Wednesday, 10 September 2014

Dilbert And Embedded Bullshitness

As much as I’m sure Matthew wouldn’t like to be lumped in with Emp, the two did again both have comments on my last post.

Matthew's is worth a read, and is in full below, discussing the vast array of funds and investment choices we are faced with, and this important point caught my eye:
As you rightly say there is not just one index but if an investor currently holds a FTSE All Share tracker and a Russell 2000 small cap tracker and he is currently beating the performance of the actively managed funds benchmarked against the performance of the same indices he should not necessarily sit back and think that he has maximised the return on his capital.
It reminded me of the early success of the XX Draws. It was only when the overall number of drawn matches declined precipitously last season that I was forced to look at the underlying numbers and ultimately take consolation from the fact that, although down on the season, the results were still better than a vanilla benchmark of draws. Simply winning or making profits isn't the be all and end all of betting or investing as Matthew correctly points out. There's often room for improvement and in betting, markets can change in a hurry.

Here is Matthew's comment in full:
Grazie Saggio Cassini,
Once again you provide a thorough and enjoyable analysis. Looking at it again I am rather comparing apples with oranges. I think my main intent was to compare different methods of allocating savings for the retail investor for long term prosperity. When you are making decisions regarding your pension, stocks and shares NISA or SIPP you are often faced with a bewildering array of funds and of every conceivable strategy. Income funds are invariably included in your pension prospectus and yet the description seems incongruous with the concept of allocating money with which you are unable to touch till you retire.
Ultimately we want to make the most money possible and if it comes from a DRIP income fund or from a passive managed index tracker is of little consequence. I am a huge fan of the low cost index trackers but simply question whether sometimes an attempt to separate the best of breed from a large index via yield evaluation might beat the returns of the tracker for the self same index. Obviously it would have to beat the additional management fees to make the exercise worthwhile.
So can a DRIP income style fund outperform an index tracker fund from an ROC perspective over the longterm? They are both called upon to perform the same role if you agree with the fund prospectus from your pension, NISA or SIPP IFA advisor. As you rightly say there is not just one index but if an investor currently holds a FTSE All Share tracker and a Russell 2000 small cap tracker and he is currently beating the performance of the actively managed funds benchmarked against the performance of the same indices he should not necessarily sit back and think that he has maximised the return on his capital.
Those who have purchased your draw selections and Graeme's TFA selections are investing in football bets but generated from different strategies. Much as they would love to simply compare your selections to other draw backing strategies and Graeme's 7-22 to other H/A backing strategies I am sure they are looking at the ROC of both and wondering which deserves the finite capital more. Of course there could just be a desire for diversification.
I feel I have rather gone off track now. As for re-allocation if one was to try and execute an income style fund strategy oneself there are of course timing issues regarding the buying and selling stock but they are certainly navigable by the retail investor. Finally a note on my education and knowledge as a financial trader. My education simply taught me to always read more, any institution that gets this message across has in my view done well by its students and it does not matter what name is on the building. As for my knowledge on financial trading I am sure I can find the back of a small envelope to put down all I know to pass on to you.
Somehow I suspect the envelope will be on the large side, stuffed with reams of A4 paper, all covered with Matthew's knowledge.

I think the assumption that we are all trying to maximize our returns should perhaps be challenged. Plenty of people, including the two people living in the house where I was born many moons ago, have quite happily gone through life happy to ‘invest’ (I use the term loosely) in bank deposit and building society accounts. I’ve mentioned before that my maternal grandfather was a stockbroker, which makes my parents’ aversion to the stock market (“too risky”) all the harder to understand, but my Mum thinks being a day late returning a library book is living on the edge. While the high interest rates of previous years (15% my Mum mentioned just a couple of days ago, as she bemoaned the meagre returns of today) has seen their savings over 50 years increase hugely, (the power of compound interest) they seem blissfully unaware, or at least don’t care, that had they invested more wisely, they might now be as comfortable as the Sultan. Their low risk tolerance meant that the higher returns associated with the volatility of the stock market were not worth the stress to them. I try not to dwell too much their poor decisions over the years have cost to me in my forthcoming inheritance.

