Evaluating Managed Funds

[Ed Miller]

[ QUOTE ]
[ QUOTE ]
[ QUOTE ]
My point was that small/value tilt in portfolio can explain a lot more than the 1-2% cited.

[/ QUOTE ]

My question was by how many percentage points.

[/ QUOTE ]

Well if you look at the link to the chart you'll see it's double digits.

This SuperInvestor stuff is such non-sense. Warren Buffet is an investor. The rest of us just trade shares of companies. Big difference.

If you are rhetorically asking me to pull out my crystal ball, then all I can direct you to is Fama and French.

[/ QUOTE ]

I'm not asking for crystal balls. But I am asking for more than a link to a chart of two indexes pitted against each other for a few years. To me, that's the equivalent of someone showing me graphs over 10k hands of two different poker players and drawing conclusions about who is better (and about specific winrates thereof) from just those graphs.

And if merely tilting your portfolio toward small/value stocks could produce DOUBLE DIGIT improvements over the S&P, why would anyone ever put their money in the big guys?

I have "Random Walk" by Malkiel on my reading list, and I suppose I'll look into Fama and French too.

Without having read the stuff about EMT, though, I am strongly skeptical of its practical application . It seems difficult for me to understand how the happenings of 1998-2002 can be explained by EMT. Or, for that matter, how stocks can go up and down so wildly, day to day, on zero news about that company. Or on news that is functionally irrelevant. This isn't, to me, how an "efficient" market would behave.

And look at how easily penny stock prices (or bigger stocks like WPTE) can be manipulated. How can the market possibly be "efficient" when one person, or a small group of people, can waltz in and predictably alter the price of the stock significantly one way or the other?

[Ed Miller]

So I read your interview.. I found this passage interesting:

[ QUOTE ]
So once you've decided to take the market risk, creating your portfolio seems to come down to deciding what your overall risk level is, and then you allocate by size, and between growth and value, to achieve your risk/reward goals.


Have there been any studies that have ever impressed you about active management in any capacity? I mean, has there been any evidence that would suggest to you that all of the Wall Street analysts, gurus, salesmen, and research departments are anything but a complete waste of time?


You used the key word: salesmen. I might be willing to say that the people who get pointed at consistently, who have shown consistent performance even after they have been pointed at, really do have something. These are always the same people, Warren Buffet, Peter Lynch, and then who?

Okay. You talk to Rex Sinquefield, and he'll tell you that in any normal distribution you're going to get those outlying orangutans.


I put it carefully. I said if you identify them, and in the future they continue to do well, then I'm starting to believe it. This sounds like the frustrations of my college days when I found that the system that worked on the old data didn't work with the new data!


So, in fact, there may be a Lynch and a Buffett effect out there somewhere?


There may be, but the non sequiturs that people jump to after that is to say, Aha! Active management pays!


No, it means that Peter Lynch and Warren Buffett pay! And what is it about them that we can clone? Where's the next one?


Yeah. I don't think that's something you can teach anybody or anything like that. The Magellan Fund [once managed by Peter Lynch] by any risk-adjusted model, is off the map. But there are only one or two like that.


Isn't it interesting that the last three years' performance at Magellan Fund isn't Peter Lynch's? Jeff Vinik's performance was also good. I presume because he made a big bet on technology stocks and won.


Another thing I found when I looked at Magellan was that it had a greater small stock bias when it was a smaller fund.

[/ QUOTE ]

[buffett]

[ QUOTE ]
It seems difficult for me to understand how the happenings of 1998-2002 can be explained by EMT. Or, for that matter, how stocks can go up and down so wildly, day to day...This isn't, to me, how an "efficient" market would behave.

[/ QUOTE ]
As of today, of the 99 US-listed cos. that have a market cap greater than $50B, 32 of them have a 52wkhi at least 40% more than their 52wklo. Did cos. like Motorola, United Health, and Dell really change more than 50% in value in the last 12 months? Or did Tyco, Verizon, and Boeing change more than 40%? Not likely, but their stocks sure did.

[rockrock]

Ed,

I think that one or more of Fama/French/Maliel have stated that while the markets may not be completely effecient all the time, it's best to allocate assests as if EMT were true.

Jeff Vinik subsequently got fired/resigned from Fidelity and now runs a hedge fund. The point is (I think), it's impossible to predict what managers will outperform in the future.

As to your book list, there is one that from all my reading, makes the most sense out of all this debate. It cites the relevant academic papers, recent research and makes a compelling case.

The name of the book and it's description at Amazon is misleading. The Only Guide to a Winning Investment Strategy You'll Ever Need : The Way Smart Money Invests Today - link

If you are at all curious about all of this it would be unfortunate not to read it.

