On beating mutual funds

Investment Analysis Clubs Saul’s Investing Discussions
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Saul, I always note with wry amusement your line about intelligent stock picking can beat any index, followed by ‘How could it not?’. This cannot possibly be a disingenuous remark so a quick riposte is required. The plain, awful fact is that not only could it not, it manifestly does not! After any reasonable investment horizon, say 20 years, the number of fund managers left standing against the index is roughly the same as pure, random chance (the coin-flippers) would predict. Hell, there aren’t that many after 15 or even 10.

Hi streina,
I know that you and I disagree about this, even in the face of my results over almost 30 years now. I’m surprised you are not more evidence based.

Basically, it’s because we are negotiating a little speed boat while the mutual fund managers are trying to turn a battleship. I remember in 2010 (after the big crash of 2008) when all the talking heads were talking about the lost decade for the markets (which apparently were where they had been at the start of 2000), and I was up 500% in those ten years (not a misprint) and didn’t know what they were talking about. Here’s what I wrote in the KB, with some additions:

You can beat any mutual fund over the long run. Since they are investing many millions, if not billions of dollars, they can only invest in very large established companies, and hope to find a pricing anomaly.

I don’t know of any fund manager or hedge manager with a run like mine. It went through a number of recessions and lasted 19 years until I finally had a down year in 2008. But again, if a fund manager does real well for a year or two, not only does his fund get larger because of capital gains, his fund get flooded, swamped, with inflows of dollars and he can’t duplicate what he did when the fund was small.

Also, investors pour money into the mutual fund when it’s at the highs, and the managers, who usually have to be 95% invested or something, have to buy at the top. Then the investors pull money out at the bottom when everyone is shouting “Sell!” and the managers have to sell at the bottom to cover withdrawals. It’s no wonder we always beat them.

Also a mutual fund can’t be concentrated like our portfolios can be. They usually have to be invested in at least 50 to 100 stocks and finding 50 stocks that might rise 40% or 50% on the year is a LOT harder than finding and following 10 or 15. they can’t possibly follow what’s going on with all their stocks.

Also they have lots of people looking over their shoulders for quarterly results (are they equaling their benchmark each quarter?) It makes it hard to get good results, I’m sure. It’s the old “You never get fired for investing in IBM” syndrome, which makes them avoid taking chances on little companies the way we do.

So saying that mutual fund managers don’t beat the indexes has nothing to do with what we can or can’t do.

Best,

Saul

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The plain, awful fact is that not only could it not, it manifestly does not! After any reasonable investment horizon, say 20 years, the number of fund managers left standing against the index is roughly the same as pure, random chance (the coin-flippers) would predict.

Coin flipping has a normal (bell shaped) distribution. Prices have a power law (Pareto) distribution. Comparing the two is apples to aardvarks. This is why black swans happen more often than predicted by normal distribution mathematics.

Why Does the Average Mutual Fund Underperform?

It has often been stated that the average mutual fund underperforms the market but I have never seen an adequate explanation. I used to believe in a simplistic reason: Since mutual funds make up the average, if you deduct their management fees, their results will be that amount below the average. While this holds true, it is not the real reason. For an explanation we have to look at the Pareto Distribution of wealth.

https://softwaretimes.com/files/why+does+the+average+mutua.h…

Indeed individual investors have advantages over industry behemoths but you have to be truly a great stock picker, an agile trader, stay away from speculation, and control your emotions to get these above average results for decades.

Denny Schlesinger

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Saul, I am not talking about you (see my last para.) I said you are a rare exception that proves the rule!

I wish you were right about speedboats and agility. Unfortunately, even a mutual fund has to start somewhere and there are plenty of small ‘boutique’ ones. And there are numerous small and even tiny funds (and hedge funds) and their after-fees returns to investors over any reasonable investing timescale also fail to beat the index. That is why they love to give their results over shorter periods - and change their benchmark if it suits! Or close down the fund and open another; the tricks are numerous. But with the advent of ETFs, managed funds are starting to be held to more rigorous standards

I will add a guess that individuals do no better, probably much, much worse!

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I will add a guess that individuals do no better, probably much, much worse!

There are two entirely different issues here.

Yes, in general the individual will do less well than the index. As Denny keeps informing us, this is a necessary part of the power distribution.

But, a MF, even a small one, is dealing with large amounts of money and serious constraints on what is considered a safe investment and the need to make numbers every quarter and dealing with money coming in at the wrong times and going out at the wrong times as described. In this respect, it is easier for an individual to have an excellent record … even though most individuals won’t.

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Saul, I wrote about this following 8 years of running Motley Fool Funds.

In short: you don’t know the half of it.

https://www.nasdaq.com/article/i-know-why-mutual-funds-fail-…

Bill Mann

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all them apply but at the heart of it is that individuals buy mutual funds deep into bull markets (all their friends are talking about getting rich) and sell mutual funds deep into bear markets (fear is pervasive)

Thus funds are forced to buy and sell at all the wrong times, even though managers know better.

One kind of fund may be a good buy- closed end funds, but only at the worst of the bear where many have significant discounts- pick a closet indexer type, some of the discount will go away soon after he bull starts. It’s like getting a dollar for 85 cents

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well hot dog. Bill, I started investing with you back during the HG and GG days. I never sent you an email to thank you for the positive influence you had on my investing career. I learned a lot but more importantly you guys nurtured a great community. I remember being so very excited when new picks were coming out. Anywho, in my mind this place is a great spiritual successor to those days.

Welcome to the board and thanks for all the fish!

Ethan
(p.s. that is a teach a man to fish reference)

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Same Bill Mann(Otterpater I think) who hung out with Rat and the chatline in those early crazy days?

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I don’t know of any fund manager or hedge manager with a run like mine.

Clearly you haven’t the luck of the typical individual investor.

Sure one can beat the average mutual fund manager with all the overheads of their trade… but indexing is king in the long run. Anything else is just sport/fun/hobby.

It’s merely statistics that bear this out. Not anecdotes. That all said there was a thread shutdown here not long ago that took issue with the overall track record. It’s easy to win in a bull market. What separates the men from the boys is the grizzly bear.

Pride goes before destruction, And a haughty spirit before stumbling.

🆁🅶🅱

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Thanks Bill, that was a great article and expands on my reasons why mutual funds not beating the indexes has nothing to do with what we as individual investors can do. Terrific article. Thanks again.
Saul

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