SOMETHING FOR THE WEEKEND
What is it with Canadians? Americans get it. They noticed long before anyone the gap between what active fund management appears to promise and what it actually delivers. OK, it’s taken a while for the message to get around but, in recent years at least, they’ve deserted active funds in their droves.
North of the border, however, ignorance is bliss. According to Morningstar, passive market share is about the same today as it was five years ago, if not even lower.
Why is that? One word: banks. Canadians love their banks. And yet there’s mounting evidence that their affections are misplaced.
Predictions vs probabilities
What a year it’s been. Revolution in the investing industry, Trump, the Brexit negotiations and now — how can we possibly afford the time? — a pending general election! No wonder my reading list has been been building up of late.
One article I meant to share before now is this from Charlie Bilello: The difference between a prediction and a probability. For me, it’s this distinction that defines the whole debate going on about the rôle of the financial adviser — or, in the institutional space, the investment consultant.
Until now, pride of place has gone to predictions. People love making predictions or, when it comes to investing, asking people make to predictions for them: What are the markets going to to do? Which sectors are due for a resurgence? Who are the managers most likely to outperform?
Active less risky than passive? Yeah, right
It was Barry Ritholtz who coined the phrase “the daily firehose of bullshit” to describe the output of the asset management spin machine. And, goodness me, we’re being well and truly blasted with the brown stuff at the moment.
A good example is the way that, to divert attention from all the evidence that actively managed funds are not worth investing in, the industry tries to associate index funds with risk.
It happens all the time. Yesterday, for example, after a report on the active versus passive issue on BBC Radio 4, the studio guest, Gervais Williams from the Miton Group, effectively pooh-poohed the story by changing the subject to risk. “The whole point about passive funds,” Williams told listeners, “is they’re largely disinterested in portfolio risk.”
Positive skew & the near impossibility of consistent alpha
If you read nothing else today, read this. It’s an article by Oliver Renick for Bloomberg Markets on positive skew, which might just be the single biggest reason why only around 1% of active fund managers consistently beat the market over the long term.
To quote Renick, “The distribution of returns in the stock market is bizarrely lopsided. Often, equity benchmarks are so reliant on gigantic gains in just a handful of stocks that missing them — as most managers do — consigns the majority to futility.”
Or, as JB Heaton, joint author of a 2015 paper called Why Indexing Works, puts it: “Your intuition is that you can randomly pick stocks and start at zero. But the empirical fact is if you randomly pick, you are starting behind zero.”
Fund managers’ costs don’t rise with the market — but their fees do
Whichever asset manager it was who first decided that they would set their fees as a percentage of assets under management knew what they were doing.
Think about it for a moment. First, as the economy grows, so does prosperity and the amount of money that people have to invest. Ergo, the fees earned by asset managers continue to increase substantially without them having to lift a finger.
Secondly, over time, markets too go up. After all, we wouldn’t invest in them if they didn’t. So again, the value of assets under management almost automatically rises with no input whatsoever from the asset management industry.
Podcast Episode 14: An Interview with Barry Ritholtz
On this week’s podcast we speak to Barry Ritholtz, co-founder and CIO of Ritholtz Wealth Management.
Barry is a tireless blogger and advocate for evidence-based investing. It was his team that put on last year’s inaugural EBI conference in New York. Following on from that success, this year the show is travelling west to Dana Point, California.
Listen to find out:
- How the idea came about for the EBI conference
- Why the financial media is so unhelpful
- His view on the dramatic changes taking place on Wall Street
- How to prevent behavioural biases from ruining a portfolio.
Robin is a journalist and campaigner for positive change in global investing. He runs Regis Media, a niche provider of content marketing for financial advice firms with an evidence-based investment philosophy. He also works as a consultant to other disruptive firms in the investing sector.
