Failure of the Really Smart People


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Part 3 of the series: Rethink the Way You Invest.

The Roman philosopher and statesman Marcus Tullius Cicero once said: “time destroys the speculation of men, but it confirms nature.”

Time has not eroded the relevance of these words, especially in regards to the financial markets. The longer the time frame, the more abysmal our track record in successfully picking the right stocks.

In an efficient market, stock prices reflect all publicly available information – and only new information causes prices to change as investors adjust their views of the future. Since new information cannot be foretold, most stock pickers and investment managers fail to deliver long-term value. Prophecy only seems to have worked in the Bible and some may argue that even that is the product of survivor bias (who wants to write about all the prophecies that failed?)

The Standard and Poor Indices Versus Active (SPIVA®) Scorecard regularly reports on the performance of actively managed mutual funds. It is the most objective study I know of in evaluating the effectiveness of the mutual fund industry.

For the ten year period, ending June 30, 2017, the SPIVA Canada Scorecard gives us the percent of actively managed funds that outperform their underlying index (or benchmark).

8.89% of Canadian Equity managers outperformed the S&P/TSX Composite Total Return. 2.54% of US Equity managers outperformed the S&P 500 Total Return Index and over the past 5 years, 11.54% of International Equity managers outperformed the S&P EPAC LargeMidCap Total Return index. The report has been adjusted for the fact that many of the poorly-performing funds of the past have been swept under the carpet through fund closures or mergers with other funds. You might want to google the report to read the details.

I don’t like those odds! Clearly, few active fund managers can outperform their respective market indices.

Not enough bad news? The DALBAR QAIB 2015 (Quantitative Analysis of Investor Behavior) has found that over the 30 year period ending December 31, 2016, average investors substantially underperformed the market. During this timeframe, the S&P500 Index of U.S. stocks averaged an 11.96% compound rate of return. Average U.S investors only returned 7.26%. That’s a difference of 4.70% that was collectively lost to bad behaviour, fees and expenses. This study is only done in the U.S. but I don’t think investors are any smarter this side of the border.

Professional fund managers are not idiots, nor is the average investor. However, I think there has clearly been a failure of the notion that we can time the markets, pick the right stocks or buy the right mutual funds. Active fund management simply adds speculation risk to the equation.

What to do? If you consider yourself an investor, don’t run for the hills and throw your money at the mercy of inflation-ravaged savings accounts and GICs. Rather, you need to find an advisor who is willing to face these truths, guide you through the factors of long term investment success and help you build a plan and a portfolio around your own unique objectives and risk tolerances.

Click here for Part 4: “Put Your Eggs in All the Baskets.”