Consistently Inconsistent

Yep. That’s the latest word about money managers trying to best their index & peers.

Financial Times:

F und managers are still failing to deliver any consistency in their investment performance, according to a new analysis of returns from more than a thousand funds – making it almost impossible for private investors to pick long-term winners.

Thames River Multi Capital (TRMC) has just produced its latest “consistency ratio”, which measures the proportion of funds in the 12 main fund sectors that have produced top quartile returns in each of the past three years.

This shows that only 16 out of the 1,188 funds in those sectors with a three-year track record – just 1.3% – have been in the top 25% for performance in three consecutive 12-month periods to the end of March 2011.

And yet, we still get ads like the one below (on the right).

Exhibit A:(name of the guilty redacted)

Now, don’t get me wrong. That ad isn’t criminal. The placement is maybe… (criminally funny).

The firm does actually have some great managers on their platform. And Thames findings do confirm that about 1% of the world’s investors can do well, consistently.

 Exhibit B: click to embiggen

But most investors spend 99% of their time (and money) chasing the 1%. Chasing the hot dot. And then usually selling the hot dot at the bottom. (See: Exhibit B)

Silliness. Douchebaggery, if you will.

Me? I think chasing the Alpha Dog status for returns is fine. But I mostly advocate copying off of the super smart kids– The Buffett’s & Soros of the world. The Big Money. The movers. Or maybe with Blue Ridge or Greenlight. You know, the Einhorn’s of the world. The real players. Track their SEC filings. Meb Faber has a great synopsis on the discussion going on in that arena right now.

But for me, if all I have is $1 or 2 million liquid — I’d only have 10% of my money trying to just kill it. Maybe 20%. If I lose half {or more} at any given time, so be it. I’m young though. But I’m certainly not about to take half of my money or 90% of my money to do that. Ever. I’ve worked too hard for that money. But that’s just me. I never want to be that billionaire sweating bullets because I’m so leveraged.

To some degree that’s what you are doing though, when you invest in 99% of the active managers that are sold to you you’re advised to buy. Every single manager is trying to give better returns, or why not just invest in the index then? Right? And so, you’re taking your money & placing a bet on them, that they are going to do better than average — net of their risk, the fees, & of course, taxes. And they’re not. In fact, recent studies show 24% will add negative value. The other 75% will add no value.

Exhibit C:

Bill Gross is like the godfather of bonds to the retail brokerage salesforces of America. Right? In every office & kitchen table around the country, a broker points to the 5-stars from Morningstar, says the words “Bill Gross” & then the client smiles & says, sounds good to me. And why not?

Look at this chart. It’s his Total Return fund (blue). In one of the ‘easiest’ times to be in the credit markets (pre-2008), he was doing great. For five – almost six – years. Beating 7-10 year treasury bonds pretty consistently.

And now? In the long haul? He’s getting his ass handed to him. Since 2001– that’s 10 years folks. 7.28% vs. 16.48%. He’s underperforming by almost 10%. And like I said, that’s not to mention all of the fees & taxes you’ve paid. Or the fact, that the index costs about 30% less, every single year vs. Pimco.

And that’s bond money– you know the stuff that isn’t really supposed to be that crazy, hence the ‘total return’.

Look at the chart again. He killed, then 2008 happened. And look, he goes the opposite direction. That’s when everyone had the safety trade on, like captain obvious stuff. I guess he didn’t get the memo. And since 2010, his line looks like a watered down version of the index. He’s hugging the ropes now. The jury is still out I suppose. He might turn it around. But, that’s the hard part about being on point with the expectation of beating an index. It’s relentless. But if you do it right, it’s the lottery baby. KaChing.

I mean look, Bill Gross is a billionaire now.

So, I guess I shouldn’t be surprised that people keep chasing the dream. It’s probably one of our oddest mental quirks. You’ve seen it play out, probably at the Roulette table, or watching grandma play Keno. She plays 23. Always. When it doesn’t hit, she only gets more confident that she’s due. Sometimes, she’ll double down.

