Specifically the skeptics, people convinced that indexing is the only way and beating the market is black magic/voodoo, and if you are beating the market, you just got lucky or “If you have such a good strategy, why aren’t you employed by a hedge fund?”.
I don’t even bother trying to convince anyone. It’s their loss. More alpha for me.
This is the point I’m getting to as well.
The same way that quant investing is not for everyone, trading is not for everyone, the same way that indexing is not for everyone. The key is understanding what each topic entails to, and few can tell the difference.
Indexing has 3 issues, ask any indexer how they deal with that:
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No control on quality of holdings - you need to buy the whole market, which includes companies losing money. Not every company carries the same risk or meets the same goals, and yet, when you index, you buy them all.
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No control on valuation. You must pay market price for all holdings, including paying more than you should for the ones that are overvalued, dragging returns eventually.
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MER on ETFs drag returns further.
Quant investing not only mitigates these issues above, but also takes emotion out of the equation, since rules are always executed in a consistent way.
Regarding the fallacy about being employed by a hedge fund… Me, as a small investor, have many advantages over them, and Ben Graham couldn’t have said it better:
"One of Graham’s most powerful insights is this: “The investor who permits himself to be stampeded or unduly worried by unjustified market declines in his holdings is perversely transforming his basic advantage into a basic disadvantage.”
What does Graham mean by those words “basic advantage”? He means that the intelligent individual investor has the full freedom to choose whether or not to follow Mr. Market. You have the luxury of being able to think for yourself.
The typical money manager, however, has no choice but to mimic Mr. Market’s every move—buying high, selling low, marching almost mind- lessly in his erratic footsteps. Here are some of the handicaps mutual- fund managers and other professional investors are saddled with:
• With billions of dollars under management, they must gravitate toward the biggest stocks—the only ones they can buy in the multimillion-dollar quantities they need to fill their portfolios. Thus many funds end up owning the same few overpriced giants.
• Investors tend to pour more money into funds as the market rises. The managers use that new cash to buy more of the stocks they already own, driving prices to even more dangerous heights.
• If fund investors ask for their money back when the market drops, the managers may need to sell stocks to cash them out. Just as the funds are forced to buy stocks at inflated prices in a rising market, they become forced sellers as stocks get cheap again.
• Many portfolio managers get bonuses for beating the market, so they obsessively measure their returns against benchmarks like the S & P 500 index. If a company gets added to an index, hun- dreds of funds compulsively buy it. (If they don’t, and that stock then does well, the managers look foolish; on the other hand, if they buy it and it does poorly, no one will blame them.)
• Increasingly, fund managers are expected to specialize. Just as in medicine the general practitioner has given way to the pediatric allergist and the geriatric otolaryngologist, fund managers must buy only “small growth” stocks, or only “mid-sized value” stocks, or nothing but “large blend” stocks.6 If a company gets too big, or too small, or too cheap, or an itty bit too expensive, the fund has to sell it—even if the manager loves the stock.
So there’s no reason you can’t do as well as the pros. What you cannot do (despite all the pundits who say you can) is to “beat the pros at their own game.” The pros can’t even win their own game! Why should you want to play it at all? If you follow their rules, you will lose—since you will end up as much a slave to Mr. Market as the professionals are."
The Intelligent Investor - Benjamin Graham
Rod
Well put Rod. I also like this Warren Buffett quote:
“What could be more advantageous in an intellectual contest–whether it be chess, bridge, or stock selection–than to have opponents who have been taught that thinking is a waste of energy?”
The most important thing is for people to invest some money in the stock market, be it in funds or individual stocks. Many don’t even invest in equities and that is the real shame.
If one has the time and talent for investing in individual equities, then history shows that it is ‘possible’ to do better than SPY, for instance. But you have to have a good plan, patience, and know yourself (ie, limitations). Many people who buy individual stocks have no process and no patience. Just ‘intuition’. They might as well go to Las Vegas.
If you are reading Graham/Dodd/Buffet and others, then you are standing on the shoulders of giants. A good place to start the journey.
And yes, trying to talk about if Efficient Markets really exist (or not) is like talking about if God exists. it is really hard and frankly, mostly just faith (which is fine by me). But there seems to be consistent evidence that markets are not all that efficient. So why not try?
Caley89 - I don’t know if this will convince the skeptics, but the “market” is essentially the sum total of everyone who is buying and selling stocks and by definition at any point in time half of them are beating the market and half of them are being beaten by it. You can then ask them who they think are being beaten by the market. They’ll probably say mutual fund managers, newbies, and the kinds of individual investors who put their money into whatever cable TV show they watch tells them is the hot stock of the moment. That leaves a lot of winners out there. Then you can show them, using your annual returns, that you’re one of them.
I have this conversation many times, and ultimately I ask them “Do you invest in the SP500 index fund?” Congrats, you’re already participating in quantitative investing. A very simple but effective quantitative investing screen formula: Country = US & Ascending Marketcap Rank <= 500. And why is it so effective and hard to beat by stockpickers over the long haul? Partly because it has some inherent advantages in diversification and quality, but most importantly it’s systematic and immune to behavioral biases that cause us to sabotage ourselves. It’s a consistent investing approach. The index doesn’t watch CNBC or read the Wall Street Journal and freak out one day and move all to bonds/cash, or change their investment strategy from value to momentum and back and forth because they read a Fortune article about what philosophy should outperform this year.
Now the next followup question is do you believe market cap and country are the only, or even best, two factors to account for when evaluating future price?
This is argument basically paraphrased from James O’Shaughnessy first few chapters of What Works on Wall Street. I guess his exact quantitative formulas have been inconsistent in their success, I haven’t checked in a while, but I found the logic of the book as to why the approach works really resonated with me when I read it.
I agree, the first few chapters of WWoWS about psychology are very good.
Good point about the Standards and Poors committees using quantitative-like methods to derive the list of companies for their indices. I never thought about it that way.
I sometimes wonder whether the overall success of screening is due to effective identification of relevant stock factors or whether it’s a product of emotionless, regularly-evaluating discipline. Portfolio123 users don’t need to worry about that split, because we get both.
For me its the only way if you are not a professional, just do not have the time to stock pick discreationary. Also I doubt that a human beeing
can beat constantly algos and good ranking systems, at least not if your port size is small (lets say below 10 Mio.), the higher the liquidity,
the higher the competition for alpha.
My ranking systems do totally crazy (but pretty consistent right) things, I would never have bought 50% financials this year, but my
model did and it was the right thing.
I got a friend that I try to talk into systematic trading, no way, because he likes to gamble and the thrill, I rater make money!
Regards
Andreas
I’m surprised no one has mentioned showing the skeptic your actual trading results that you produced from P123. Log into your brokerage account show them the performance. Black out the NAV if you need to. Then print off all the trades. Next show them p123 OS performance that tells you what to trade. If someone wanted to sell me investment advice I would want every trade for the last ten years. Especially for 2008. How many financial advisors would do this? The bottom line is you need a strong long term performance to convince anyone. And we all know out of sample performance is all that matters.
Regards,
MV