Don’t Confuse Me with the Facts

As surely as we saw the ball drop in Times Square, at the turn of the year we see predictions that this year, unlike last, will be the year when active equity management shows its true value.  Of course, similar predictions were made a year ago, and they didn’t work out particularly well, but that never seems to diminish the confidence of the new year’s forecasters.  A cynic might remember Upton SInclair’s observation that “It is difficult to get a man to understand something, when his salary depends on his not understanding it.”

One current argument for active management is that, with the S&P 500 and Dow Jones Industrial Average near all-time highs, the consequently heightened possibility of a bear market means that active managers are needed to mitigate risk.  This sounds like an appealing thesis; unfortunately it is untrue.  In the dozen years since our SPIVA reports began to keep score on U.S. active managers, there have been only two bear market episodes.  In the 2000-2002 deflation of the technology bubble, and again in the financial crisis of 2008, 54% of large cap funds underperformed the S&P 500.  Mid-cap and small-cap performance was even worse.  Whatever else one might say of active management, it is clearly no sure port in an investment storm.

Does that mean that successful active management is impossible?  Certainly not — but investors who are contemplating it should understand, as a matter of both theory and empirical evidence, that success is unlikely.  On the other hand, as Ellis has recently argued, true value added is more likely to reside in investment counseling than in portfolio management.  Advisers who can keep their clients from succumbing to the alternating temptations of fear and greed perform a valuable service.  Advisers who think they can identify active fund managers who will reliably outperform their index benchmarks, on the other hand, should realize that the odds are against them.


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

2 thoughts on “Don’t Confuse Me with the Facts

  1. Teddy V

    Given the often parlous state of investor’s portfolios, I am surprised that you claim:

    “true value added is more likely to reside in investment counseling than in portfolio management”.

    One hedge fund manager’s approach to portfolio selection and management techniques has the following results:

    “Our return has decreased slightly to 7.1% per year (from 7.7%), however the maximum drawdown has crashed from 23% to 5%. Thus, we obtain a portfolio with very limited downside risk (at least historically) and quite interesting return.

    This shows how simple concepts (such as diversification, risk-parity and trend-following) combined in a clever way can bring low-hanging fruit to investors.”


    Surely that is what constitutes outstanding value added?

    Investment counseling can add absolutely nothing if the portfolio is woefully constructed so it inevitably takes a 50% loss the next time a 2008/9 situation is encountered again.

    Counsel all you like – but what I really want is loss-reduction techniques implemented by my wealth adviser, plus being optimised for good annual growth.

    Do you know any reliable ways to achieve this, i.e. minimise drawdown & participate fully in upside ?

    Many thanks,

  2. Craig LazzaraCraig Lazzara Post author


    Thanks for your comment.

    I note that the data in the article you cite go back to 1990, which means they are simulated/backtested. That’s not a condemnation in itself (we backtest new indices when we introduce them), but backtest results, especially really good ones, need to be taken with a grain of salt. See for what I hope will be a helpful salt shaker.

    Second, this is, as you point out, the result from “one hedge fund.” Our SPIVA reports, and similar studies from other authors, are concerned with active managers as a group. There’s no theology that says successful active management is impossible, but there’s plenty of good evidence (theoretical and empirical) that says it’s very difficult — so much so, in fact, that the average investor has little chance of finding it.

    Finally, perhaps I wasn’t clear about what I meant by “investment counseling.” An investor whose portfolio “is woefully constructed so it inevitably takes a 50% loss” in distressed conditions needs a good investment counselor to fix his portfolio. The distinction I want to draw is between counseling — which has to do with asset allocation, risk tolerance, rebalancing strategies, etc. — and portfolio management — which has to do with picking stocks, industries, sectors, etc. Ellis makes the point well in the article I cited.

    Do I know any reliable ways to minimise drawdown & participate fully in upside? No. I do know of some strategies that, historically at least, have successfully attenuated (not eliminated) downside risk; the price of doing so is that they also attenuate upside participation. We call these “low volatility” strategies; others call them “minimum variance” or “minimum volatility.” (See for a general description and for evidence that the strategies work globally.) In the interest of full disclosure, you can also find active managers who offer these approaches.


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