I’m going through the LVL3 reading 8 which explains behavioral finance etc. I happened to read these paragraphs:
“Barras, Scaillet, and Wermers evaluate the skill of active managers. Their study was intended to make general statements about the mutual fund industry rather than about any single mutual fund. They evaluate performance over the full set of mutual funds and separate them into three categories—skilled (generating positive alpha), unskilled (generating negative alpha), and zero-alpha. They add to previous research by explicitly accounting for skill and luck. Earlier empirical work either assumes no luck or full luck, thus producing biased conclusions about the prevalence of truly skilled and truly unskilled fund managers. Barras et al. conclude that 75.4 percent of the 2,076 funds analyzed were zero-alpha funds over their lifetimes. Of the remainder, only 0.6 percent were skilled and 24.0 percent were unskilled. In sum, Barras et al. conclude that the majority of actively managed domestic equity mutual funds have generated at most zero alpha after adjusting for luck, trading costs, and fees.”
and then
“These results are consistent with Bogle. Bogle illustrates that returns earned by a group of investors must fall short of the reported market returns or mutual fund returns by the amount of the aggregate costs the investors incur. Thus, we can conclude that the additional costs of moving in and out of funds and lack of performance persistence will generally result in returns lower than those expected by investors. Moving in and out of investments based on categorizations that place undue reliance on recent performance and new information is likely to result in excessive trading and inferior performance results.”
If this is actually true, what is the point of actively managed funds?
To manage risk and return targets that are based on an investors goals and the rest of their investment profile. Most people don’t need to beat the market. They need to save enough for college, retirement, preserve principal, among other things. Some managers are too active. We just want them to manage portfolio drift and protect us against profound changes in the economy.
Task any arbitrarily large number of monkeys and direct them to randomly buy/sell a portfolio of stocks, surely one will “consistently” generate above average returns over some fixed benchmark.
I think the more interesting question is of those managers or investors that consistently outperform, what proportion of them can we attribute their performance to being due primarily to luck or skill? Though I’m not that well read on all the research on this front, I’m inclined to think that the majority of it is luck.
Thanks for your 2 cents but my question wasn’t if people need to beat the market or not or what people are saving for. It was whether or not it is possible to beat the market consistently? (see the quotes included in my first post).
