By Chris Giaouris
August 27, 2018
“Mum, where do returns come from?”

There are many theories about why most “active” fund managers fail to consistently outperform their benchmarks. It takes many years of study and market experience to become a portfolio manager, but good results are often elusive. One theory is that there are so many managers out there using fancy algorithms to price shares that the market is relatively efficient and tough to beat.

The research surrounding this, dare I say phenomena, is very interesting to read and if you follow us on Facebook you will already have seen plenty of different points of view.  If you don’t you can follow us here.

Some common themes that we have seen over many decades include:

  • The large majority of ‘expert’ investment managers can’t generate returns that are at the very least equivalent to the market (aka they under-perform the market).
  • In Australia, over long periods (10 years plus) about 41% of funds need to be closed down leaving you with a 59% chance that the one you chose was a survivor.

Arizona State University shows active management and stock selection is really difficult. They found that most stocks listed in the US since 1926 delivered lifetime negative returns relative to one-month US Treasury bills (i.e. cash). Only 4% of companies (represented by the blue box below), or about 1,000 out of a total data base of over 25,000, produced half the returns of the entire market.

The cream (grey) coloured space of the outer box represents the vast majority of companies that generated no returns, with 12% delisting at an average of 2.5% of their listing price. It’s more common to invest in losers than winners, especially when competing against other talented analysts.

Sure, if you can pick the winners and only the winners you will generate some serious returns for your portfolio but the problem is nobody can do this on a consistent basis.  Think about it, if you could would you share your (extremely valuable) secret?  Of course not!

Now, coming back to the question at hand.  When thinking about where returns come from, it’s important to understand trends like the one outlined above.  Sure this is based on the US market but the data globally tells a similar story.  For example, if you invested in the S&P/ASX300 (Australia) between 2001 and 2017 you would’ve earned 8.32% per annum over this period.

However, if you missed the 5 best single days over this period your annual return would’ve been 6.71%.  It gets worse if you miss the 15 / 25 best single days – returns here dropped to 4.18% / 2.05% respectively.  That’s a drop of over 6% each year if you miss the best 5 weeks across a period of more than 500 weeks of real-time stock trading.

It’s not a lot of time to be out of the market.  That said, if you’re trying to time when you buy and sell the ‘winners’ we find most people stay on the sidelines waiting for the right time to buy for much longer than only 5 weeks.  Everyone has a buying strategy but not many people have a selling strategy.  Emotion is a returns killer.

Don’t be part of the problem.  Don’t even be part of the solution.  Just don’t get ambition and ability mixed up, something I’m still learning when it comes to my Wednesday night Futsal games…!

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