaks, right before crashes? Still works out great. http://awealthofcommonsense.com/worlds-worst-market-timer/ http://awealthofcommonsense.com/worlds-worst-market-timer/
  - dxhdr 12y ago
    http://www.acting-man.com/blog/media/2014/10/2-Nikkei-Long-term.gif http://www.acting-man.com/blog/media/2014/10/2-Nikkei-Long-t... Yes we're talking about the S&P500 but I'd like to point out that this isn't a general rule of markets; past performance does not guarantee future results. The S&P500 was at around 60 in 1960 and near 2000 today. It doesn't matter when you bought or at what intervals, money invested has performed well.

vilhelm_s 12y ago

> In other words, if all of the managers of the 2,862 funds hadn’t bothered to try to pick stocks at all — if they had merely flipped coins — they would, as a group, probably have produced better numbers. Instead of two funds at the end of five years, basic probability theory tells us there should have been three. Um. You are trying to tell me that 2 instead of 3 is enough to reject the null hypothesis? I rather doubt it.

andrewmutz 12y ago

Actively managed funds struggle to beat the market over the long term. There's a lot of evidence that passive investing (i.e. just buying a low-fee index fund) is the way to go right now for most investors. The presence of active management, however, is good for the rest of us. Through their struggle to beat the market, they conduct extensive research that is used to better price public equities. Those better prices help the passive participants, since they pay roughly correct prices for the dividends they will be receiving.

lordnacho 12y ago

There's not much emphasis on risk in this article. If some fund returns the same as the market with less risk, that's arguably beating the market. If you can get leverage from anywhere (such as a mortgage) you can invest more in such a fund than you otherwise could and make more money.

ndesaulniers 12y ago
The term you're looking for is "efficient." Equal returns but lower risk means the fund or allocation is more efficient. http://en.wikipedia.org/wiki/Efficient_frontier http://en.wikipedia.org/wiki/Efficient_frontier

swalsh 12y ago

" The truth is that very few professional investors have actually managed to outperform the rising market consistently over those years." To be honest, the market has been performing so well I don't really care if my portfolio outperforms it. My index funds have been doing pretty well by themselves.

ghufran_syed 12y ago

For an interesting perspective by a guy who runs his own hedge fund, but also appears to have a lot of insight into his own performance and the way the market works, read "Fooled by Randomness" by Nassim Taleb

rifung 12y ago

Not that I would advocate for investing in actively managed funds, but my understanding is that part of the reason it's been very difficult to beat the market these past years is because stocks as a whole have been doing very well. At least for value investors like Warren Buffet, it seems they are more likely to be able to beat the market when it isn't so bearish, because that's when you'd be able to find stocks at good prices. It also appears that the reason stocks are doing so well recently is because of quantitative easing, although I'll admit I don't know much about the economy; this is just what I gather from reading articles. Still, if this is true then it's rather disturbing that the markets can be so heavily influenced by decisions which are arguably outside of a business's direct control.

spevak 12y ago

This article is extremely misleading about the statistics it presents. It claims that you could outperform the funds by investing in random stocks, but the probabilistic model presented in the "source" article (http://www.nytimes.com/2014/07/27/your-money/heads-or-tails-either-way-you-might-beat-a-stock-picker.html http://www.nytimes.com/2014/07/27/your-money/heads-or-tails-...) is a completely different system. It assumes that every 12 month period, there is a 1/4 chance of being in the top quartile of funds, which is an absurd assumption and also completely unrelated to modeling success of picking random stocks. Sure, there'd be a 1/4 chance of being in the upper quartile of other funds ALSO INVESTING RANDOMLY. But to say you'd have the same chances of beating other actively managed funds makes the assumption that all the other funds are not doing any better than random investment. Big surprise that the conclusion is that funds don't do any better than random investment.

pessimizer 12y ago
For this objection to be meaningful wouldn't the group of funds as a whole need to have outperformed the market as a whole? The average of the return of all stocks in the market is the same as the average of an infinite number of random samples from the market.

OisinMoran 12y ago

"Still, those two funds did manage to perform splendidly in that study. Their stubborn persistence at the top of the heap over that five-year period suggested that there was some hope for active fund managers. If they could do it, after all, others could, too." If the authors expected randomly picking stocks to churn out 3 mutual funds that beat the market 5 years in a row then this explanation is nonsense. Their "stubborn persistence" is just an empty narrative slapped over a blatant case of survivorship bias. This paragraph makes it seem like whoever wrote it didn't understand any of the rest of the article.