Average Performance

This morning’s Wall Street Journal advised us that the performance of many large institutional investors has lagged that of the equity market since the beginning of the recovery five years ago.  The Journal attributed this performance gap to institutions’ moves into alternative investment categories such as hedge funds and private equity.  The explanation may be even simpler than that.  Any large endowment or pension fund will be diversified across a number of asset classes, and by definition the whole portfolio must underperform its best-performing component.

The most striking part of the article was a short quotation from Yale Professor William Goetzmann: “Alternative asset classes are expensive, especially if you have to live with the average fund instead of stellar funds.”  Of course, at the end of the day, the average fund is exactly what the average investor has to live with.

This is a direct consequence of what Sharpe called “The Arithmetic of Active Management.”  All asset owners own all the assets there are to be owned.  Therefore the weighted average return of all asset owners will be the weighted average return of all assets — in other words, the capitalization-weighted market return.

As a group, passive managers accept the market’s return, which means that as a (weighted) group, active managers must also accept the market’s return.  But the cost of running an active strategy means that the average active manager will typically underperform an index appropriate to his investment style, as our SPIVA reports have long demonstrated.  All the children in Lake Woebegon may be above average.  The average active investor is not.

The posts on this blog are opinions, not advice. Please read our disclaimers.

2 thoughts on “Average Performance

  1. avg antivirus free download

    Hello! This is my 1st comment here so I just
    wanted to give a quick shout out and say I truly enjoy reading your blog posts.
    Can you recommend any other blogs/websites/forums that cover the
    same subjects? Thanks!

  2. Craig LazzaraCraig Lazzara Post author

    Thanks for your kind comment.

    All ETF sponsors will have website content that covers some of the same territory that we do. Of course, for us, ETF sponsors are like children — we love them all the same. So I’m reluctant to recommend one for fear of inadvertently leaving out someone else who’s equally deserving of a mention.

    That said, you might enjoy http://www.sensibleinvesting.tv/ and http://www.rickferri.com/.


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