No

Help Wanted: Stock Pickers Need Not Apply

No


“The debate about whether you should hire an “active” fund manager who tries to beat the market by buying the best stocks and avoiding the worst — or a “passive” index fund that simply matches the market by holding all the stocks — is over.”

-Jason Zweig, “The Decline and Fall of Fund Managers,” The Wall Street Journal, (8/21/14)

 


 

Charles Ellis is one of my favorite financial writers. He is a perfect combination of erudite, clear, comprehensive, and yet succinct. He is the former chairman of the Yale Endowment, a professor of finance, the author of seven books and numerous academic papers. He is arguably one of the most knowledgeable and insightful authorities on investing.

A recent paper by Ellis was published in the July/August 2014 issue of the Financial Analysts Journal (a publication from the CFA Institute). It is titled: “The Rise and Fall of Performance Investing.” It is valuable reading and I strongly encourage every investor to print it and carefully read it. Then pass it along to friends and family, or other interested parties. Investors around the world need to know this information.

Ellis’ brief 10-page paper chronicles the history of institutional investment management, describing the proliferation of investment consultants that resulted from early success in beating the market some 50 years ago.  Ellis describes the market climate in 1964 and contrasts it to today.

“Fifty years ago, beating the market (i.e., beating the competition: part-time amateurs and overstructured, conservative institutions) was not just possible — it was probable for hardworking, well-informed, boldly active professionals,” he states. “Today, the statistics are upended. More than 95% of trades in listed stocks, and nearly 100% of other security transactions, are executed by full-time professionals who are constantly comparison-shopping inside the market for any competitive advantage.”

Ellis points out milestone moments that led to today’s efficient environment for investors — an environment in which all information is so widely and swiftly dispersed that there remains little opportunity to beat the collective wisdom of the market.

Data, technology and regulatory requirements have led to a fiercely competitive marketplace -- one that “pits Ivy League MBAs on either side of most trades, with one not wanting to let go of their shares too cheaply, and the other not wanting to pay too much,” says IFA president and founder, Mark Hebner.

What does this mean to institutional investors? For Ellis, it means that active investing is no longer a game worth playing. Wall Street Journal columnist, Jason Zweig puts it this way, “Active fund management is outmoded, and a lot of stock pickers are going to have to find something else to do for a living.”

For Ellis, there’s a potentially worse fate in store for the industry than bidding “adieu” to stock pickers and active manager consultants – and that is a stubborn clinging to a clearly broken system that threatens to paint all members of the financial industry with a wide swath of greed, self-interest and zero credibility.

“Members of the establishment in any field have much to lose in institutional stature, their reputations as experts and their earning power,” per Ellis. And, this is why active investing has persisted, despite the overwhelming and irrefutable evidence that indexing is a superior course.

Ellis faults “the human desire to do better by trying harder; the ‘yes, you can’ encouragement of fund managers, investment consultants, and other participants who make their living as advocates of ‘doing better,’” as the primary culprits for reigning in what otherwise should be an unbridled demand for indexing.

The higher fees that come with active management can buy a lot of cleverly crafted inducements. “Advertising notoriously concentrates on the superior performance of a small and ever-changing minority of managers,” observes Ellis. “Little is said, however by insiders about “the numbing consistency with which a majority of active managers fall short of the index or how seldom the past years’ winners are winners again in subsequent years.”

"When will we recognize and accept that our collective skills at price discovery have increased so much that most of us can no longer expect to outperform the expert consensus by enough to cover costs and management fees and offer good risk-adjusted value to our clients?,” Ellis asks.

This long overdue recognition needs to happen sooner rather than later because there’s just not enough advertising money to overcome the damage when — as Ellis points out — “clients decide that continuing to take all the risks and pay all the costs of striving to beat the market with so little success is no longer a good deal for them … Selling our services after passing that tipping point would clearly raise the kind of ethical questions that separate a proud profession from a crass commercial business."

We now know concretely that active management has no justifiable role in a portfolio. But, sound investment management will continue to play a very important role in portfolio performance. Advisors who provide asset allocation advice that is rooted in quality long-term data, carefully executed portfolio implementation and management, methodical spending and liquidity management, and ongoing fiduciary partnership with their clients will only increase in demand. These advisors bring the ability to add true and quantifiable value to their clients’ portfolios -- ad infinitum. And that is a proud and persistent profession.