A client sent me this piece from last weekend’s WSJ: “An Index Fan Goes More Active” (paywalled, sorry).
The Journal does this regularly, interviewing an advisor to get a “hot take” on the markets and how professionals are recommending their clients invest. I hate these, of course, because it reflects the worst of what an advisor should do. It’s chock full of what some random dude thinks the market is going to do next. And we eat it up! Of course we do. We so badly want to believe that the professionals know what we should be doing right now. It’s hard wired into our terribly functioning brains to trust someone who sounds authoritative.
The general premise (or at least headline) of this edition is that this guy thinks the markets are scary, and as a purported solution he is moving more money out of index funds and into actively managed funds. From the article:
“…since last year he has raised the allocation to actively managed funds—figuring they will do better than a straight index fund if the stock market declines overall.”
In the very next sentence the advisor says he thinks managers can’t beat the market, but he thinks they will in a downturn. Or, more specifically he thinks he can identify which managers are going to outperform in the next downturn. To the latter point, umm, good luck with that. To the broad point that active managers can outperform in a downturn, I’ve got some bad news. We have lots of data on whether or not that is what happens, and it doesn’t look good for active managers.
You see, in 2008 Standard & Poors reviewed the performance of stock mutual fund managers throughout two bear markets (2000-2002 and 2008). What they found was that in practically every asset class, the majority of active managers underperformed their benchmark, despite actively managed funds having high cash allocations than an index fund. Here’s some of the data (any number over 50 means the majority of funds underperformed the benchmark):
But the myth persists, in large part with assistance from advisors who tell their clients a nice-sounding story about managers who reduce risk in down markets.
I could probably go on for another 1000 words about the things in this article that drive me nuts, like ignoring survivorship bias of changes that advisors make in their portfolios, the idea that an 83% stock allocation is appropriate for a retired client who “needs to build capital with low risk,” that European stocks have “gotten ahead of earnings” despite a CAPE ratio for developed European stocks of 15.7x vs US stocks at 25.5x, that the S&P 500 is a good way to own US large cap stocks, that investors shouldn’t own plain vanilla bonds but can instead reduce risk (????????) by owning junk bonds and emerging markets debt. But my favorite other part is this piece:
“Advisers at Hamilton typically make changes to portfolios either based on their assessment of how macroeconomic themes will play out over two years or so, or if they think an asset has become cheap or too expensive.”
The rise of the macro tourist is alive and well. I have my doubts that an investment advisor in Columbus, OH or Des Moines, IA or Manhattan, NY or Los Angeles, CA or even Lakewood, CO has it all figured out. I have more doubts that their predictions about the macro environment in the next two years and how the global stock and bond markets will react to that macro environment are totally accurate. Again, we want to believe this so badly! But every single piece of research done on any professionals ability to predict the future in any business or field of study has shown that we are no better than a roll of the dice. The most frustrating part of this is that it perpetuates the myth that this is what an investment advisor should do: lend his or her “expertise” to the active construction of an investment portfolio, relying on “expert” predictions to decide how to make short-term allocations to markets. Obviously I believe that a reputable and educated financial professional adds value to a client’s financial life, but this ain’t the way, folks.
Bason Asset Management 