We all rely on weather forecasts from time to time. It’s nice to know whether to toss an umbrella in the car or bring a jacket, just in case.
But you know, deep down, that weather is to some degree about chance. The rain that’s clearly coming might fall five miles west of you, after all. And you know that a forecast is really best for the next 24 hours. Anything five to 10 days out is guesswork, and we just accept that.
Weather forecasting is actual science, while market forecasting — well, let’s hear it from Charley Ellis, former Yale University investment committee chairman and author of the investing classic Winning the Loser’s Game, speaking to an audience of Canadian money managers recently:
“Think of how many people have gotten really good educations that come in to be practitioners and have been provided with fabulous equipment, tools, and information so that they can compete,” Ellis told the CFA Society Calgary.
“Unfortunately, each of them is competing against others who also went to great schools, also studied, also became CFA [charterholders] and also have wonderful facilities, and also have tremendous energy and brain power, and as a result the case for indexing gets stronger and stronger and stronger.”
Charley’s point is that the science of investing has gotten better — much better. Like the meteorologists with their radar systems and satellites, Wall Street is awash in data unknown even 10 years ago.
And everyone has those tools. That’s why active managers have been slipping in their ability to outperform their benchmarks. The aggregate knowledge of what’s going on in the world outweighs even the most savvy of traders.
Short of insider trading and chance, there’s just no room to box anymore. Once you tack on hefty active management fees, you’re bound to lose against the market itself. It’s common sense.
In a related item, Jason Zweig at The Wall Street Journal recently took to task the Nobel Prize committee for their choices in the economics field: Eugene Fama, Lars Peter Hansen and Robert Shiller.
Not for the choice of recipients, but for apparently completely misunderstanding their contributions.
Zweig notes that the committee seems to think their collective work shows that it’s possible to foresee the direction of the markets several years ahead. He then goes on to explain how completely backwards the committee has it.
Fama’s argument about efficient markets is that markets can’t be predicted, and that active management is no better than chance at figuring things out in advance. Hansen told Zweig that his models reinforce the notion that predictions based on models are dangerous.
And Shiller, the Yale professor best known for predicting both the dot-com crash and the housing bubble, simply laughs off the idea that his tools can predict the value of stocks except in the very long-term — so long out as to be useless to traders.
Back to Charley in Calgary. He asked the managers assembled, point blank, if they have a future at all, at least in terms of market fortune-telling:
“At some point, if you are in there as an active investment manager, one after another you can’t continue to beat the market, because the market is getting stronger and stronger, because the talent that is coming into the market is getting better and better, and the tools and facilities in which they do their work is getting better and better,” he said.
Ellis, of course, is on the Investment Committee of my firm, Rebalance. His long career in the business, at Yale and at his own firm, Greenwich Associates, has greatly informed how we think about retirement portfolio management.
It can be summed up, I think fairly, in this way: Own investments, yes, but let the markets set your prices and worry instead about managing risk. Lower costs, rebalancing and prudent investing go a long way toward bringing you the performance you need to retire with more.