Investment managers have failed, for the most part, to outperform the market.
Research has shown that as much as 97% of equity mutual funds underperformed benchmarks.
And we’re not talking about staff members who are terrible talents by any measure. These are crème de la crème picked out of cohorts of intensively trained folks who have been given the mandate to beat the market or die trying.
Yet, time after time, they have failed to do so. Only a small percentage actually do by a small margin that when you add in fees, underperformance sets in. There is value, however, in having active managers manage your funds for you, if you are, for example, an institutional investors with a larger quantum leading to more efficiency. However, the outperformance is rather modest – setting in at about at most 100 basis points or 1%.
There will be managers of course that are able to do 200 to 300 basis points of outperformance, but to do so consistently may be a little of a rarity. Many investors are hoping to find a manager who is able to deliver extreme returns for them but as interest rates are dismal, their way out can only go in a combination of these areas, as opined by Randolph Cohen:
First, illiquidity.
Entering into areas like rarely traded bonds, frontier markets or even cryptocurrencies is one area. Regardless of the countries they come from, stocks have progressed towards efficiency as there are ways of valuation and analysis. However, the outsized returns may come from areas where information is, truth be told, scarce. For example, many of the cryptocurrencies that you see now on the market, only serves out information that is befitting to its rise. The market comes in and tells you what it is not good about it. For example, Dogecoin.
The market claims that it has no utility, but there are those who bought into the coin believing that Elon Musk will use it for his businesses. There is no real ratio table with P/E, P/S, EV/EBITDA that you can use to determine Dogecoin’s intrinsic value. It is what the current market is valuing it.
Secondly, velocity.
This is where a fund manager uses velocity or the turnover of trades to deliver returns on slightly mispriced stocks without using leverage. By making just 1% each month, he will be able to deliver 12% for the entire year, before fees. Of course, there are issues with this approach in that because the gains are marginal, a bigger than usual loss on a typical month can erase gains of the previous months. Also, some gains can only be realised after a few months.
Thirdly, concentration.
By setting up a proper investment thesis and focusing on a few really good stocks, a fund manager can continue to do well. Catherine Wood has proven herself in that area by focusing thematically on tech stocks in the areas of medical technology (eg CRISPR), transportation (e.g Tesla), for example.
Finally, leverage.
This is something that we highly discourage, as leverage can backfire as quickly as it propels. Bill Hwang is a prime example and there will be many others who are still in the market using this approach, but because they have not experienced the rarity in implosion as Hwang did, the tide has not gone out to the extent that they are found swimming naked. To give you an idea of what leverage looked like to Hwang, for every dollar that he held/owned, he borrowed five to ten more to place bets on investments. The returns were crazy, and it went on for a while until just in March 2021, a few of his investments went awry quickly within the same period, prompting margin calls from the banks that lent him the money. Of course, he did not have the money on hand for the margin calls and that was when Archegos, his firm, sank.
Which of these strategies can you think of employing on your own if you are managing your own money?
Yours,
Chief Editor
BBA Market Perspectives
*Not investment advice. Do your own due diligence before you invest!
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