The Case for Active Investing

[ginmqi]

If the failures of active guys are not hard enough studying/work...then this also implies there is are tried and true methods/strategies for active management. Much like medical school...if a student fails a test/rotation it is much likely the student's failure to study rather than the system itself (can happen the other way but is rare).

So if there are textbooks of active management then everyone should be reading/studying these to beat the market. And I'm sure all of us would love to know these.

I did come across a recent active management book that touts momentum investing and shows some VERY nice graphs on very very nice returns.....another physician/financial blogger seems to like it quite a bit over at the Miles Dividend MD blog.

[G]

As mentioned above (Zaphod?), the amount of work required for the tiny alpha isn't worth it.  Unless, perhaps, it is your full time job, ideally with others paying you to do it, the more the merrier in terms of scale.  Thinking of the liquid portion of my portfolio as a late-mid career physician, I would need to beat the market by 20-25% this year to equal my anticipated income from medicine in 2017.  Not gonna happen unless by sheer luck.  Even when my boring index-dominated portolio (hopefully) doubles in 10 years, I would need to beat by 10% to equal my full-time doctor income.  That's not going to happen either; besides, I'll be too busy in mostly-retirement to do financial research work.

And this is assuming that research and hard work actually leads to making the right call...which I, respectfully, think is a deeply flawed assumption.

[CM]

WallStreetPhysician wrote:

CM wrote:

WallStreetPhysician wrote:

CM wrote:

It is difficult. It requires education (formal or informal) and research. It might not pay off, and most people don’t want to invest the effort. Who can blame them?

Most blogs don’t make money. Rental properties and franchises can lose money. All of these things require effort and risk.

However, just about everyone acknowledges that it’s possible to earn a return on effort with blogs, real estate, or franchise operations. Yet there seems to be a consensus that equity investing is an impossible black box.

Based only on my acquaintances, most people fail at active investing because they don’t make sufficient effort. They dive in without knowing what they are doing, or they treat the endeavor like a night at the casino. They are the bloggers that give up after a year, and the franchisees who don’t understand their UFOC.

But I should stop writing. The fewer intelligent, motivated investors the better (for the rest of us).

 

Click to expand…

Trust me, there are plenty of smart people working in Wall Street. Some people lament the brain drain from academia into finance; imagine all the advances we could achieve in science and medicine if the best and brightest worked in medical research instead of coding algorithms to make money off Donald Trump’s tweets.

Click to expand…

I know who works on Wall Street. I earned an MBA from Booth (a prominent Wall Street feeder) and the CFA designation while working as a healthcare equity analyst. My former colleagues are scattered throughout the sell side and (mainly) the buy side.

Click to expand…

What chance does a full-time physician have to out-analyze the mutual funds / hedge funds who employ your former colleagues?

Click to expand...

A very small chance. As I wrote above, "There is no reason to believe that a busy physician (lawyer, engineer, etc.) with no financial training can beat indexes." Most should buy an index.

I only object to the notion that equities are impervious to talent and work, but blogs, rental units, franchises, and (insert favorite active investing endeavor here) can make attractive side-hustles.

We have advantages over active fund managers (some listed above), but they beat the market before fees (which is both surprising and reassuring). The greatest advantage (related to size) may be the illiquidity premium (http://www.ibbotson.com/US/documents/MethodologyDocuments/ResearchPapers/LiquidityAsAnInvestmentStyle.pdf).

Note that despite my training and experience, I currently invest in stock indexes and individual treasury bonds, but I've been working 12 hour days and taking call every other night and every other weekend--until this month. Now I take call 10 nights/month and one weekend/month. That is still probably too much to allow successful investing, but I hope to find an opportunity here and there (if I can pull myself away from finance blogs long enough to study).

If I had the energy that WCI or Michael Burry apparently possess, and if I could modulate my workload as readily as an ER doc, then I would be a much more active investor. When I "retire," my tentative plan is to start with indexes and gradually transition to my handpicked portfolio as I find opportunities.

[G]

Rex wrote:

There are zillions of people with the time and the interest.  Guess what they dont beat the indexes the vast majority of the time.  Its sort of foolish to believe that its going to be highly likely that one can do a better job actively managing just bc they have time and interest and this wouldnt even account for the value of that time.  Now with that said, i do own a few stocks.  I call it what it is…gambling….I like to do it.  I dont spend a ton of time on it but it does interest me for fun.  I actually do better than my index funds entirely because of both luck and taking on more risk.  I dont kid myself.  There would be tons of warren buffets out there if this was truly the case that time and interest can make it happen.

