Don’t Believe the Hype: Active Managers Rarely Outperform

Photo by Jamie Street on Unsplash

Although Nobel prize winning research points to sustained investing outperformance being impossible, active management continues to capture the imagination. Since one cannot know the future, it is extremely difficult to pick stocks that will outperform the general market. SPGI finds that past performance is not a reliable indicator of future performance. Fama and French identify several factors that explain almost any manager’s investment performance. Even those managers that have unexplained excess return do not have it persistently.

Managers and the investing public continue to spin stories that attempt to explain why a given fund outperformed and why they will continue to do so. Often, the story boils down to the manager conducting more due-diligence on a company, having more or faster information, or having the skill to prognosticate. Most of these managers suffer from cognitive biases. Recency bias and confirmation bias lead the investing community to believe that recent winners have some sort of skill that leads to their performance. Rigorous research and empirical evidence demonstrate that most outperformance is fleeting.

There are those managers that have had statistically significant outperformance across their careers. The likes of Buffett, Pabrai, Klarman, and Lynch inspire many young investors to try their hands at wealth creation. A careful review of their advice and their careers reveals only a few prevailing themes. First, each emphasizes that the future is unknowable. Second, one should not focus too much on what can go right but more on what can go wrong. Third, combining the first and second, one should execute extreme caution and discipline. Discipline is the most emphasized advice from these celebrated gurus. Those investors that can stick to their convictions and repeat their process over and over consistently beat the market over their life.

The financial industry thrives on public excitement for stock investing. It also preys on the emotional nature of most retail investors. By dressing up sales literature in academic research, the industry can churn more trades from its clients. Investing, however, is not an emotional activity. The best advice that I can give from my academic training, professional experience, and candid opinion is for every investor to either cultivate discipline in process or submit to prevailing research and passively invest.

--

--

--

Traveling through the Intersections

Love podcasts or audiobooks? Learn on the go with our new app.

Recommended from Medium

Shopaholics Unite!

Before the Pandemic I Had No Savings and £2,000 worth of Debt

Whether you just embraced the concept or you’ve had a focus on becoming financially independent…

7 Ways To Earn More Money

Who are those guys in the FreeCreditReport.com commercials?

Profit Trailer — Market Trend Scripts ( PT Feeder and PT Magic )

Bad Investing Advice: What to ignore [and why]

Common Home Buying Mistakes and How to Avoid Them

Get the Medium app

A button that says 'Download on the App Store', and if clicked it will lead you to the iOS App store
A button that says 'Get it on, Google Play', and if clicked it will lead you to the Google Play store
Synthenaut

Synthenaut

Traveling through the Intersections

More from Medium

You Cannot Fight the Fed

You Cannot Fight the Fed

Typical Late-Cycle Phenomenon — Surge In Commodity Prices

Market Noms — Curated Market Digest #2

Investing in Spotify: Opportunities and Risks