One of the qualities that impresses me most about people is their resilience – that ability to hang in the fight for a time long after most would have quit. And then if things have not gone their way to pick themselves up and start again. If we take a broader perspective human history in all its facets is only advanced by such people – those who stick with a situation and by simple dint of personality push through.
However, there is a dark side to this and it is the holding the line or clinging to a belief long after it should have become apparent that that they were wrong. We have all known people who have stuck with relationships or jobs long after the point of no return had been reached. And in some cases it undoubtedly not because of their resilience but rather that a change is simply too frightening or they actually lack the resources to take the plunge. But many hang in like a demented barnacle often as if to simply spite themselves – their own ego drives them towards destruction.
This ego driven headlong dive towards self destrution fascinates me because for many years I have been following the fate of John Hussman the manager of Hussman Strategic Fund. Hussman is a former professor of economics and international finance at the Uninversity of Michigan. So in an academic sense he is no fool but as is so often the case smart people use their intellectct to defend their emotional failings.
To begin to understand why I find Hussman an interesting case study we first need to understand the investment approach that this fund adopts. The following is from their prospectus –
The Funds portfolio will typically be invested in common stocks favored by the Hussman Strategic Advisors Inc, the funds investment manager , except for modest cash balances arising in connection withe Funds day to day operations. When market conditions are unfavourable in the view of the investment manager , the fund may use options and index futures , or effect short sales of exchange traded funds (‘ETFS’) to reduce the exposure of the Funds stock portfolio to the impact of general market fluctuations. When market conditions are viewed as favourable, the Fund may use options to increase its exposure to the impact of general market fluctuations.
This all sounds reasonable, it is a basic stock portfolio that at times undertake some form of hedging to reduce the impact of market fluctuations. And this approach found great success during the GFC. As can be seen from the chart below this fund easily outdistanced the S&P500 and the funds under managed grew to US$6.7 billion. Since then the fund has shrunk to approximately $US365M.
The reasons for this contraction are instructive and can be found in the funds prospectus. The fund speaks of hedging exposure in unfavourable market conditions. To those of us on the outside this means market downturns as defined by some form of collapse in the trend. This is something that is easily quantifiable and therefore is binary in nature. In my simple world the market is either going up or down. However, Hussman and his management team have a narrative and the narrative is that despite the market going up continually since the GFC all stocks are overvalued. So whilst they may be invested in these stocks they also have in place hedges of equal sizes. Hedging is a drag on performance – it costs money and this cost translates to poor performance. Since the GFC Hussman’s funds have lost on average 2.1% pa whilst the market has gained 2.3%.
Since the bull market began Hussman has been calling for a slide in the overall market to match that experienced during the Great Depression and he has positioned his fund accordingly. This internally driven narrative is directing the investment strategy which in in turn pushing the fund into the ground.
He has issued a never ending stream of warnings about the market –
November 2010: Bubble, Crash, Bubble, Crash, Bubble…
March 2011: Anatomy of a Bubble.
March 2012: A False Sense of Security.
November 2013: A Textbook Pre-Crash Bubble.
July 2014: Yes, This Is An Equity Bubble.
October 2015: Not The Time To Be Bubble-Tolerant.
October 2016: Sizing Up the Bubble.
March 2017: The Most Broadly Overvalued Moment In Market History.
June 2017: Two Supports Kicked Away Already.
July 2017: Salient Features Of Bull Market Peaks.
These market calls have an almost plaintive nature about them, as if he is desperate for the market to agree with him and his thesis. All of this is driven by a desperate need to have the narrative proved correct, once again such a desire is more reflective of ego than common sense. To the astute trader such behaviour is incredibly strange since being wrong is part of being a trader. But so too is the ability to adapt and learn from being wrong, there is resilience and then there is suicidal behaviour that has a very intriguing tone to it. And Hussmans behaviour has a strange tone of self destruction about it.
If there were a cornerstone to trading it would be the ability not only to be resilient when in drawdown but also to accept that we get things wrong. Sometimes there is a flaw in our methodology that we have not seen and that we simply have been lucky up until this point. This does raise the question of when do you know you have entered this spiral of self destruction and to my way of thinking the answer is not that hard. If you have been losing money for the better part of a decade then it is fairly obvious that there is something seriously wrong in your methodology.
Each year Standard and Poors produce a scorecard of the performance of a regions fund managers against their comparison indices. You can find the raw scorecards here.
I decided to download the one for Australia and tidy up the data a little so it was more presentable. The chart below looks at the number of funds in various categories that have failed to match or beat their benchmark over a 1, 3, 5, and 10 year period. Just a reminder this table shows the number under performing, not the number that beat the index.
As you would expect this is one of those – I think I have seen this movie before type of scenarios. The majority of fund managers failed to match the index in all categories over all time frames. I had a quick glance at the scorecards for the other regions and this pattern repeats itself in all regions. The reasoning for this I think is that all managers are captive to the same narrative fallacies and are caught in the same academic, philosophical and psychological delusion. It is not that markets cannot be beaten because there are clearly well known managers who have beaten their index year after year. But if you based your investment strategy on notions such as the Efficient Market Hypothesis, perceptions that you know the value of something and plain stupid ideas such as we dont need stops because we are smart and would never buy a company that went down. Then you deserve to made to look like an idiot.
