Showing posts with label passive. Show all posts
Showing posts with label passive. Show all posts

Friday, May 08, 2009

SSRN-Luck versus Skill in the Cross Section of Mutual Fund Alpha Estimates by Eugene Fama, Kenneth French

Ok, for starters It was from Fama and French. So even if I said nothing more, you would probably assume it was good. Like most of their work, this one is thought-provoking and insightful. Their interest this time is in Mutual Fund performance.

Their findings? More evidence that markets are tough to beat.

SSRN-Luck versus Skill in the Cross Section of Mutual Fund Alpha Estimates by Eugene Fama, Kenneth French:

From the abstract:

"Bootstrap simulations produce no evidence that any managers have enough skill to cover the costs they impose on investors. If we add back costs, there is some evidence of inferior and superior performance (non-zero true alpha) in the extreme tails of the cross section of mutual fund alpha estimates. The evidence for performance is, however, weak, especially for successful funds, and we cannot reject the hypothesis that no fund managers have skill that enhances expected returns."

A look-in:
"The VW portfolio of funds that invest primarily in U.S. equities is close to the market portfolio, and
estimated before costs, its α relative to common benchmarks is close to zero. Since the VW portfolio of funds
produces α close to zero in gross (pre-cost) returns, α estimated on net (post-cost) returns to investors is
negative by about the amount of costs. And since mutual funds in aggregate produce α close to zero before
costs, equilibrium accounting allows us to infer that in aggregate other active managers do the same.

This latter parts rests on the assumption that if mutual fund performance was negative, "other" active managers would be beating the market. (it should be noted that this is not evidence that others do not beat the market, only that if they do, those gains on average must come from a group other than mutual fund managers.)

Of course this is just an aggregate test. The next step is to look to see whether individual fund managers beat the market:

"The aggregate results imply that if there are mutual funds with positive true α, they are balanced by
funds with negative α. We test for the existence of such funds. The challenge is to distinguish skill from luck.
Given the multitude of funds, many have extreme returns by chance. A common approach to this problem is
to test for persistence in fund returns, that is, whether past winners continue to produce high returns and losers
continue to underperform (for example, Grinblatt and Titman 1992, Carhart 1997)

.....We take a different tack. We use long histories of individual fund returns and bootstrap simulations of
return histories to infer the existence of superior and inferior managers. We compare the actual cross-section
of fund α estimates to the results from 10,000 bootstrap simulations of the cross-section.

The findings? From the conclusion:
For funds on average and the average dollar invested in funds underperform three-factor and four-factor benchmarks by about the amount of costs (fees and expenses). Thus, if there are fund managers with skill that enhances expected returns relative to passive benchmarks, they are offset by managers whose stock picks lower expected returns. We attempt to identify the presence of skill via bootstrap simulations. The tests for net returns say that even in the extreme right tails of the cross-sections of three-factor and four-factor t(α) estimates, there is no evidence of fund managers with skill sufficient to cover costs

Good stuff as always....

Cite: Fama, Eugene F. and French, Kenneth R.,Luck versus Skill in the Cross Section of Mutual Fund Alpha Estimates(March 9, 2009). Tuck School of Business Working Paper No. 2009-56. Available at SSRN:

Thursday, October 09, 2008

Presidential Address by Ken French

In spite of the market collapse that is going on, classes can not devote all of our time to it. So here is a video of Ken French's 2008 presidential address to the AFA.
Presidential Address: "2008 Presidential Address: The Cost of Active Investing
by Kenneth R. French"
It is really good. The paper which he talks about was mentioned back in March. Here is the blog article about it from then.

This is required for all my MBA courses as well as SIMM our student run investment fund.

Saturday, June 07, 2008

ETFs dominate Canada Cup -- and a looming threat to Canada's mutual funds - The Wealthy Boomer

ETFs dominate Canada Cup -- and a looming threat to Canada's mutual funds - The Wealthy Boomer:
"Seif said ETFs are popular because they're good for investors: 'They provide the ability to get exposure to the market and use them in multiple ways, whether for asset allocation or as a complement to stocks or active managers.'