 

Its also funny to see the size argument.  I love how active proponents use it both ways.  People also argue that because they have such size that then they can get special deals or that the costs become a small fraction.

 

There is no real tax advantage of managing it yourself vs buying an index.

Click to expand...

I have a gambling portion of my portfolio too...some of them have soared, some of them have tanked.  The majority have done just ok.

For the longest time, I had a line on my account of a stock that was worth like $0.05...a 99.99% loss.  It glared at me whenever I logged on, heckling me, calling me names.  Finally, I got the brokerage service to put me out of my misery and take it off so that I could claim it as a complete loss.  Perhaps I should have left it on there forever as a reminder of my genius.

[Sneezy]

By definition, the overall return of all active investors before fees and costs must equal the overall return of the market as a whole.

So for every active investor who beats the index, someone else must do worse.  And fees and trading costs are non-negligible, especially if you trade a lot.

So sure, maybe you can outwork/outsmart the market but lots of people just as smart as me went to work on Wall Street, not in medicine.  Absent some "inside" information I am not confident I can beat the market, nor is the small increase in return I might be able to achieve likely to be worth the time

[Zaphod]

CM is one of those guys and can probably do it, this doesnt transfer to the majority though. Honestly there are several ways to do it, but it increases your risk of course. The easiest is to do things others are unwilling to do.

Single stocks were last generations only option, so thats what they trade. This generation has etfs and thats whats common. Even when I trade I now try to use indexes as its simpler and less overall company specific risk (and upside).

What is absolutely right is most drs certainly dont have the time to be paying attention. Im impressed with the amount of thought most of this board puts into it. It takes effort. With our level of income and contribution ability really there is no need to do more than get the market rate or take on extra risk, though some of us will inevitably play.

@G I have now started to cut my losses asap, before 10% turns into 50% and there is no reasonable hope to get back to break even in that vehicle. I do keep some of my twtr around to remind me of my brilliance in single stock days though.

The less I've played with my portfolio the better my returns have been. Now Im just really selective and opportunistic, like last year I tried like crazy to put everything in while the market was tanking, and whenever it hiccups I try to capitalize.

[WallStreetPhysician]

CM wrote:

WallStreetPhysician wrote:

CM wrote:

WallStreetPhysician wrote:

CM wrote:

It is difficult. It requires education (formal or informal) and research. It might not pay off, and most people don’t want to invest the effort. Who can blame them?

Most blogs don’t make money. Rental properties and franchises can lose money. All of these things require effort and risk.

However, just about everyone acknowledges that it’s possible to earn a return on effort with blogs, real estate, or franchise operations. Yet there seems to be a consensus that equity investing is an impossible black box.

Based only on my acquaintances, most people fail at active investing because they don’t make sufficient effort. They dive in without knowing what they are doing, or they treat the endeavor like a night at the casino. They are the bloggers that give up after a year, and the franchisees who don’t understand their UFOC.

But I should stop writing. The fewer intelligent, motivated investors the better (for the rest of us).

 

Click to expand…

Trust me, there are plenty of smart people working in Wall Street. Some people lament the brain drain from academia into finance; imagine all the advances we could achieve in science and medicine if the best and brightest worked in medical research instead of coding algorithms to make money off Donald Trump’s tweets.

Click to expand…

I know who works on Wall Street. I earned an MBA from Booth (a prominent Wall Street feeder) and the CFA designation while working as a healthcare equity analyst. My former colleagues are scattered throughout the sell side and (mainly) the buy side.

Click to expand…

What chance does a full-time physician have to out-analyze the mutual funds / hedge funds who employ your former colleagues?

Click to expand…

A very small chance. As I wrote above, “There is no reason to believe that a busy physician (lawyer, engineer, etc.) with no financial training can beat indexes.” Most should buy an index.

I only object to the notion that equities are impervious to talent and work, but blogs, rental units, franchises, and (insert favorite active investing endeavor here) can make attractive side-hustles.

We have advantages over active fund managers (some listed above), but they beat the market before fees (which is both surprising and reassuring). The greatest advantage (related to size) may be the illiquidity premium (http://www.ibbotson.com/US/documents/MethodologyDocuments/ResearchPapers/LiquidityAsAnInvestmentStyle.pdf).

