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That's some bad reporting by Bloomberg. The advice against active manage fund isn't that they can't beat the market. It's that they can't beat the market better

by NhanH 12y ago

That's some bad reporting by Bloomberg. The advice against active manage fund isn't that they can't beat the market. It's that they can't beat the market better than random chance. In other words, the argument was that performance of stock picker is a completely random process that follow the standard normal distribution. Some one will beat the market, you can't tell who it is though

Mikeb85 12y ago
You most definitely can beat the market, and beat it by a lot. However, the bigger your holdings, the less likely it is to beat the market, since your trade execution suffers the more you're trying to trade at a time (try selling off 100K shares in something when the daily volume is less than a million, for instance). Anyhow, half the point of a hedge fund isn't even to beat the market, but to hedge against market downturns. The ones beating the market are prop traders and the like...
- cowsandmilk 12y ago
  funds 4, 5, and 6 on the bloomberg list (the primecap funds) are all closed to new investors. That is one way to try to avoid the problem.
vasilipupkin 12y ago
yes, if you have a million money managers, 50K of them will beat the market, at a 5% confidence interval another problem is, what is the proper benchmark? say he beat S&P 500. Ok, but we know that small stocks or value stocks outperform S&P 500. Did he beat a small stocks index? My guess is once you construct a proper benchmark, it becomes even less likely that he really did beat it.
- mizzao 12y ago
  Another way to look at what you're saying is to ask whether a small cap index beat the S&P 500 over the last 40 years. Of course it did (see the following link for the last 10 years, as Google doesn't have earlier data; https://www.google.com/finance?chdnp=1&chdd=1&chds=1&chdv=1&chvs=maximized&chdeh=0&chfdeh=0&chdet=1427071690248&chddm=1064088&chls=IntervalBasedLine&cmpto=INDEXSP:SP600&cmptdms=0&q=INDEXSP:.INX&ntsp=0&ei=IGIPVYHoB4O38QafpIDABA https://www.google.com/finance?chdnp=1&chdd=1&chds=1&chdv=1&... ); as higher (diversified) risk begets higher return, but the returns were also far more volatile. So if he still achieved the return of a small cap index without as much volatility, that would have accomplished something.
makmanalp 12y ago
I believe it's also that a lot of times even if the /fund/ consistently beats the market, once you include fees, it becomes much worse or riskier a deal.
codexon 12y ago
I don't understand why people think everyone has access to the same amount of information and that the efficient market hypothesis holds outside an academic setting. In the real world insider trading is everywhere, and people pay big bucks to get data faster and trade faster than everyone else. The main reason most people lose money on the stock market is because it is a zero sum game baring inflation, not because of EMH.
- Mikeb85 12y ago
  A significant amount is returned to the market through buybacks and dividends...
  - codexon 12y ago
    That money comes out of the company which came out of other people. It doesn't come from thin air. I know you can create "value" when currency changes hands, but we're talking about beating the average returns. And for someone to do better than the market, someone else will obviously do worse.
    - Mikeb85 12y ago
      And it returns to the economy when those investors buy basically anything. Money will always return to the economy, except when people hoard cash (which is why inflation is key to our society - it reduces the value of cash and increases the money supply so that hoarding is a bad investment). > And for someone to do better than the market, someone else will obviously do worse. While it's true someone will do worse (especially when 'trading'), that 'worse' could just be a lower profit. After all, the stock markets do generally go up over time. Inflation helps, and of course economic growth too. One post isn't enough to explain the entire monetary system, however investing isn't a 'zero-sum' game...
DavidSJ 12y ago
If the title of the article were accurate (which it's not, since the text of the article confirms the fund did not outperform in each of those 40 years), then that performance would be hard to explain by random chance. Assuming naively a 50% chance of beating the market each year, doing it consecutively for 40 years straight is 10^12 against, which is far larger than the number of people in the world, never mind number of funds. Now, the naive assumption of 50% odds of beating the market is a little dangerous, since there are plenty of investments that are highly likely to beat the market but suffer occasional catastrophic losses -- i.e. without being particularly clever one can trade probabilities for magnitudes. So at the end of the day, there's no substitute for understanding how a fund manager actually thinks and operates. It is possible to beat the market, and to do it consistently and for reasons other than luck. And it's possible, with diligence, to pick a fund manager to do it for you. But merely looking at the history of returns is not diligence, it's laziness, unless the fund has a truly astounding statistical record, which very, very few funds do, even the good ones.
- NhanH 12y ago
  I can't recall the statistical test being done in those papers that conclude how the funds don't do better than random chance right now, but I don't think random chance imply 50% chance to beat the market each year - so your maths following that won't hold. Why? I don't know the reason, but have a note: one year is a completely artificial cut off range. There is no reason to naively assume that it would be 50% chance of beating the market every year rather than 50% chance every 10 years, or 50% every other full moon. I think the maths will have to be done on something else and not a range period.
  - DavidSJ 12y ago
    You're right that it's an arbitrary interval, but the math is still valid if you assume (as I cautioned against) that each investment is a coin flip relative to the market. In that case, over any time period your relative performance is the sum of a series of coin flips, i.e. a binomial distribution with mean 0. This has a 50% chance of outperformance regardless of the interval -- what changes as a function of interval is the total variance, not the median result. One consequence of this is that the probability of outperforming each day over 40 days is the same as outperforming each year over 40 years. The latter sounds more impressive, but it actually isn't. The former would be impressive too if the null hypothesis really is a series of coin flips (but again, it's not).