Near the end of the session Seif took a direct shot at traditional mutual funds: 'High-fee index-hugging general mutual funds charging 2.5% a year that underperform the market just don't cut it any more. That's the reality.'"
I am always surprised that some still pay mutual funds such high fees for performance that mirrors (or worse) indexed performance.

Friday, April 11, 2008

Closet Indexing By Mutual Funds: Worse Than We Thought? - Seeking Alpha

Seeking Alpha has an important article on ETFs being held within mutual funds.

Closet Indexing By Mutual Funds: Worse Than We Thought? - Seeking Alpha: ". is extraordinary how many traditional long-only mutual funds hold ETFs, either to equitize their cash or to get the market return and then just layer on fees. You may not see the ETFs held during the reporting periods, but certainly inside those periods."
One more look-in which sums up the issue:
"First, "'s not inherently wrong for mutual fund managers to equitize cash with ETFs. Depending on a manager's investment discipline and conditions in the relevant asset class, it can be perfectly sensible to combine a set of active opportunities and ETFs for portfolio completion....

But Keenan's remarks reveal a couple serious -- and potentially related -- problems:

(1) reporting-period manipulation designed to conceal the fact that managers are equitizing assets using ETFs and

(2) the cynical laziness of earning market returns and layering on active-management fees."

The part about the funds not holding the ETFs during reporting periods is example 1,734,651 of an agency cost. Specifically this "window dressing" increases costs merely to make it look like the managers are somehow adding value.

Good stuff as always. SeekingAlpha is well worth a look.

Monday, January 21, 2008

Learn the ABCs of ETFs - ETF - Strategy - IVV

A pretty useful (and easy to read) article on ETFs, definitely worth reading for introductory students!

Learn the ABCs of ETFs - ETF - Strategy - IVV:
"Exchange-traded funds, or ETFs, are index funds that trade like stocks on major stock exchanges. They were introduced to U.S. markets in 1994 and now have a market value of $150 billion. Although that's still a relatively small number compared with the $7.5 trillion held in open-end mutual funds, ETFs are experiencing explosive growth and are now commonly found in the portfolios of institutional and retail investors alike."

Thursday, December 06, 2007

Stocks rise when sun shines | Dallas Morning News | News for Dallas, Texas | Business

We've talked about this several times in class so when I stumbled upon this in the Dallas Morning News (it is orignally from the Washington Post) I figured I better share it!

Stocks rise when sun shines | Dallas Morning News | News for Dallas, Texas | Business:
"In a study of 26 stock markets around the world between 1982 and 1997, researchers David Hirshleifer and Tyler Shumway showed that the annualized average return on perfectly sunny days was 25 percent, while the annualized average return on overcast days was only 9 percent."
" Mark J. Kamstra, a finance professor at York University in Toronto, argued that seasonal variations in the markets might be related to seasonal affective disorder."
and finally:
"Given the transaction costs of buying and selling stocks, Dr. Hirshleifer said, it's impractical to use sunshine as a stable investment strategy.

But an investor who's planning to sell some stocks anyway might want to time the sale to a sunny day of the week instead of a cloudy day.

"The main lesson for investors is something broader," Dr. Hirshleifer said. "It is important to discount for your moods in making investment decisions.""

Saturday, December 01, 2007

Blaine Lourd Profile - Executive Articles -

What a great article! Inherently readable, a great story, and even ends up with a happy ending. I usually hate to give away the story, but in this case I will. It is the story of a stereotypical stock broker who sees the light and realizes that indexing is generally a better idea.

