How many people are actually "beating the market"?

[niffe9]

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There is a lack of academic study showing the persistence of outperformance by mutual funds, or studies that would give the average investor the information they would need to choose actively managed mutual funds that would provide superior long term risk adjusted returns over their appropriate indexes.

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As Najdorf has mentioned before, Roger Ibbotson has clearly shown persistence in mutual funds in his research, particularly in following article.
Do Winners Repeat with Style
"Our data of domestic equity mutual funds indicates that winning funds do repeat good performance."
This is a recent paper (2002) by a definitive researcher (sold his financial information firm to Morningstar for tens of millions and is highly regarded by his peers and the industry).

[niffe9]

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Survivorship bias: - It is worse in the hedge fund industry than mutual funds. A hedge fund crashes and burns and it is removed from the statistical pool. That has a huge effect on the appearance of outperformance. It reminds me of the European soccer leagues. Say you have divisions A,B and C. The worst team in division A goes to B and so on. Let’s say you examine the records over the last ten years of all A league teams. They will be over .500 on average. Why? We shipped the losers off the charts and aren’t counting them.

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I think the effect of survivorship bias on mutual funds and hedge funds is often overstated. Many hedge funds close down because of their superior performance and them getting too much money to manage. Mutual funds are compared to benchmarks that have a large survivorship bias of their own (not positive about this correct me if I'm wrong) For example, the original DJIA had 12 stocks where GE is the only survivor today.

[wdcbooks]

I think this article has a good unbiased summary of the evidence:

Summary

I also think there are two sites that gather some really good information in one place, although they do tend to gravitate towards articles that support their viewpoint.

Bogleheads

Altruist

[wdcbooks]

Niffe, I am going to take a flyer without doing the reasearch and say that if a hedge fund company achieves superior performance and closes down a fund for that reason they are still going to list that performance data in support of their management abilities. If their fund crashes and burns it will be scrubbed from the record as if it never existed.

You can see this in mutual funds by going to the Fidelity website for instance. There is a section of closed funds. There is not a section of 'funds so bad that we had to merge them or get rid of them'.

[niffe9]

You provided some good resources in the last post. I agree that on the whole index management outperforms active management. However, like the Ibbotson article concludes, "the highest persistence is exhibited by funds whose alpha is greater than 10% and also by funds whose alpha ranks in the top 5% of the sample." A person does not have to invest in all mutual funds or a random mutual funds, I think it's realistic for someone to be able to do some research and pick one that is likely to outperform its benchmark.

I'm not going to argue your point on the possibility of negative survivorship bias in hedge funds. I was just bringing up a point and after a quick search I still have no idea how valid it is.

My main problems with a lot of these arguments is that people oversimplify things. Just because stocks are really complicated and often efficient doesn't mean the market is holely efficient. Most mutual funds and hedge funds do poorly, but talking about each industry as a whole isn't very productive.

[DcifrThs]

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I guess I disagree with you Barron about the necessity of believing that the market is efficient or it isn't. I see a continuum of efficiency from non-existent to strong.

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interesting. i've said numerous times that i believe the market is weakly efficient, thus implying a clear spectrum from 100% efficiency (which i've also used as a thought experiment in the posts above) to 0 efficiency. when i say the market isn't 100% efficient, i mean that literally and i think you'd agree. are you sure you read my post directly above?

namely where i said:
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simply by finding exceptions, the efficient market hypothesis has been disproved. to what degree do you think the market is not efficient?

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I tend to belive that the market is more efficient than it is generally creditted to be.

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lets just be clear that we are talking only about equity markets, correct?

in that case, i wholeheartedly agree in the same sense that i agree that those beating the game of poker are more likely to think their skill is a larger driver than it likely is. poker is more variance than it is generally credited to be at the practitioner level.

similarly, i agree that eequity markets are more efficient (where successes are more likely to be the result of positive variance) than is generally acknowledged

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I part from you in believing that there are massive inefficiencies. I think these are largely identified in hindsight.

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i don't think that is true. many people have gone bust shorting a rising market. they were correct, the stocks they were aiming at were indeed overvalued & eventually tumbled well below the levels at which the short was instituted...but those short folks couldn't ride out the storm. taking the 1990s bubble, the fed chairman even said the markets were clearly valued beyond rational pricing. the bubble in the equity market was clear, but the flows & intermarket action were driving the market ever higher despite the fundamental aspect.

so in this case, the bubble (inefficiency) was known at the time, yet it went on. that is a pretty strong case for a less efficient market than you're giving credit for.

