{"id":21955,"date":"2011-06-27T10:55:17","date_gmt":"2011-06-27T14:55:17","guid":{"rendered":"http:\/\/www.investmentu.com\/?p=21722"},"modified":"2011-06-27T10:55:17","modified_gmt":"2011-06-27T14:55:17","slug":"why-money-managers-fail-to-beat-the-market","status":"publish","type":"post","link":"https:\/\/www.investmacro.com\/fx\/2011\/06\/27\/why-money-managers-fail-to-beat-the-market\/","title":{"rendered":"Why Money Managers Fail to Beat the Market"},"content":{"rendered":"<p><a class=\"post_title\" href=\"http:\/\/www.investmentu.com\/2011\/June\/why-money-mangers-fail-to-beat-the-market.html\">Why Money Managers Fail to Beat the Market<\/a><\/p>\n<p>by <a href=\"http:\/\/www.investmentu.com\/investment-experts\/alex-green-archives.html\" >Alexander Green<\/a>, <em>Investment U&#8217;s<\/em> Chief Investment Strategist<br \/>\nMonday, June 27, 2011: Issue #1543<\/p>\n<p>Here are three easy ways to beat the market: Deception, irrelevance  and bad math.<\/p>\n<p>Perhaps some explanation is in order&#8230;<\/p>\n<p>It&#8217;s a well-known fact that three out of four investment  professionals fail to beat an unmanaged index each year. Over the long term,  the percentage is much greater.<\/p>\n<p>Yet everywhere you go, investment advisors claim they&#8217;re  generating superior results. It&#8217;s a bit confounding. So let&#8217;s take a closer  look&#8230;<span id=\"more-21722\"><\/span><\/p>\n<p><strong>Why Money Managers Fail to Beat the Market <\/strong><\/p>\n<p>Most money managers fail to <a href=\"http:\/\/www.investmentu.com\/2009\/May\/how-to-beat-the-markets.html\" >beat the market<\/a> for a number of  reasons.<\/p>\n<ul>\n<li>Some, quite frankly, are inexperienced or inept.<\/li>\n<\/ul>\n<ul>\n<li>Others, being human,  make mistakes.<\/li>\n<\/ul>\n<ul>\n<li>Some find it impossible to beat the market after charging  substantial fees.<\/li>\n<\/ul>\n<ul>\n<li>And most operate at a disadvantage because they must keep  substantial cash on hand to meet redemptions. (And cash is a notoriously poor  performer.)<\/li>\n<\/ul>\n<p>Yet despite these headwinds, many money managers &#8211; perhaps  most &#8211; still claim that they&#8217;re beating the market. Are they lying? You be the  judge&#8230;<\/p>\n<p><strong>Beating the Market&#8217;s Isn&#8217;t Arithmetic&#8230; It&#8217;s Geometry&#8230; <\/strong><\/p>\n<p>I once attended a conference where the speaker &#8211; a local  <a href=\"http:\/\/www.investmentu.com\/2008\/June\/money-managers.html\" >money manager<\/a> &#8211; claimed that his managed accounts had averaged a 25-percent  annual return over the previous two years, an impressive number during a  difficult period.<\/p>\n<p>But a member of the audience took issue with his claim. &#8220;I  invested $200,000 with you two years ago,&#8221; he said. &#8220;And while you did double  my money the first year, the account lost half its value the next. I&#8217;m now back  to $200,000. So how can you claim a 25-percent annual return?&#8221;<\/p>\n<p>Without missing a beat, the speaker wrote out the  calculation on the overhead. He showed that when you subtract the 50-percent  loss the second year from the 100-percent gain the first, you end up with a  50-percent return. And 50 percent divided by two years is a 25-percent average  annual return.<\/p>\n<p>This left many in the audience scratching their heads. He  was correctly determining the <em>arithmetic<\/em> average, a meaningless calculation when negative numbers are involved. What all  investors should be interested in &#8211; indeed what the SEC now requires funds and  registered reps to provide in their literature &#8211; is the average annual <em>geometric<\/em> (or compounded) return. What  the money manager was saying, strictly speaking, was true. But it was also  meaningless and misleading.<\/p>\n<p><strong>Excluding Dividends and Outperforming the Wrong Benchmarks <\/strong><\/p>\n<p>Other managers boast of beating the market in a less  audacious but still erroneous way: They understate the market&#8217;s performance by  leaving out <a href=\"http:\/\/www.investmentu.com\/2011\/March\/levered-cash-flow-reliable-dividends.html\" >dividends<\/a>.<\/p>\n<p>For example, over the last decade, the S&amp;P 500 has  averaged just 0.7 percent annually without dividends. But with dividends it has  returned 2.81 percent annually. That&#8217;s still no great shakes, but easier for  brokers and money managers to beat.<\/p>\n<p>How often is this done? It&#8217;s hard to say, but <em>The Wall Street Journal<\/em> reports that  Allan Roth, a financial planner at Wealth Logic in Colorado Springs, estimates  that at least 20 times a year he sees &#8220;account statements from financial advisors  comparing a client&#8217;s returns, with dividends, against those of market  benchmarks without dividends.