Update No. 108 – 12/04/13

Investors the world over are, or at least should be looking for one thing only.  That thing is defined most eloquently in this article, wherefrom this quote is drawn:

“Investing is the transfer to others of purchasing power now with the reasoned expectation of receiving more purchasing power — after taxes have been paid on nominal gains — in the future. More succinctly, investing is forgoing consumption now in order to have the ability to consume more at a later date”

Bill Gross from PIMCO made the statement recently that:

"All of us, even the old guys like Buffett, Soros, Fuss, yeah – me too, have cut our teeth during perhaps a most advantageous period of time, the most attractive epoch, that an investor could experience,"

The implication that the outperformance achieved would be unachievable in a weaker market. Now, if I was a young fellow who had the good fortune to meet Warren Buffett in 1957 and had given him my money to invest and stayed with him for the ensuing 56 years, my annual return would have been 20.9% ($1 becomes $40,885 over 56 years) – this figure is oft-quoted. The S&P (or the DOW) have returned 9.3% per annum ($1 becomes $145 over 56 years).

It beggars belief that this has to be pointed out to journalists in the financial media, but Buffett’s fame as an investor comes from the 10.6% gap between these two numbers not the 20.9% number.  The investor who stuck with Buffett for 56 years has about 282 times more money as a consequence of following a capital allocator manifold more competent than the broader market.

Assume Bill Gross is correct and that most of the gains over the last 50 or so years are the consequence of ‘unrepeatable’ factors such as credit market growth.  Assume the S&P/DOW only returned 4.6% per annum over the period and Buffett ‘only’ got 15.2% p.a (i.e. same ‘margin of victory’). Well, the outcome is not that much different. The DOW investor turned each dollar into $12.40 and Buffett turned his investors $1 into $3,355, about 271 times better. Presumably, because economic performance was weaker, the deflation in the value of money would have been slower and the utility of the $3,355 here is probably not wildly different to that of the $40,885 above.

The great investors are feted because of how they perform next to a relevant measure of performance. Buffett is an equities investor and has routinely trounced every suitable equities benchmark. Bill Gross is a bond investor and has devastated any suitable bond benchmark. Even when overall results are lower, competent investors will continue to beat relevant benchmarks.

More frustrating than articles like the above are the ones that try to imply ‘dartboards’ or ‘Monkeys’ (paywall) can beat the market – from the article:

The process was then repeated 10 million times over each of the 43 years and has been described by the school as “effectively simulating the stock-picking abilities of a monkey”.

The article then goes on to mention (my emphasis):

But that return was beaten by half of the computer-simulated monkeys used in the study.

GENIUS! A random selection of stocks beat the ‘un-managed’ market 50% of the time!!! I don’t know about you, but I reckon I could have picked that outcome before I started the experiment…

By the articles own admission, the top 25% of ‘monkeys’ are about 1.5% per annum better than the market.  The ‘Top 10%’ were just over 1.6% p.a. better than the market. I would hazard the top 0.1% (those greater than 3 standard deviations better than the mean) probably stretched as far as 3% p.a. better than the market. So 10 million monkeys couldn’t get within ‘cooee’ of the 10.6% annual beating Buffett has handed the market for 56 years (i.e. 13 years longer than the study), last I heard Buffett was up to about 9 or 10 standard deviations.

Professional investors would probably distribute along something that looks approximately like a bell curve, perhaps skewed to gross results slightly better than the market. So I’m suggesting professionals are probably on the average better than amateurs you ask? But don’t I always say that over the longer term something like 80% of professional investors will fail to beat a suitable benchmark after fees?

I do say that. It is the ‘after fees’ that bring the mean result of the average professional below the mean result of the unmanaged market. This is because professional fees for money-managers are improperly structured in my view. If you assume the ‘average’ fees/costs charged by professional money managers are 1.6% and the results match the monkey results above, then 90% of them will underperform. Given that fees/costs are probably slightly higher (on average) than 1.6% and only 80% (by my estimation) underperform, you can see where my assertion that the underlying results of professionals are ‘skewed slightly better than the market’. This is why the professional money manager who is confident in their abilities should be unafraid to adopt something like the EGP Fund No. 1 fee structure, with 100% (or at least something close to it) of earnings based on outperformance of a suitable benchmark. This will lead to lumpy/unpredictable earnings, but if a money-management professional is as good as they think they are, very good results should still be made over time.

I always assume these stories are planted in the financial media to make most average investors feel a little better about their own shabby results. I think the financial media is wasting their time if that is what they’re trying to achieve. In my view, most private investors are like gamblers, they block out losses and remember wins and persuade themselves they are ‘better than average’ even though their wealth stubbornly refuses to grow at a rate comparable with the market return – Tony Hansen 12/04/13

EGP Fund No. 1 Pty Ltd. Up by 15.76%, leading the benchmark by 6.57% since January 1^st. Since inception, EGP Fund No. 1 Pty Ltd is Up by 40.91%, leading the benchmark by 27.12% all-time (April 1^st 2011).