Note that despite my training and experience, I currently invest in stock indexes and individual treasury bonds, but I’ve been working 12 hour days and taking call every other night and every other weekend–until this month. Now I take call 10 nights/month and one weekend/month. That is still probably too much to allow successful investing, but I hope to find an opportunity here and there (if I can pull myself away from finance blogs long enough to study).

If I had the energy that WCI or Michael Burry apparently possess, and if I could modulate my workload as readily as an ER doc, then I would be a much more active investor. When I “retire,” my tentative plan is to start with indexes and gradually transition to my handpicked portfolio as I find opportunities.

Click to expand...

CM, I think we've found some common ground here. While we fundamentally disagree on the validity of the efficient market hypothesis, I think you should try your hand at individual stock picking.

If you are right, you will get above-market returns. If I am right, you will end up with an expected return equal to the market (assuming you invest in individual stocks and in a tax-efficient manner, albeit likely with a higher standard deviation).  All you've lost is the time and effort analyzing the markets in vain, but it's something you (and most of us on this forum) enjoy doing.

I say go for it.

[Dicast]

I'm all for attempting to outsmart the market.  I know from prior performance that I'm not likely to be that guy though.  Indexing may be the lame, boring way to invest but it makes it much easier for me to sleep at night.  I don't have to spend significant amount of time deciding when the right moment to sell is, or when the right moment to buy is.

Despite the above I've been fighting the urge to go back to individual stock picking and it has pretty much played out like this in my head...I could rationally put 10% of my portfolio into individual stocks...but for them to make any meaningful positive impact on my portfolio they need to go big...well, I know the last time I went "big" I created a tax loss harvesting opportunity...I'll just stick with index funds.

[Zaphod]

I think there is far safer opportunity using indexes than individual stocks. You have to get so much right with a single stock on the long side, and the market has to not see it. Lot of more time to get it done as well. Its easier to spot great short candidates, but then your timing becomes the problem as it may be awhile before the market realizes it and the company will sometimes fraudulently do what they can to go on, or you get a wicked short squeeze (DRYS amirite?).

[CM]

WallStreetPhysician wrote:

CM wrote:

WallStreetPhysician wrote:

CM wrote:

WallStreetPhysician wrote:

CM wrote:

It is difficult. It requires education (formal or informal) and research. It might not pay off, and most people don’t want to invest the effort. Who can blame them?

Most blogs don’t make money. Rental properties and franchises can lose money. All of these things require effort and risk.

However, just about everyone acknowledges that it’s possible to earn a return on effort with blogs, real estate, or franchise operations. Yet there seems to be a consensus that equity investing is an impossible black box.

Based only on my acquaintances, most people fail at active investing because they don’t make sufficient effort. They dive in without knowing what they are doing, or they treat the endeavor like a night at the casino. They are the bloggers that give up after a year, and the franchisees who don’t understand their UFOC.

But I should stop writing. The fewer intelligent, motivated investors the better (for the rest of us).

 

Click to expand…

Trust me, there are plenty of smart people working in Wall Street. Some people lament the brain drain from academia into finance; imagine all the advances we could achieve in science and medicine if the best and brightest worked in medical research instead of coding algorithms to make money off Donald Trump’s tweets.

Click to expand…

I know who works on Wall Street. I earned an MBA from Booth (a prominent Wall Street feeder) and the CFA designation while working as a healthcare equity analyst. My former colleagues are scattered throughout the sell side and (mainly) the buy side.

Click to expand…

What chance does a full-time physician have to out-analyze the mutual funds / hedge funds who employ your former colleagues?

Click to expand…

A very small chance. As I wrote above, “There is no reason to believe that a busy physician (lawyer, engineer, etc.) with no financial training can beat indexes.” Most should buy an index.

I only object to the notion that equities are impervious to talent and work, but blogs, rental units, franchises, and (insert favorite active investing endeavor here) can make attractive side-hustles.

We have advantages over active fund managers (some listed above), but they beat the market before fees (which is both surprising and reassuring). The greatest advantage (related to size) may be the illiquidity premium (http://www.ibbotson.com/US/documents/MethodologyDocuments/ResearchPapers/LiquidityAsAnInvestmentStyle.pdf).