[Ed Miller]

[ QUOTE ]
If you are at all curious about all of this it would be unfortunate not to read it.

[/ QUOTE ]

I'll be happy to read it. I'll order it today.

[DesertCat]

[ QUOTE ]
his SuperInvestor stuff is such non-sense. Warren Buffet is an investor. The rest of us just trade shares of companies. Big difference.

The babble I was referring to was coming from you. Warren Buffet is an investor that buys businesses and actively participates in their management.


[/ QUOTE ]

RockRock,

I'm not sure I'm going to be able to get through to you since your Fama brainwashing seems complete, but Fama has never been able to refute the arguments in the SuperInvestor speech. Let's recap where it started.

Fama and other EMT guys were confronted with the fact that Buffett had averaged a high return (over 25% annually in his first 30 years or so) for a very long time. At first they just called him an "outlier". Buffett's speech points out that there is a family of outliers all descended from Ben Graham (several who worked directly for him), who all operate with the same philosophy, but buy different things. Even if you believe that these guys are one in a million exceptions, it doesn't make sense that the exceptions are tightly packed in one corner of the universe.

And the problem is that Buffett isn't one in a million by EMT theory, he's one in a trillion. Buffett's old joke is that the EMT guys just keep adding a sigma as he keeps beating the market.

So Fama decided to come up with another explanation. Buffett's not an investor, he's a businessman who actively manages businesses. This idea is a laughable fraud. First, for the first part of Buffett's career, he was just the lead investor of a tiny fund, who had little contact with management of his investments. And that was his period of greatest outperformance, he crushed the market a 35%+ annually.

As he managed more money, he was forced to take a more "active" role with managemnet in some rare cases. But that role can hardly be credited with providing outperformance. In some cases, Disney for example, management didn't give a horses behind for his views, so he was forced to sell. In others, Coke, it was just a great business run by great ma management (at the time). They had the same views. And since then, Coke management has screwed up left and right, despite his "influence".

Mostly, he likes to buy companies outright at great prices when given the chance. But do you really think he's responsible for the success of See's candies over the last 30 years? Berkshire owns so many companies that WEB taking active roles defies common sense. Most of his CEO's rarely hear from him. They are just great businesses that stay great because he keeps the original management.

Even if you figure that Buffett's success is based on his hands on management skills, it doesn't explain the rest of the super investors. Few of those are actively involved in hands-on management. Bill Miller isn't running Amazon.

And your viewpoint that small cap exposure explains outperformance for these guys is silly. Academic studies credit small caps with an extra 1% per year or so of outperformance decades. That doesn't explain beating the market by 10-15% per year, esp. when most of the SuperInvestors long ago stopped being able to invest in small caps. Buffett for example is now limited in most cases to $10B market caps and above.

The reality is, and I think Buffett would say this as well, EMT is true most of the time. The market is usually efficient. It's difficult or impossible to trade based on "patterns", since no-one can predict which ones will continue. For most investors, index funds are the best low cost choice. Most active management fails to beat the market by more than their fees. This may not be as true with hedge funds, but it's especially true in mutual funds, which have horrible structures almost destined to trail the market.

But if you are a good value investor, investing in a private investment fund or just on your own, you can beat the market. There are mispriced securities out there. Finding them just requires patience and hard work. I know this because I've been doing it for over four years with great results.

Fama doesn't know this because he doesn't understand value investing, i.e. real investing. Fama and other EMT guys think that some stocks are "value stocks" and some "growth stocks", when in truth, all stocks are value stocks at the right price. They think you must be able to predict price action to be a successful investor, which isn't true. Fama lumps in large actively managed mutual funds that are really index funds in drag, chartists, momentum guys, brokerage firms interested more in commissions than performance, etc, when he talks about "investing". Of course the majority of those guys don't beat the market. But in the small group of intelligent Graham-Fisher type investors, there are a great many who do.

BTW, Peter Lynch was a value investor. He ranged all over looking for value, from cheap banks to cheap growth stocks, as long as they were priced as bargains in relation to their true value. When he left, his successors trailed the market for two reasons. One is they weren't as good as Peter, and didn't share the same philosophy. Second, was that Magelleon had simply gotten too large. No matter how good an investor you are, managing bigger portfolios equals worse returns. There simply aren't as many easy to find mispricings in large caps as there are in small.

[adios]

[ QUOTE ]
Of course I'm not sure how Buffett beat the market since he believes the CAPM is pure BS, and that Beta has nothing to do with risk. He's just an old fuddy duddy so out of touch with these smart academic types that he's content with a 50 year record averaging north of 25% a year....

[/ QUOTE ]

Honestly Bill Gates has done much better hasn't he?

[DesertCat]

[ QUOTE ]

Honestly Bill Gates has done much better hasn't he?