However, there is a wider implication and that is the impact that this sort of massive non performance has on issues such as retirement. As I have said before part of the looming retirement crisis could be solved simply by nationalising all superannuation funds and placing everyone in an index fund. Overnight long term returns would double and fees would be more than halved. But there is also another impact and this one in related to the impact of on performance on the broader confidence in market participants. Is it any wonder that Australians opt for real estate as the prime mechanism of passive wealth creation when they hear about this sort of rip off.
Long before the Apple Watch or the Fitbit, what was arguably the world’s first wearable computer was conceived by Ed Thorp, then a little-known graduate student in physics at the University of California, Los Angeles. Thorp was the rare physicist who felt at home with both Vegas bookies and bookish professors. He loved math, gambling, and the stock market, roughly in that order. The tables and the market he loved for the challenge: Could you create predictability out of seeming randomness? What could give one person an edge in games of chance? Thorp wasn’t content just pondering these questions; like Shannon, he set out to find and build answers.
More here – The Nautilus
I shared a stage once with Ray way back in the last century and always found him to have something interesting to say.
It is at this time of the year when superannuation funds crow about how good they have done and of their inestimable benefit to mankind in general and this year was no exception. So as is my now annual tradition I thought I would have a look at how good they have done and compare that to the real world where delusions about how good you think you are dont exist. From the article I linked to I took this table which looks at the average return of a a growth fund since 1993.
This piece acts as a good starting point for comparison with the market. For this I used the All Ordinaries Total Return index which used to be known as the Accumulation Index. It includes not only the price movement of the index but also folds back in the dividends of the index components so it is a good benchmark for simply passively holding an index fund or ETF.
When the chart of the average return of a growth fund is first viewed it does create an overall favourable impression – there are only three negative years and returns seem overall to be quite robust. It is only when you compare this active management with a passive benchmark that you realise how poor local managers actually do when compared to the index. Remember these are people who are paid to beat the index and as we will see they are paid staggering sums of money. Looking at annual percentage returns is quite crude and does lack a bit of fidelity, you dont actually know what the true performance differential is so I looked at the value of $1 invested into an average growth fund and into the index and got the following.
The market leaves the industry for dead – the market investment would now be worth $9.87 versus the industries $5.91 and for this privileged investors have been ripped off handsomely. The chart below looks at what my guess of the annual fee intake of superannuation funds is. For this I have assumed an average fee of 1.5% to cover not only management fees but also advisor commissions.
So to produce a theoretical return of slightly better than half what the market produced in the period above the superannuation industry has collected probably close to $310B in fees. So to once again steal from Winston Churchill – never in the field of human endevour has so much been paid to so few for so little.
This is a chart of investor sentiment as produced by the American Association of Individual Investors. Each week the association polls its members with the question where do you feel the stockmarket will be in the next six months. The results are tallied to give a percentage bullish, bearish or undecided. These sorts of metrics are given great status in certain parts of the investing community and I have to admit when I first entered this business back when we all rode dinosaurs and wrote on slates I spent many and evening looking at sentiment indicators trying to work out exactly what they actually did, if anything.
A simple maxim when looking at survey data is to look at the population that is generating the results you are looking at. In this instance individual investors are being asked their perception of the market over a given time period. It is important to note that investors are being ask to rate what is effectively and emotional response to the market – do they feel bullish, bearish or disinterested. They are not being asked a quantitative question. A quantitative question would something simple such as how tall are you? A sentiment or emotional question would be how tall do you feel? Such questions can be considered context questions and are such are dependant upon circumstance. For example I stand about 1.93 metres tall and yesterday I attended a 10 year birthday party so my perception of my height is that I am giant. However, if I was playing in the NBA where the average height is over 2 metres then I would be less cocky about my height. To put it into the context of this survey around 10 year olds I am bullish about my height, around NBA players not so much. My height has not changed, what has changed is the context of my height. The same is true for these investors when polled, there is no context given to the circumstances that generated their response. For example if you have just come off a winning trade then you are apt to be bullish about the future. If you have just come off a losing trade then your confidence would be shaken and you might be more circumspect about the future.
However, there is a further point to be considered and that is the somewhat blunt one of who cares what average investors think about anything? The narrative fallacies of individuals is of no concern to any other market participants. But more importantly it is of absolutely no concern to the market. There is no way to communicate either the perceptions of individuals or the results of their collective perceptions to the market and given that average investors are consistently wrong in their perceptions it doesn’t seem to matter what they think.
This does raise the question of what about the polling of professional investors and professionals are often surveyed about their perceptions of the market and people attempt to divine something from this sentiment. However, this approach also runs into problems. Consider the table below which was drawn from the Investor Intelligence Database. The table operates on a simple maxim. When fund managers are bullish they move out of cash and into stocks. When they are bearish they do the reverse. This cash/asset ratio was measured and then compared to the Dow to see whether the move was prescient in any way. Unfortunately, it wasn’t. The professionals managed to be correct in their interpretation of sentiment on only 7 out of 33 occurrences. You would have been better off tossing a dart.
At the heart of much of this surveying is an attempt to generate some sort of predictive modelling about markets. I note that the current fad is to look at social media tools such as Twitter to see if they tell us anything about the underlying emotional intensity of the market. Whilst I sympathise with the need for the average investor to try and predict where the market is going for the time being trading remains a reactive profession that is best served by simply looking at price, making a bet and managing the trade. Despite what many would have you believe it is not rock science.