Of course, the odds are completely reset with each new session, so she isn’t really ever due anything — except living the dream.

It’s called the gambler’s fallacy.

Me? I don’t gamble. Kind of as a rule now.

I don’t even buy squares in the office pool — I’m a stick in the mud, I know.

When I was a kid, I would bet on everything, but rarely with money. I’d trade commodities, like 5 Michael Jackson stickers, or a super awesome pencil fighting pencil, maybe a haul to the mall as a teen. I was fearless. Bet me I can’t jump off the house into the pool? I’m in. Drink pepper, salt, and anything else at the coffeeshop counter with milk. You’d better have my five bucks.

Ok, in retrospect– I was mostly an idiot with bravado. So today I don’t bet. Not that you can eat 15 habernos in 90 seconds, or clean off an entire chicken wing bone in single all-encompassing bite. Or that either of us can outdrink the other.

My wise ole imaginary TV dad (who’s the amalgamation of: Mr. Keaton, Dr. Huxtable, Obewon Kenobi, and Al Bundy) always tells me the same thing; if someone is willing to bet you — chances are they know something you don’t.

…Or they’re an idiot. {bravado optional}

Either way. Life is enough of a gamble. 

And people get struck by that; my no gambling rule.

The scene plays out consistently enough. There’s the: double take, the “huh?” with just a hint of “smells like shit in here”, the snort, the yelling of “get the fsck out of here!” (my personal favorite), and of course, the always embarrassing chortle.

Almost all of these happen after one too many Zinfandels or fruit garnished beers. “But you’re a broker. How can you not gamble? The stock market is like legalized gambling, isn’t it?”

I’m pretty consistent with my answer lately…”Well, depends on what game you’re trying to play.”

And their response? Consistently inconsistent.


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13 thoughts on “Consistently Inconsistent

  1. Wow, I heart wall street guy, you were way off. Mutual fund returns are quoted net of trading costs, and net of expense ratio, but not net of taxes. Why you ask? Because tax rates are very different for each investor, not to mention if they own the fund in an IRA (which currently is where just over 50% of mutual fund assets sit). You should have focused on the fact that 2/3rd’s of fund managers underperform their benchmark index, and the 1/3rd that do don’t do it consistently. Gross has. Will he do so in the future? Who knows. But looking backward, he has. But just by random chance you’d expect a percentage of managers to do so. What’s disturbing is your lack of understanding how mutual funds report returns. You’re so wrong on performance not being included in the returns, i had to reread what you wrote. As others have educated you on, trading costs are not included in the expense ratio, true, but returns are calculated after fees. That’s a requirement in the 1940 act. I see alot of retail guys jumping on Yahoo Finance, pulling a chart and not really know what they are looking at. For example, pull your favorite high dividend yielding stock on a yahoo chart. It will show you the price return. The return could stay flat for 10 years on a price level. But the stock pays a 4% dividend which is part of the return. After 10 years you don’t have a flat return, you actually have a reasonably decent compounded rate of return. I think Indo is right, you’re trying, but you got to be careful of your facts before speaking to an informed investment community. The streets no place for those with thin skins my friend.

  2. I’m sorry if i sounded smug, it’s just that misinformed people running blogs seem to be the norm. Internet freedom to publish is a beautiful thing, but it comes with a responsibility to be right on your facts or risk getting called out. Your overall theme is correct, cost matter. Trading costs are not included in OER’s, etc. etc… But….Mutual fund published returns are NET of trading cost, Net of expense ratio, and GROSS of tax impact. Morningstar has a nice analysis tool that you should have used considering it’s free, that still shows NET of trading costs, NET of expense ratio, and NET of TAXES!! Whereas they assume highest cost tax impact. Your message is good, but stay away from the details unless you’re prepared to do the research. Or again, risk being called out.

  3. Sorry about your bad day. You’ll be fine. Have a drink, walk around the block, veg for awhile. I wasn’t attacking you, although that’s clearly what you felt. I agree with the general theme of your article, active mangers don’t add value and it is hard to understand the published returns.