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I guess the reason I argue these things can be distilled to a couple of things that you can see on this board. One in fact is in this very thread.

First, I am battling claims from people who claim to 'beat the equity market', and usually claim to do so rather easily. I feel confident that the vast majority of those people don't have:

Any clue what market they are beating, or are not comparing their investments to the appropriate index. They almost always mean they achieved a return that exceeded the S+P 500.

No records to support their performance record.

Insufficient length of time to demonstrate that their positive risk adjusted returns are anything more than randomness. This is really the biggest one. For a trading strategy to prove itself it has to persist over several market cycles. I always feel foolish explaining this to poker players who accept that you need X amount of hands to show your true win rate, yet believe that two years of investing data is sufficient.

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i believe here that many people who claim to do it easily are wrong as you do. i have faith that DC, scorpion man, and folks like mrbaseball have indeed beaten the market b/c their apporach is sound.

taking a step away from equity markets for a second. this is analagous to picking hedge funds for institutional investors (pension funds etc.). they can't just go by returns. even 10 years of strong risk adjusted returns is not sufficient. due diligence into their process is necessary. you have to have faith in the hedge fund's process. strong risk adjusted returns over 10 years AND a strong process are likely sufficient conditions.

similarly, strong risk adjusted returns (i don't want to say that DC or the like should post their returns, but i'd bet you significant money they beat the market handily) and a strong thought process over many cycles IS extremely strong evidence of beating the equity market.

further, your post implies that there ARE people who CAN beat the market and that goes immediately to the point that the market can be beaten and is thus sufficiently NOT efficient for that to be the case. i believe, as i've said before, that the equity market is weakly efficient. that it has sufficient inefficiencies to be beaten.

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Finally, I argue about this because I am appalled by the lousy and contradictory advice most people get when they seek it.

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isn't that the case in almost all endeavors? where more variance is concerned, i'd think the more likely it is that the advice on average is poor. especially when those giving the advice have financial (or other) motives for giving it.

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Investing successfully is really very simple.

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not to bring this up again but if by "investing" you mean "putting your money someplace and earning market returns" then yes, investing is easy.

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There are thousands of high cost products created and marketted to obscure that simplicity.

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obviously because those doing the marketing gain regardless of performance. further, those who have performed well, have better marketing and thus earn higher profits off of investors.

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Quite simply, the vast majority of people would fare best with a properly diversified and allocated portfolio of index, or very low cost actively managed mutual funds that are invested in a way consistent with their goals and risk tolerance.

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that i'd take as sufficient for good results. i'd go one step further though and aim for outstanding results with passive investing and say that you can do better than just equity markets without having anybody manage anything for you and achieve a higher sharpe ratio than is available via solely index (or low cost managed quity) investing through international & inter-asset class diversification.

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Basically, go to the Vanguard website answer some questions and you will achieve performance that is far better than your peers.

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well, that depends on who your peers are now doesn't it?

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There is another tangent I have been thinking about and I think I will follow up in another thread if there is interest, but I think some of the things poker players learn helps them be better investors, and some things really hurt them. I think one of the most detrimental ideas is that to be a successful investor you have to win. In poker there must be a loser for every winner (in fact several losers for every winner).

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well, to take a quick point at that, i believe you are mistaken. there really only needs to be a few big losers for many winners. either way, the distribution isn't important, just that it is zero (or actually negative) sum.

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As an investor you don't need to be smarter than the crowd.

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true if you are talking again solely about passive investing.

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The rake is on your side and the more effort you apply to winning the worse you are likely to do.

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i very strongly disagree with that statement, as many would so long as that effort is well placed and not just going in and out of funds for no rhyme or reason chasing the best performers. learning about markets and having a passive portfolio in addition to an actively managed portfolio can be even better than just a passive one.

i'm strongly in the camp that shoving money away in a diversified passive portfolio AND having money to trade with is the way to go if you want to put in a ton of effort. i'd bet those people are the ones that fare better than the crowd or their peers if their peers are their friends and family and classmates.

specifically, when i get my money from the lovely illiquid investments that i'm temporarily regretting right now (since i don't have the money, but will obviously be quite happy when i get it), i plan on doing just that.

keeping money to trade with (actively manage aside from my passive portfolio) in large part invested in very safe assets like tbonds and waiting for opportunities to arise while studying the market. i've found good ones and wish i had a ton of money to throw at them (and many of those i've documented on this site).

that, to me, is the way to go..may not be for everyone though.