Blaine Lourd Profile - Executive Articles -
"As a group, professional money managers control more than 90 percent of the U.S. stock market. By definition, the money they invest yields returns equal to those of the market as a whole, minus whatever fees investors pay them for their services. This simple math, you might think, would lead investors to pay professional money managers less and less. Instead, they pay them more and more...Nobody knows which stock is going to go up. Nobody knows what the market as a whole is going to do, not even Warren Buffett. A handful of people with amazing track records isn’t evidence that people can game the market. Nobody knows which company will prove a good long-term investment. Even Buffett’s genius lies more in running businesses than in picking stocks. But in the investing world, that is ignored. Wall Street, with its army of brokers, analysts, and advisers funneling trillions of dollars into mutual funds, hedge funds, and private equity funds, is an elaborate fraud."
And later on some so-called experts:
" There's a shelf of financial bestsellers whose titles now sound absurd: Ravi Batra's The Great Depression of 1990; James Glassman's Dow 36,000; Harry Figgie's Bankruptcy 1995: The Coming Collapse of America and How to Stop It. There’s BusinessWeek’s 1979 description of "the death of equities as a near permanent condition,"

and after he finds DFA (yeah Eugene Fama's firm) and comes to realize that indexing is probably the way to go.
"I think more and more brokers will move to an efficient-markets strategy, because all of their products go bad. They just do...

BTW, IF I haven't convinced you to read it, consider this: it was written my Michael Lewis (Of MoneyBall fame) which should be reason enough to read it even if it were on checkers.

Thanks to Greg for pointing this out to me! (two articles in one day, definitely not random ;) )

Saturday, September 29, 2007

Publish and Perish -

Publish and Perish -
"Before taking over Alpha, Mark Carhart was an assistant professor of finance at the University of Southern California. He had studied under Eugene Fama, a founding father of the efficient-market theory, which says investors can't consistently beat the market. Carhart himself drew attention with a research paper warning investors against mutual funds with 'hot hands.' He wrote that his analysis of 1,892 funds over 32 years showed that high repeat returns had little to do with skill, and the winning streaks didn't last long anyway"
and then:
"Goldman hired Carhart soon after his article appeared in the Journal of Finance, and put him and a fellow Ph.D. from the University of Chicago, Raymond Iwanowski, in charge of the fledgling Alpha. Trading on complex mathematical models, Alpha returned 21% a year in the ten years through 2005. Goldman put many of its private banking customers into the fund.

Then, true to Carhart's theory, hot turned cold. Last year Alpha lost 9%. This year, thanks partly to bad bets on the yen and the Australian dollar, it's down 33%. Assets have fallen to $6 billion from $10 billion and are expected to fall by another 25% as investors bail out in the next few weeks."

Tuesday, March 27, 2007 Exclusive Exclusive:
"Which approach is best, active or passive investing, is a never-ending debate on Wall Street, where passive indexers such as DFA and Vanguard Group Inc. are the antithesis of celebrity stock pickers. If there's any criticism of indexing, it's that as goes the market, so go the indexes, which can lead to losses unless an investor also invests in active funds to mitigate the market swoons.

The indexers have been winning lately. According to the Standard & Poor's Indices Versus Active Funds Scorecard, which tries to add substance to the debate, the S&P 500 Index beat both actively managed large- and small-cap U.S. stock funds last year. The index topped 69.1 percent of large-cap funds, while the S&P SmallCap 600 Index led 63.6 percent of small-cap funds. The indexes posted similar results for the past three- and five-year periods."

Tuesday, January 30, 2007

Not academic and not even that good but it is interesting to read and the conclusion is pretty good: i.e. passive and automatic investing wins out in the end!

From FoxNews

Short version: Quantitative analysis, which limits impact of behavioral finance's impact, is catching on and indexing seems to be better way to go than stock picking (nothing new with that!)