    Disclosure of trading costs is a significant and important issue as several of your posted links point out. With better disclosure, investors can see how effective portfolio managers back office operations are. Excessive portfolio turnover is one metric we can use to evaluate trading costs. It is a good idea to avoid high turnover managers. Trading costs are not separately disclosed by most fund managers. No governing body requires it. However, these costs are buried in the reported returns numbers even if they are not broken out. Fund performance is reported after trading costs, they just don’t break them out.

    My training is in finance. In my career I have managed large pools of pension assets so I have some basis for writing this. Communicating financial concepts is not easy. I have made more than my share of mistakes. I offer this as constructive feedback.

    Good Luck,

  4. Do I think Gross’ trading is actually costing his fund 4% more? No. Do I think it’s more than the .42% after-tax performance spread vs. the index? Probably.

    Dude, read this:
    and this

    And do I think? Yes– I think Mutual fund companies & Morningstar (whom I love) might be a bit biased toward making sure 99% of the industry it’s involved in, doesn’t look like total assholes.

    Click on the chart to embiggen for the return.

    There are other things in your comment that I want just want to shred now… Like, you’re joking about government regulation protecting investors, right? Like we’ve reached some platitude of perfection. We’re all set. All of the right rules are in place. Let’s just call it a day everyone…

    Can I just ask? Would you talk to your mom this way? or dad? Or a teacher? Or a friend? Or the trashman? I know about trolls. I don’t think you’re one– but in general, commenters like you are just so fucking rude & confrontational. So self-servingly smug. Too lazy to post a thoughtful refute on your own site. Or document a source. Too anonymous to have any consequences, while I lay it on the line.

    That’s not to say I’m infallible– I’ve been schooled. Even embarrassed. By assholes & classy people. Maybe, that’s why I’m probably more humble than you. I’ve also definitely left a trail of unnecessary nastiness, but mostly when I was young or drunk or both. Or I focused it toward someone that everyone is jealous of– you know, “Lebron is a punk for moving to miami instead of NY.” He was also pretty smart. So who care?

    For a while I was really pissed about Henry Blodget, because I was starting my career at the height of all the IB/retail lovefest. But I kept reading him (and slamming him) — And then I realized, you know what– he’s learned, he’s been WAY humbled & he is really smart. And I actually like him now. I was an asshole. Because I didn’t seek to understand. And you know what– he is a rockstar, rightfully so. Me? This post was read by like 2000 people. Which is totally awesome. But Henry types “I farted” & it gets retweeted at least 40 times.

    To me, on a site I’ve taken the time to read, by a “normal” person who took time to write it– I just don’t do that. Maybe someone posts a picture that’s dumb. sure, Lame. But stuff like this? That obviously took more than 10 minutes.

    Me? I always hedge with “respectfully” or “maybe I missed something or misunderstood…”

    You? “Still Waiting On That Hamburger Julio…”

    I don’t mind you asking questions or offering a challenge, but obviously what I wrote found you through some trusted source probably, since I’m not even close to syndicated. And what I wrote moved you on some level, right? — So I’m probably not a total asshole. I’ve been vetted.

    Look, selfishly I love to write, and I got to share some playful thoughts. And you liked it. You probably even agreed with a lot of what I said but not everything & and maybe you learned/saw something you didn’t know before you took the time to read me. Maybe you laughed. So did the person who told you about me. And then you wrote your thoughts/challenge & even came back to the site (probably a couple of more times) to see if I’d respond or what other BS I wrote.

    I did write & share more. And I did respond.

    So why not enjoy the experience & our new connection rather than being so flippant & making this such a miserable experience {for me at least}. I’m honored to be part of the experience that brought us together — and you’re shitting all over it. You don’t even know me. I don’t know you either.

    I’ve had a really rough day. But you didn’t know that. But I’m still taking the time. My wife is asleep on the couch. And I’m hacking out stuff. And this is one of like 4 major projects I’m working on, building a company with people’s lives at stake, & trying to finish a memory book for my 5 year old son & his teammates before Saturday.