Note that despite my training and experience, I currently invest in stock indexes and individual treasury bonds, but I’ve been working 12 hour days and taking call every other night and every other weekend–until this month. Now I take call 10 nights/month and one weekend/month. That is still probably too much to allow successful investing, but I hope to find an opportunity here and there (if I can pull myself away from finance blogs long enough to study).

If I had the energy that WCI or Michael Burry apparently possess, and if I could modulate my workload as readily as an ER doc, then I would be a much more active investor. When I “retire,” my tentative plan is to start with indexes and gradually transition to my handpicked portfolio as I find opportunities.

Click to expand…

CM, I think we’ve found some common ground here. While we fundamentally disagree on the validity of the efficient market hypothesis, I think you should try your hand at individual stock picking.

If you are right, you will get above-market returns. If I am right, you will end up with an expected return equal to the market (assuming you invest in individual stocks and in a tax-efficient manner, albeit likely with a higher standard deviation).  All you’ve lost is the time and effort analyzing the markets in vain, but it’s something you (and most of us on this forum) enjoy doing.

I say go for it.

Click to expand...

If even Fama still believes in the Efficient Market Hypothesis after so many anomalies have been discovered and published, then it's only because (to paraphrase Upton Sinclair), "It is difficult to get a man to understand something when his academic reputation depends upon his not understanding it."

If Jim Simons ever publishes his memoirs, the literature will expand by an order of magnitude.

[WallStreetPhysician]

CM wrote:

WallStreetPhysician wrote:

CM wrote:

WallStreetPhysician wrote:

CM wrote:

WallStreetPhysician wrote:

CM wrote:

It is difficult. It requires education (formal or informal) and research. It might not pay off, and most people don’t want to invest the effort. Who can blame them?

Most blogs don’t make money. Rental properties and franchises can lose money. All of these things require effort and risk.

However, just about everyone acknowledges that it’s possible to earn a return on effort with blogs, real estate, or franchise operations. Yet there seems to be a consensus that equity investing is an impossible black box.

Based only on my acquaintances, most people fail at active investing because they don’t make sufficient effort. They dive in without knowing what they are doing, or they treat the endeavor like a night at the casino. They are the bloggers that give up after a year, and the franchisees who don’t understand their UFOC.

But I should stop writing. The fewer intelligent, motivated investors the better (for the rest of us).

 

Click to expand…

Trust me, there are plenty of smart people working in Wall Street. Some people lament the brain drain from academia into finance; imagine all the advances we could achieve in science and medicine if the best and brightest worked in medical research instead of coding algorithms to make money off Donald Trump’s tweets.

Click to expand…

I know who works on Wall Street. I earned an MBA from Booth (a prominent Wall Street feeder) and the CFA designation while working as a healthcare equity analyst. My former colleagues are scattered throughout the sell side and (mainly) the buy side.

Click to expand…

What chance does a full-time physician have to out-analyze the mutual funds / hedge funds who employ your former colleagues?

Click to expand…

A very small chance. As I wrote above, “There is no reason to believe that a busy physician (lawyer, engineer, etc.) with no financial training can beat indexes.” Most should buy an index.

I only object to the notion that equities are impervious to talent and work, but blogs, rental units, franchises, and (insert favorite active investing endeavor here) can make attractive side-hustles.

We have advantages over active fund managers (some listed above), but they beat the market before fees (which is both surprising and reassuring). The greatest advantage (related to size) may be the illiquidity premium (http://www.ibbotson.com/US/documents/MethodologyDocuments/ResearchPapers/LiquidityAsAnInvestmentStyle.pdf).

Note that despite my training and experience, I currently invest in stock indexes and individual treasury bonds, but I’ve been working 12 hour days and taking call every other night and every other weekend–until this month. Now I take call 10 nights/month and one weekend/month. That is still probably too much to allow successful investing, but I hope to find an opportunity here and there (if I can pull myself away from finance blogs long enough to study).

If I had the energy that WCI or Michael Burry apparently possess, and if I could modulate my workload as readily as an ER doc, then I would be a much more active investor. When I “retire,” my tentative plan is to start with indexes and gradually transition to my handpicked portfolio as I find opportunities.

Click to expand…

CM, I think we’ve found some common ground here. While we fundamentally disagree on the validity of the efficient market hypothesis, I think you should try your hand at individual stock picking.

If you are right, you will get above-market returns. If I am right, you will end up with an expected return equal to the market (assuming you invest in individual stocks and in a tax-efficient manner, albeit likely with a higher standard deviation).  All you’ve lost is the time and effort analyzing the markets in vain, but it’s something you (and most of us on this forum) enjoy doing.

