Seeking Portfolio Manager Skill

Why not invest your assets in the companies you really like? As Mae West said, “Too much of a good thing can be wonderful”.

Wide diversification is only required when investors do not understand what they are doing.  –Warren Buffett

Buffett’s investing abilities were discussed here:http://wp.me/p1PgpH-ww

Seeking Portfolio Manager Skill

Mauboussin, a market strategist (cheer leader for Bill Miller?) writes painfully about finding ex ante investment management skill. http://contenta.mkt1710.com/lp/26966/115068/

MauboussinOnStrategySeekingPMSkill_MIPX014394.pdf

Two studies are mentioned in his article on index investing

  1. Active vs. Passive Investing and the Efficiency of Individual Stock Prices: http://finance.bwl.uni-annheim.de/fileadmin/files/Paper_Finance_Seminar/Wermers.pdf
  2. The economic consequences of index-linked investing. http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1667188

Takeaways:

  • Active managers are better off maintaining high active share (how their portfolio differs from a benchmark index) through stock picking than through sector bets.
  • Mutual funds with expense ratios of 1.25% or more and that have more than 40 stocks will have low active share—be quasi-indexers—and will have to massively outperform on the active part of their portfolio to equal the benchmark returns.  33% of the portfolio would have to outperform by 3.75% to make up for the 1.25% expense. Wow! There is a compelling reason to use a low-cost index or not to invest in a mutual fund.
  • If you go passive, then really go passive and have no to low costs.
  • However, if you are an active manager, go active. Concentrate on your stock picks and don’t over diversify.
  • There is a role for active management since active management makes prices less inefficient.
  • Most statistics fail the the actual test of reliability and validity.
  • The combination of active share and tracking error provides insight.  Funds with high active share and moderate tracking error deliver excess returns.
  • There is a long-term trend toward lower active share. More investors are indexing, therefore the markets are becoming less efficient.  Don’t own a fund with low active share, because the chances are good that the fun’s gross returns will be insufficient to leave you with attractive returns after fees.

I am not a big fan of the academic jargon that fills this article, but some readers may gain the insight that I had reinforced–mostly, institutional investors do NOT earn an adequate return AFTER fees for investors because they are closet indiexers with high fees. Buyer beware.

And, if you are an individual investor, concentrate in your best ideas.

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