Barron

[john kane]

This is something I don't understand:

If we exclude fees, and say the market is the FTSE100, then surely if you researched enough to realise that stock number 24 is worse than the average stock of 100 leading companies, then you have a portfolio of 99, which will outperform the market.

If you go on zecco (not sure if its this one as i am non-us/uk-er) and have your free trades, thus excluding fees, then wont you beat the market this way.

[pig4bill]

[ QUOTE ]
I guess I disagree with you Barron about the necessity of believing that the market is efficient or it isn't. I see a continuum of efficiency from non-existent to strong. I tend to belive that the market is more efficient than it is generally creditted to be. I part from you in believing that there are massive inefficiencies. I think these are largely identified in hindsight.

I guess the reason I argue these things can be distilled to a couple of things that you can see on this board. One in fact is in this very thread.

First, I am battling claims from people who claim to 'beat the market', and usually claim to do so rather easily. I feel confident that the vast majority of those people don't have:

Any clue what market they are beating, or are not comparing their investments to the appropriate index. They almost always mean they achieved a return that exceeded the S+P 500.

No records to support their performance record.

Insufficient length of time to demonstrate that their positive risk adjusted returns are anything more than randomness. This is really the biggest one. For a trading strategy to prove itself it has to persist over several market cycles. I always feel foolish explaining this to poker players who accept that you need X amount of hands to show your true win rate, yet believe that two years of investing data is sufficient.

Finally, I argue about this because I am appalled by the lousy and contradictory advice most people get when they seek it. Investing successfully is really very simple. There are thousands of high cost products created and marketted to obscure that simplicity. Quite simply, the vast majority of people would fare best with a properly diversified and allocated portfolio of index, or very low cost actively managed mutual funds that are invested in a way consistent with their goals and risk tolerance. Basically, go to the Vanguard website answer some questions and you will achieve performance that is far better than your peers.

There is another tangent I have been thinking about and I think I will follow up in another thread if there is interest, but I think some of the things poker players learn helps them be better investors, and some things really hurt them. I think one of the most detrimental ideas is that to be a successful investor you have to win. In poker there must be a loser for every winner (in fact several losers for every winner). As an investor you don't need to be smarter than the crowd. The rake is on your side and the more effort you apply to winning the worse you are likely to do.

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This attitude just strikes me as flat-out lazy. "Nobody can beat the market, so why should I put out the effort?". If you think the market cannot be beaten, by a wide margin, your depth of knowledge is very shallow. You haven't tried to find out anything about the subject beyond a couple posts here and maybe reading a book that supports your conclusion, possibly written by someone just as lazy. Or looked towards academia, who are the laziest of all. "Wow, I just spent four hours googling. I'm wiped out". Put some effort into finding successful traders and you will find them.

BTW, statements like this: "For a trading strategy to prove itself it has to persist over several market cycles." are really silly. Who's going to be stupid enough to use the same strategy in a bull market as a bear meket? Who's going to use the same strategy in a low-volatility market as a high-volatility market? Not someone successful. Do you play the same way at every poker table, regardless of who's there, or the stakes?

[DcifrThs]

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This is something I don't understand:

If we exclude fees, and say the market is the FTSE100, then surely if you researched enough to realise that stock number 24 is worse than the average stock of 100 leading companies, then you have a portfolio of 99, which will outperform the market.

If you go on zecco (not sure if its this one as i am non-us/uk-er) and have your free trades, thus excluding fees, then wont you beat the market this way.

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this is what mutual fund managers (long only) do. they underweight certain stocks in their index when they feel they have a view and overweight others around some leeway that they have.

doesn't mean it's easy. it is easier than beating the mkt by a wider margin though.

Barron

[Mr. Now]

About 3% beat the market consistently. Many more inconsistently -- but only when running good. This latter group takes larger risk per unit of reward. They are 'out of line'.

The 3% that systematically beat are the ones that systematically remove any (collectively, almost 'all') available edges.

The 3% are overweight-- in terms of responsibility-- for overall market pricing efficiency.