&#8221;<\/p>\n<p>There&#8217;s yet another way &#8211; an even simpler way &#8211; that money  managers outperform their benchmark. They use the wrong one. Fixed-income  managers will compare their performance to an equity index. Small-cap managers  will compare their performance to a large-cap index. Global equity managers  will compare their performance with a domestic index. And vice versa.<\/p>\n<p>Major investment banks have one more trick up their sleeves.  When a fund (or managed account) performs particularly poorly, they shut it  down or merge it into another one. Poor returning funds? No problem. Just get  rid of them.<\/p>\n<p><strong>Past Performance <em>Doesn&#8217;t<\/em> Predict Future Results <\/strong><\/p>\n<p>Let me state, for the record, that ethical money managers  don&#8217;t do these things. However, not all firms are ethical. And not everyone at  a first-rate firm is an ethical representative. I could tell you stories that  would raise the hair on the back of your neck.<\/p>\n<p>So what&#8217;s the takeaway here? First, if you&#8217;re paying for  investment services, know whom you&#8217;re dealing with. Examine the printed  literature and don&#8217;t rely on oral representations. Second, when a money manager  states his average annual investment returns, recall the old boilerplate: Past  performance really <em>doesn&#8217;t<\/em> predict  future results.<\/p>\n<p>And that past performance? You may want to look twice.<\/p>\n<p>Good investing,<\/p>\n<p>Alexander Green<\/p>\n<div class=\"feedflare\">\n<a href=\"http:\/\/feeds.feedburner.com\/~ff\/InvestmentU?a=EOY6mClezWw:RUb6-jNjo3Q:yIl2AUoC8zA\"><img decoding=\"async\" src=\"http:\/\/feeds.feedburner.com\/~ff\/InvestmentU?d=yIl2AUoC8zA\" border=\"0\"><\/img><\/a> <a href=\"http:\/\/feeds.feedburner.com\/~ff\/InvestmentU?a=EOY6mClezWw:RUb6-jNjo3Q:V_sGLiPBpWU\"><img decoding=\"async\" src=\"http:\/\/feeds.feedburner.com\/~ff\/InvestmentU?i=EOY6mClezWw:RUb6-jNjo3Q:V_sGLiPBpWU\" border=\"0\"><\/img><\/a> <a href=\"http:\/\/feeds.feedburner.com\/~ff\/InvestmentU?a=EOY6mClezWw:RUb6-jNjo3Q:qj6IDK7rITs\"><img decoding=\"async\" src=\"http:\/\/feeds.feedburner.com\/~ff\/InvestmentU?d=qj6IDK7rITs\" border=\"0\"><\/img><\/a> <a href=\"http:\/\/feeds.feedburner.com\/~ff\/InvestmentU?a=EOY6mClezWw:RUb6-jNjo3Q:gIN9vFwOqvQ\"><img decoding=\"async\" src=\"http:\/\/feeds.feedburner.com\/~ff\/InvestmentU?i=EOY6mClezWw:RUb6-jNjo3Q:gIN9vFwOqvQ\" border=\"0\"><\/img><\/a> <a href=\"http:\/\/feeds.feedburner.com\/~ff\/InvestmentU?a=EOY6mClezWw:RUb6-jNjo3Q:F7zBnMyn0Lo\"><img decoding=\"async\" src=\"http:\/\/feeds.feedburner.com\/~ff\/InvestmentU?i=EOY6mClezWw:RUb6-jNjo3Q:F7zBnMyn0Lo\" border=\"0\"><\/img><\/a>\n<\/div>\n<p><img loading=\"lazy\" decoding=\"async\" src=\"http:\/\/feeds.feedburner.com\/~r\/InvestmentU\/~4\/EOY6mClezWw\" height=\"1\" width=\"1\"\/><\/p>\n","protected":false},"excerpt":{"rendered":"<p><a href=\"http:\/\/www.investmentu.com\/2011\/June\/why-money-mangers-fail-to-beat-the-market.html\">Why Money Managers Fail to Beat the Market<\/a><\/p>\n<p>by <a href=\"http:\/\/www.investmentu.com\/investment-experts\/alex-green-archives.html\" target=\"_blank\">Alexander Green<\/a>, <em>Investment U&#8217;s<\/em> Chief Investment Strategist<br \/>\nMonday, June 27, 2011: Issue #1543<\/p>\n<p>Here are three easy ways to beat the market: Deception, irrelevance  and bad math.<\/p>\n<p>Perhaps&#8230;<\/p>\n","protected":false},"author":1,"featured_media":0,"comment_status":"closed","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":{"footnotes":""},"categories":[],"tags":[],"class_list":["post-21955","post","type-post","status-publish","format-standard","hentry"],"_links":{"self":[{"href":"https:\/\/www.investmacro.com\/fx\/wp-json\/wp\/v2\/posts\/21955","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/www.investmacro.com\/fx\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/www.investmacro.com\/fx\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/www.investmacro.com\/fx\/wp-json\/wp\/v2\/users\/1"}],"replies":[{"embeddable":true,"href":"https:\/\/www.investmacro.com\/fx\/wp-json\/wp\/v2\/comments?post=21955"}],"version-history":[{"count":0,"href":"https:\/\/www.investmacro.com\/fx\/wp-json\/wp\/v2\/posts\/21955\/revisions"}],"wp:attachment":[{"href":"https:\/\/www.investmacro.com\/fx\/wp-json\/wp\/v2\/media?parent=21955"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/www.investmacro.com\/fx\/wp-json\/wp\/v2\/categories?post=21955"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/www.investmacro.com\/fx\/wp-json\/wp\/v2\/tags?post=21955"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}