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|| Step 3 : Stock Pickers |
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The most common form of active
management is stock picking. On average, stock pickers will
always lose by the amount of their costs and expenses. Some
will do better and some will do worse than an appropriate
or blended benchmark of risk factors. Since the average return
of the market is the average return of all investors, the
average investor gets the average return. Although you may
think that you can choose or be the investor who beats the
others, the probability of a money manager outperforming other
managers each year is equal to getting heads on the toss of
a coin: 50/50. This is because the markets are random, just
like the coin toss. The chances of a manager beating a market
over the long term (more than 10 years) were 1 in 36 in one
study, and 1 in 39 in another 30-year study! You would be
better off betting on one number on the roulette table in
Vegas, where odds are 1 in 38. So far, we have collected over
200 articles measuring the performance of active managers,
starting with Alfred Cowles in 1933, and the results are not
good for active management.
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more |
Stock
pickers are exactly what their name implies - active
investors who pick stocks or even mutual funds based
on perceived mismatches between the current market
prices and their supposed true values. This is a major
problem. In this random and efficient market, there
are no mismatches between the current market prices
and their true value. Stock pickers are listening
to their feelings and instincts when deciding what
stock to pick. A study in this Step reveals that the
chances of the active manager beating the appropriate
index are one in thirty-six, the same long shot as
throwing snake eyes at the craps table! Less than
three percent of managers even beat their proper benchmark.
Unlike methodical index investors, active investors
who try to stock pick are little more than gamblers
who rely on raw emotion and their imagined ability
to predict tomorrow's news. As Nobel Laureate Bill
Sharpe asks, "why pay people to gamble with your money?"
When investors pay high loads, commissions or fees
to stock pickers, it may be more appropriate to refer
to them as pocket pickers.
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" it turns out for
all practical purposes there is no
such thing as stock picking skill.
It's human nature to find patterns
where there are none and to find skill
where luck is a more likely explanation
(particularly if you're the lucky
[mutual fund] manager)." Mutual fund
manager performance does not persist
and the return of stock picking is
zero." We are looking at the proverbial
bunch of chimpanzees throwing darts
at the stock page. Their "success"
or "failure" is a purely random affair " |
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William Bernstein, The Intelligent Asset Allocator
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" If there's 10,000 people looking at the
stocks and trying to pick winners,
one in 10,000 is going to score, by
chance alone, a great coup, and that's
all that's going on. It's a game,
it's a chance operation, and people
think they are doing something purposeful...
but they're really not. " |
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Merton
Miller, Nobel
Laureate and Professor of Economics, Univ.
of Chicago, Transcript of the PBS Nova
Special,"The Trillion Dollar Bet" |
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"
Empirical evidence provides no support
for the claim that active management
of small-cap portfolios is more fruitful
than it is for large-cap portfolios.
" |
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" The economists arrived at a devastating conclusion:
it seemed just as plausible to attribute
the success of top traders to sheer
luck, rather than skill. " |
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Transcript of the PBS Nova Special, "The Trillion Dollar
Bet" |
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" Not surprisingly,
the efficient market hypothesis does
not exactly arouse enthusiasm in the
community of professional portfolio
managers. It implies that a great
deal of the activity of portfolio
managers - the search for undervalued
securities - is at best wasted effort,
and quite probably harmful to clients
because it costs money and leads to
imperfectly diversified portfolios.
" |
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Zvi Bodie, Alex Kane,
Alan J. Marcus, Investments, p.
355 |
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" After taking risk
into account, do more managers than you'd
see by chance outperform with persistence?
Virtually every economist who studied this
question answers with a resounding "no."
Mike
Jensen in the Sixties and
Mark Carhart in the Nineties both
conducted exhaustive studies of professional
investors. They each conclude that in general
a manager's fee, and not his skill, plays
the biggest role in performance." [the higher
the fee, the lower the performance " |
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Eugene Fama, Jr. |
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"
I
have been a stockbroker for 5 years
and have made people money, but I
always lose it in the end.
I have taken
huge risks with my clients. I have
lost millions, but I am tired of looking
for new clients. " |
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" Very little evidence [was found] that any
individual [mutual] fund was able
to do significantly better than that
which we expected from mere random
chance. " |
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Michael Jensen, "The Performance of [115
US Equity] Mutual Funds in the Period
1945-1964", Journal of Finance,
May 1968 |
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" It's like giving up a belief in Santa Claus.
Even though you know Santa Claus doesn't
exist, you kind of cling to that belief.
I'm not saying that this is a scam.
They generally believe they can do
it. The evidence is, however, that
they can't. " |
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Professor Burton Malkiel: - ABC News Program: 20/20, November,
1992 |
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" The only way to "beat an index" is to invest
in something other than the index.
Why would you, when the only source
of long-term risk and return data
IS the index? Since you can't beat
the index, be the index." |
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Mark
Hebner, Founder, Index Funds Advisors,
Inc. |
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" The implication
[of the Efficient Market Hypothesis]
for the investor is that it is almost
impossible to "beat the market. " |
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12th
Grade Economics Text Book, Economics,
(even our kids are learning this)
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"
Investment managers sell for the price
of a Picasso [what] routinely turns
out to be paint-by-number sofa art.
" |
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Patricia C. Dunn, CEO, Barclays Global Advisors (World's
largest money management firm, approx
$1 trillion of assets under management,
approx 80% indexed) |
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Stock Pickers
Stock
pickers are active investors who bet they can beat
a market by picking stocks they believe will outperform
an index. To be precise, the only proper comparison
to their result is the portfolio they choose. All
other portfolios will end up with different risk and
return characteristics. Generally, they are taking
more risk than the index, because they are concentrating
their bets on fewer stocks than those in the index.
When they allocate their portfolio differently than
the index, they are guaranteed to obtain a different
return and risk level. Sometimes it is more and sometimes
it is less, but we can always assume it will be different
when looking at both risk and return. Since it takes
at least 20 years of risk and return data to confirm
skill over luck, stock pickers are faced with a virtually
impossible task in assuring continued success against
the appropriate market index. However, indexes are
a source of 20-year risk and return data, and consequently
are the only logical choice for establishing efficient
portfolios of various levels of expected risks and
returns
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