Two look-ins:
"Behavioral Finance, the new science of irrationality, [is] also known as behavioral economics, quant-trading, neuro-investing, etc.
"Behavioral finance is going through a major transition that will impact the future of investing worldwide. The old behavioral finance has been around for several decades, dominated by psychologists studying irrational human behavior. Recently a newer, more secretive and potentially dangerous version has emerged. Psychologists are being sidelined by mathematicians speaking a language as foreign to Main Street investors as ancient Mayan without subtitles."
and later:

" What can you do? Very simple: Since you can't beat them, don't play their game by their rules. Build a lazy portfolio. Then leave it alone. Let it do its job automatically. Build wealth doing something you love in a business or profession you enjoy, and spend as much time as you can with family and friends."
In fact, even if you might be able to beat them" this is good advice!

Monday, November 07, 2005

Why indexing is less controversial now

Joanthan Clements has long been one of my favorite WSJ writers and once again he nails it! In his most recent article (Nov. 6, 2005) he suggests that the reason indexing has finally caught on is because brokers and advisors no longer have as much of an incentive to fight it. - Getting Going: "Yet the widespread acceptance of indexing has come only in the past few years. Indeed, as recently as five years ago, I would be inundated with scornful phone calls, letters and emails whenever I recommended index funds. Today, I don't get that reaction"

Why? In his words:

"I think the acceptance of indexing has been driven by two key developments: The proliferation of exchange-traded index funds, often known as ETFs, and the emergence of fee-only financial advisers."

Brilliant! Read the article! In fact, if you are in my class, definitely read the article! But be forewarmed, the article will not stay online for long.

Friday, August 26, 2005

Measuring the True Cost of Active Management by Mutual Funds by Ross Miller

SSRN-Measuring the True Cost of Active Management by Mutual Funds by Ross Miller:

Yet another WOW paper!

Miller decomposes mutual fund returns into an active portion and a passive portion. He then shows that the fees are for the active portion are much higher than most investors would suspect.

Longer version:

It is well known that actively managed funds are highly correlated with market indices. What Miller does in this paper is to break funds down into a passive index plus an actively managed portions. He then looks at expenses for the funds and then using a sort of weighted average tries to allocate them to the active and the passive portions of the fund.

When this is done, the reported fees for actively managed funds (which are reported for the whole fund but theoretically stem largely from from largely from the active portion, are much higher than a combination of indices and leveraged "market neutral" investments would suggest.

In Miller's words:
"Mutual funds appear to provide investment services for relatively low fees because they bundle passive and active funds management together in a way that understates the true cost of active management. In particular, funds engaging in "closet"” or "shadow" indexing charge their investors for active management while providing them with little more than an indexed investment. Even the average mutual fund, which ostensibly provides only active management, will have over 90% of the variance in its returns explained by its benchmark index."
Of course that active funds are highly correlated with market indicies is not new. We've known that for a long time (at least since Sharpe's 1992 Portfolio Management paper). What Miller now does however is to attempt to uncover how this impacts the true benfits of active management as well as what investors are paying for this actmanagementment.

Probably the best way to understand the idea is with an example from the paper:
"Consider, for purposes of illustration, the Fidelity Magellan Fund at the end of 2004. Based on monthly data from the preceding three years, an investor could have replicated the risk and return characteristics of the fund (including its R2 of 99%) by placing 90.87% of his or her assets in an index fund that tracks the S&P 500 and the remaining 9.13% in an appropriately chosen marketneutral investment. In this new portfolio, 99% of the variance of this portfolio is explained by the index and we can leverage it in a way that Magellan'’s beta and variance are also replicated. If we then take 18 basis points as the expense ratio for the passive component of Magellan (the same ratio as the version of Vanguard'’s S&P 500 index fund marketed to individual investors), Magellan might be seen as "“overcharging"” investors by 52 basis points on the passive component of its portfolio. If we were to assess those 52 basis points against the 9.13% of the portfolio that is actively managed, we would find that annual expenses account for 5.87% of those funds."
See, I told you it deserved a WOW!

Miller, Ross M., "Measuring the True Cost of Active Management by Mutual Funds" (June 2005).