I say go for it.

Click to expand…

If even Fama still believes in the Efficient Market Hypothesis after so many anomalies have been discovered and published, then it’s only because (to paraphrase Upton Sinclair), “It is difficult to get a man to understand something when his academic reputation depends upon his not understanding it.”

If Jim Simons ever publishes his memoirs, the literature will expand by an order of magnitude.

Click to expand...

Agreed on Jim Simons. But I think he would rather keep on printing billions of dollars for himself than share his secrets with us. As would any investor who has found a market inefficiency to exploit. My guess is that they would not publish it in the academic literature.

[PhysicianOnFIRE]

ginmqi wrote:

I did come across a recent active management book that touts momentum investing and shows some VERY nice graphs on very very nice returns…..another physician/financial blogger seems to like it quite a bit over at the Miles Dividend MD blog.

Click to expand...

I'm not sure if he's stuck with it or not, but he reported his returns after 14 months using dual momentum, and the strategy underperformed for him over that time frame. He stated he still likes it for the potential to reduce drawdowns when the market tanks, but the last update was over a year ago.

Regarding individual stock or sector picking, the time and stress involved in constantly deciding whether to buy, sell, or hold each stock or fund is a hassle I wouldn't want for myself. All the woulda coulda shoulda and second guessing would drive me up a wall. There's a chance I would outperform the markets, and there's a pretty good chance I would underperform. Either way, it would be a lot more work.

If you enjoy the work and what I call stress, you call excitement, knock your socks off. You gotta do what works for you. I do what works for me, and that's index funds. I take a little extra risk for potential reward with tilts to small cap value and EM, and I've invested in new craft breweries with play money, but that's the extent of my risk taking.

[ginmqi]

^^Interesting. Looks like his blog is a bit barren and maybe other needs are more pressing for him. The Dual Momentum strategy does sounds very very enticing (I read the ebook) and I applaud people who have the guts to try that.

As an evidence based man myself, I can't say unequivocally that the market is perfectly efficient and there are no inefficiencies to exploit and make money for a subset of investors/managers. Certainly I think that probably is true and as the few posts above mentioned...those are likely very closely guarded secrets to those in the know.

From my very cursory knowledge of active management and my watching of a few documentaries on how hedge funds work....it seems one of the core pillars is overwhelming information asymmetry. Where one side has information that is clearly advantageous to the other side (whether its on the buy side or sell side). And that information can be either be content-sensitive (ie, specific information regarding something that other parties are unawareof ) or speed-sensitive (knowing of something that may happen before knows are able to).

Of course you can imagine that can skirt with the boundaries of the SEC/insider-trading laws and many have been publically shamed and a few are legally sanctioned. One of the leaders of that industry, now "retired" it seems, Stephen A Cohen certainly made himself extremely wealthy.

The challenge, it seems, is to find inefficiencies to exploit that is worthwhile lucrative (not just a small advantage) while being completely legal.

I too would LOVE to generate incredible returns in my investment over 10-30+ years above the market average. Though as others have alluded to...these kinds of strategies/information are rare going to be accessible to the lay public and the risk is trusting a manager to do it or risk your own time/money to do it yourself.

[Zaphod]

There are definitely "inefficiencies" or rather risk premia in areas that are still available. Its much simpler to do what most people will not, thats where its "easier". If you try to fight with millions of other professionals, funds, and individuals looking for value companies for example, good luck with that. If you're willing to take on certain risks or due to nature of our incomes have access to different deals than the average person, you certainly can get more than the "market" average.

However, the definition of "market" changes. I can beat the s/p fairly easily with only a couple extra moves or trades, however my portfolio or style no longer represents the market as previously defined and I now have a new hurdle to beat. If you want to beat the s/p index, that can be done, but you will do so by taking on extra risk, much of it reasonable but most people wont be doing it or have access to it (leverage, etc...) which is a large part in why it still works.

[The White Coat Investor]

It's really beyond me why someone would try active management with stocks. If you want to be an active manager, go do real estate. It's FAR less efficient and you are far more likely to be able to add (or subtract) value depending on your skills, connections, knowledge, work etc. You can do other small businesses too- websites, franchises etc.

But joining the crowd trying to beat an index fund? What makes you think you're better than all the pros trying to do it, 80-90% of which fail over the long run?