In general, as retirement nears, one should move out of stocks into less volatile investment, but my parents being totally out of stocks for their entire lives (save for a few gifts from the likes of the Halifax and Woolwich) is taking this to an extreme. Maximising returns usually takes second place to protecting capital at some point in our lives, but not usually from the day we’re born.

Another point is that we can all get a little too hung up on stressing over maximizing our returns. Perfect is the enemy of good, and there is much to be said for keeping life simple.

And now to Emp, and it may well be a ‘lost-in-translation’ thing, and given that just one person seems to be missing the point, it probably is, but one of the key things Emp / Prabhat is missing is what we mean by the “man-in-the-street” or Mr Average in the context of this debate.

It may sound harsh, but the average person is not a sophisticated investor, he has little understanding of investment choices, and he simply doesn’t have the tools to identify the 1% of active managers who ‘might’ beat the market. He wants to save money for his future.

For this person, the advice to investing consistently in a diverse portfolio of low cost index tracking stocks is an excellent long-term strategy.

Emp waffles on about how theoretically it is possible to find an edge, and given time and a certain knowledge set that might well be true, but this is completely irrelevant for the vast majority of people.

Emp also feels that for some (he doesn’t explain why) reason actively managed funds might outperform index funds in a bear market. Some might, some might not, but again, he is off topic. We are not debating the merits of one versus the other in a short-term bull or bear market, but over the long-term. Next, Emp will be telling us he can predict market turns. Oh wait, here he is now:
“Embedded bullishness doesn’t do so grandly in a bear-market, and there’s certainly one coming in the next year or two”.
You read it here first. Certainly? Well, no, not certainly. Quite possibly, but no one can successfully consistently predict market turns, except possibly Emp. “Next year or two” is a bit vague really. It almost sounds like he’s guessing. Come on Emp – surely you can share the market peak date with us. We’re like family. I think perhaps he meant to write "embedded bullshitness".

Although this is an interesting topic, and one that I shall likely remind readers of again in the not so distant future because it is important, especially for you younger readers, I’ve spent more than enough time for now on this.

I’ll leave you with the thoughts of Dilbert creator Scott Adams on the topic:
It's a Perfect Strategy for My Enemies
I can think of many cases in which I would recommend active money managers over index funds. For example, I might be giving the advice to someone I hate or—and this happens a lot—someone I expect to hate later. I would also recommend active money managers if I were accepting bribes to do so, if I were an active money manager myself, or if it were April Fools' Day. And let's also consider the possibility that I might be drunk, stupid or forced to say things at gunpoint. I've also heard good things about a German emotion called schadenfreude, so that could be a factor too.

1 comment:

Prabhat said...

I'll agree to agree about what the 'average' person should do. Frankly, I couldn't care less about the mythical average guy who has no information, and apparently no time to search for it either (but conveniently has just enough time to read about indexing and these articles, and convince himself that is his route to financial security and the right way to invest his fortune).

What you may be missing, is that by definition, the average guy can never do well. There just isn't room in the markets for any but a tiny minority to profit. If hypothetically, everyone jumped into index funds as you advised, the stocks in said index would necessarily become over-valued (because people buy them just because they are in the index). You would just have more and more money chasing these over-valued assets and a crash, if nearly everyone were to jump in. Minus a crash, which hasn't occurred, that actually looks remarkably like the status quo, but I digress; I will gloat about the event after, since my viewpoint on the current markets has been documented.

Maybe I can't, but 'no one can predict market turns' is one of the most salient pieces of academic bullshit ever conceived. Plenty of people can and have predicted and benefited colossally from market turns. You seem to take 'academic studies' as gospel, and beyond a point there's no response to this kind of argument from authority, except to point out the sheer degree and regularity with which academics have been spectacularly wrong about markets mainly because in a minus sum activity where very few can succeed, it's easy to confuse 'very few' with 'nobody'. Many, including academics, made the same error with poker and blackjack (oh someone actually beat casinos?!). Now everyone agrees poker is a skill game and that black-jack can be beaten with card-counting (at least in the form it existed before casinos took counter-measures).

Maybe our disagreement is in the margins, (and perhaps more to do with your tone of sneering condescension and close-mindedness), but I still disagree that 'no one can predict the market turns' (which is an utterly nonsensical and contradictory pronouncement coming from someone advocating passive-indexing (Which IS a prediction of a long-term upward turn of the markets).