    But since this is also my the closest thing I have to a diary/journal, I’m sure as shit not putting my head on the pillow with someone called NiceTry trying to make me look like a punk. Especially not today. I swear. Some days…

  5. I just realized you probably think that you have addressed my concern by referencing this link for the definition of “expense ratio” which excludes trading costs. This is correct for how they define “expense ratio” but it is not correct in defining how total return is calculated. The trading and transaction costs for day to day portfolio turnover reduce the reported total returns and also the index returns (before dividends). Consult any finance book or google it to prove it to yourself. Before you go to the trouble, just sit back and think about it for a second. Do you really think the mutual fund companies (or Morningstar)are that underhanded to report returns without trading expenses which you calculate as up to 4% for Pimco? There are Federal laws that protect investors against gaming the reported returns like this. As I said before, trading costs for reinvestment of dividends paid out to investors is handled differently.This is not a cost to the fund, but a cost the investor would pay to reinvest. My guess is this cost is typically less than 0.10%/year.

    Still waiting for an answer on how you came up with 16.48%.

  6. Total return is not as deceptive as you make it out to be. There is no way that there is a 4% hidden cost for transaction fees. Any cost for turnover of the base portfolio is included in calculation of the total return index. There may be some small trading cost for reinvestment of dividends that they have failed to capture adequately. In general, the management fees are also deducted from performance as well unless you specifically tracked down a gross of fees number.

    I don’t see any possible way that 16.48% you quoted is the 10 year return for the IEF. On Morningstar the IEF doesn’t even go back 10 years and the returns for the 8 or so years is in the 6% to 9% range.

  7. Fair enough. And thank’s for taking the time to comment. Actually, I know the difference. But the total return chart wasn’t as convincing to tell my story. 🙂

    It sounds like you know the game as well. So then you know…

    In order to really do a fair comparison, total return is also actually kind of deceptive too. But brokers love those Morningstar total return charts. Because it doesn’t take into account the after-tax returns or trading costs of course. Gross is running a 400% turnover right now. The finger in the air metric is what, additional costs of 1% for every 100% turnover? So that’s 4% in lost return, roughly.

    If you look at that PTTRX total return chart you’re talking about, you think the fund is doing 8.75% a year for the last five years. After-tax it’s more like 6.29%. But that’s still not factoring those trading costs I just mentioned.

    But you’re right, if we then just look at after-tax total return, he is beating IEF’s after-tax total return of 5.87%. But hardly killing it. And again, not really what the investor makes when you net out the trading costs. At 400% turnover, me thinks Gross is still lagging. But that’s the dark secret technical stuff that glazes over most weekend readers eyes (and should just be a dedicated post on the topic of smoke and mirrors).

    It still doesn’t really change the message, you’re betting on someone to do better the market– the dumb old index, net of all the costs and risk you’re assuming. If you net out EVERYTHING, I think you’ll still see Gross ain’t one of them.

    So I could, of course, have said all of this & then spent the time to go to three different datasources to illustrate it. But that conclusion, while still the same, is also way more boring & too much like work. I wrote this on a Saturday. For fun. I also didn’t get into the standard deviation, or if IEF is actually the perfect benchmark to use to compare the two. Or any of the stuff I’d report when it isn’t playtime.

    Duly noted though. And just a friendly tip — next time don’t be so smug.

  8. Rookie mistake of all rookie mistakes my friend. You certainly must be a retail broker. Your chart comparison of IEF vs. PTTRX is a PRICE CHART rather than a TOTAL RETURN CHART. For future reference you should certainly know the difference. All that matters in bond fund investing is price return plus interest income equals TOTAL RETURN. I’m no fan of Gross, but get some better analysis tools and you’ll see that Gross killed the IEF over that time frame. Come on rookie, you can do better than that. Overall however, good post. But be careful on the details or you will get called out……

  9. Well, that makes sense. i’ve been gone all week. 😉

    Actually the wife thought it was wordy. And it is. Like you needed to know about my imaginary tv dad.

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