[/ QUOTE ]

Well, Bill has only one investment that has done better than Warren's. It's also done better than virtually anything on the planet the last few decades, even if you don't count Microsoft's days as a private company. I'm pretty sure the aggregate performance of Bill's other investments trail Buffett's returns however

Not counting people who start their own businesses and revolutionize industries, Buffett is probably the world's best investor.

[rockrock]

DesertCat,

I am hardly an expert on Buffet but I do know that we mere mortals trade shares of stocks, I know he is an investor, and I know there is a difference.

Congratulations on straw manning Fama and French to death.

The 3 factor model is meant to explain the variation in returns of diversified portfolios. It does not say that small cap beats big caps. These are 2 different things - how an asset class works by itself vs. how performance is affected in a portfolio of diversified asset classes.

The question with FF, from my understanding, is explaining the high R-Squareds. International, Emerging markets and domestic equties have all been tested and it has been shown it is the exposure to the factors of size and growth that determines the vast majority of the returns of diversified portfolios.

Let me know if you are intersted in reading the academic papers and the source of the data sets.

The research problems with Fama and French (again from my understanding) are screening out the so-called "lottery effect" with small caps and the source of the factors - is it risk or anomalies or was the data just random.

Finally, didn't Buffet himself recently recommend index fund for most investors?

At the end of the day, the evidence that the return of a security is a reflection of the performance of it's asset class is something preached from Jim Cramer all the way down to the hallowed halls of Nobel Prize winning academics.

From there, it's an easy leap that what works best is a diversified portfolio of all asset classes. From there it's an easy leap that the best way to get proper diversification within each asset class is through index funds.

[DesertCat]

[ QUOTE ]

I am hardly an expert on Buffet but I do know that we mere mortals trade shares of stocks, I know he is an investor, and I know there is a difference.


[/ QUOTE ]

Uh speak for yourself. I invest in the exact same manner as Buffett. I buy shares in undervalued businesses, as long as there is a catalyst that will bring their price to fair value. For me this approach has been good for a 42% annualized after-tax return over the last four and half years, and that includes one stinker of a year (2005 was only 13%).

[ QUOTE ]

Finally, didn't Buffet himself recently recommend index fund for most investors?


[/ QUOTE ]

He recommended that YOU buy an index fund, i.e. anyone who's not willing to do the research and doesn't have the patience to be a value investor. That means index funds are the only best choice for most investors. But that has no bearing on whether Buffett and the other SuperInvestors serve as suitable proof that the efficient market theory is flawed.

[ QUOTE ]

At the end of the day, the evidence that the return of a security is a reflection of the performance of it's asset class is something preached from Jim Cramer all the way down to the hallowed halls of Nobel Prize winning academics.

From there, it's an easy leap that what works best is a diversified portfolio of all asset classes. From there it's an easy leap that the best way to get proper diversification within each asset class is through index funds.

[/ QUOTE ]

Well Nobel Prize winning academics have horrible track records when it comes to actual investing. Remember Long Term Capital Management?

None of this explains Buffett's success. He's rarely had a diversified portfolio, he's put up to 44% of his portfolio in a single stock. He's rarely ventured out of buying common stocks and bonds. His recent dabbles in currencies and silver have had virtually no impact on his long term performance record.

His success has almost entirely been built on skillful stock picking, and usually in one single narrow asset class at a time. In the 50's he was deep in the small cap/pink sheet stocks. As his portfolio grew he started buying bigger market cap stocks and now he pretty much can only buy the largest of the large caps.

He's beaten the market 42 out of 48 years (and this ignores 5 winning years of the Buffett partnership that overlap with Berkshire Hathaway). His annualized returns in the Buffett Partnership were 29.5% over 12 years. His annualized returns at Berkshire Hathaway have been 21.9% over 40 years.

EMT can't explain Buffett as just "lucky" anymore (like they did in the 70s and early 80s) because it's too improbable to flip a coin 48 times and get heads 42 times. So Fama came up with the silly theory that Warren is a "businessman" not an investor, as if buying 100% of the shares of a company is somehow different than buying 1%. While Warren is great at resource allocation, he doesn't run any of the Berkshire companies. In almost all cases the original managers continue to run their businesses. But I doubt Fama put in the minimal research time on Warren to discern this well known fact.

Fama admits publicly that the market is not perfectly efficient. So why is it so hard to admit that some people are able to profit from those innefficiences, and relize that Warren is the best at it? No-one is arguing the market isn't usually efficient, just that it's occasionally inefficient. There is plenty of proof that if you are patient and work at it, you will find opportunities that provide outsize returns. The problem is, that most investment managers don't understand the true basis of investing (value), and even some that do are stuck in inefficient structures (mutual funds) that make it very difficult to beat the market.