by NhanH 12y ago

Mikeb85 12y ago

You most definitely can beat the market, and beat it by a lot. However, the bigger your holdings, the less likely it is to beat the market, since your trade execution suffers the more you're trying to trade at a time (try selling off 100K shares in something when the daily volume is less than a million, for instance). Anyhow, half the point of a hedge fund isn't even to beat the market, but to hedge against market downturns. The ones beating the market are prop traders and the like...

cowsandmilk 12y ago
funds 4, 5, and 6 on the bloomberg list (the primecap funds) are all closed to new investors. That is one way to try to avoid the problem.

vasilipupkin 12y ago

yes, if you have a million money managers, 50K of them will beat the market, at a 5% confidence interval another problem is, what is the proper benchmark? say he beat S&P 500. Ok, but we know that small stocks or value stocks outperform S&P 500. Did he beat a small stocks index? My guess is once you construct a proper benchmark, it becomes even less likely that he really did beat it.

mizzao 12y ago
Another way to look at what you're saying is to ask whether a small cap index beat the S&P 500 over the last 40 years. Of course it did (see the following link for the last 10 years, as Google doesn't have earlier data; https://www.google.com/finance?chdnp=1&chdd=1&chds=1&chdv=1&chvs=maximized&chdeh=0&chfdeh=0&chdet=1427071690248&chddm=1064088&chls=IntervalBasedLine&cmpto=INDEXSP:SP600&cmptdms=0&q=INDEXSP:.INX&ntsp=0&ei=IGIPVYHoB4O38QafpIDABA https://www.google.com/finance?chdnp=1&chdd=1&chds=1&chdv=1&... ); as higher (diversified) risk begets higher return, but the returns were also far more volatile. So if he still achieved the return of a small cap index without as much volatility, that would have accomplished something.

makmanalp 12y ago

I believe it's also that a lot of times even if the /fund/ consistently beats the market, once you include fees, it becomes much worse or riskier a deal.

codexon 12y ago

I don't understand why people think everyone has access to the same amount of information and that the efficient market hypothesis holds outside an academic setting. In the real world insider trading is everywhere, and people pay big bucks to get data faster and trade faster than everyone else. The main reason most people lose money on the stock market is because it is a zero sum game baring inflation, not because of EMH.

Mikeb85 12y ago
A significant amount is returned to the market through buybacks and dividends...
- codexon 12y ago
  That money comes out of the company which came out of other people. It doesn't come from thin air. I know you can create "value" when currency changes hands, but we're talking about beating the average returns. And for someone to do better than the market, someone else will obviously do worse.
  - Mikeb85 12y ago
    And it returns to the economy when those investors buy basically anything. Money will always return to the economy, except when people hoard cash (which is why inflation is key to our society - it reduces the value of cash and increases the money supply so that hoarding is a bad investment). > And for someone to do better than the market, someone else will obviously do worse. While it's true someone will do worse (especially when 'trading'), that 'worse' could just be a lower profit. After all, the stock markets do generally go up over time. Inflation helps, and of course economic growth too. One post isn't enough to explain the entire monetary system, however investing isn't a 'zero-sum' game...

DavidSJ 12y ago

If the title of the article were accurate (which it's not, since the text of the article confirms the fund did not outperform in each of those 40 years), then that performance would be hard to explain by random chance. Assuming naively a 50% chance of beating the market each year, doing it consecutively for 40 years straight is 10^12 against, which is far larger than the number of people in the world, never mind number of funds. Now, the naive assumption of 50% odds of beating the market is a little dangerous, since there are plenty of investments that are highly likely to beat the market but suffer occasional catastrophic losses -- i.e. without being particularly clever one can trade probabilities for magnitudes. So at the end of the day, there's no substitute for understanding how a fund manager actually thinks and operates. It is possible to beat the market, and to do it consistently and for reasons other than luck. And it's possible, with diligence, to pick a fund manager to do it for you. But merely looking at the history of returns is not diligence, it's laziness, unless the fund has a truly astounding statistical record, which very, very few funds do, even the good ones.

NhanH 12y ago
I can't recall the statistical test being done in those papers that conclude how the funds don't do better than random chance right now, but I don't think random chance imply 50% chance to beat the market each year - so your maths following that won't hold. Why? I don't know the reason, but have a note: one year is a completely artificial cut off range. There is no reason to naively assume that it would be 50% chance of beating the market every year rather than 50% chance every 10 years, or 50% every other full moon. I think the maths will have to be done on something else and not a range period.
- DavidSJ 12y ago
  You're right that it's an arbitrary interval, but the math is still valid if you assume (as I cautioned against) that each investment is a coin flip relative to the market. In that case, over any time period your relative performance is the sum of a series of coin flips, i.e. a binomial distribution with mean 0. This has a 50% chance of outperformance regardless of the interval -- what changes as a function of interval is the total variance, not the median result. One consequence of this is that the probability of outperforming each day over 40 days is the same as outperforming each year over 40 years. The latter sounds more impressive, but it actually isn't. The former would be impressive too if the null hypothesis really is a series of coin flips (but again, it's not).