Bob Seawright has another great post up this week that you need to go read, “Updating the Yale Model.” The piece highlights many failures faced in the institutional investment world of pensions and endowments, specifically taking to task illiquid investments, hedge funds and performance-chasing behaviors. Individual investors have a lot to learn from the missteps made by institutions.
First, chasing “the best” investment managers is a fool’s errand. There is essentially no out-performance of the index.
Research on the performance of institutional portfolios (not just endowment portfolios) shows that after risk adjustment, 24 percent of funds fall significantly short of their chosen market benchmark and have negative alpha, 75 percent of funds roughly match the market and have zero alpha, and well under 1 percent achieve superior results after costs—a number not statistically significantly different from zero. Mutual funds aren’t any better. In a random 12-month period, about 60 percent of mutual fund managers underperform. Lengthen the period to 10 and 20 years and the proportions of managers who underperform rises to about 70 percent and 80 percent, respectively. Perhaps even more importantly, money managers who underperform do so by roughly twice as much as the “outperforming” funds beat their chosen benchmarks.
To pick the two most obvious examples: (a) passive management should be the default setting with active management used only to supplement it with very good reasons; and (b) low costs are crucial.
And in closing, don’t listen to people who tell you that despite evidence to the contrary, they are the ones who can beat the market.
As newly minted Nobel Prize winner Robert Schiller sagely notes, “[m]oney management has been a profession involving a lot of fakery — people saying they can beat the market and they really can’t.” So here’s to better investment process, but a process supported by investment beliefs and an undergirding philosophy that is reality-based and actually supported by the data. Fakery not required.
Anyhow, go over and read the whole piece and learn to avoid the mistakes made by the “big boys” for so many years.
“Updating the Yale Model” at Above the Market.