So, I guess we've given up on this innane argument that active managers "invent" companies? Correct, because in your retort(s) I don't see any explanation on how they do it. That's the argument I'm debating right now. Before, it was that active managers don't generate any alpha on average so why would anyone invest with one. But we've seemed to skip over those argument(s) altogether.Oh, and you're absolutley right, there wasn't a single active manager that took a bath on any stock. It was all the index funds, buying on the way down. Right. No, I think it was the active managers that thought they were smarter than the market. I should know, I worked for some of them.And when or how did lender's/banks become active investors. Are you now defending banks? Yes, banks and some private equity investors give money to startup companies. I don't know, do you define an active manager as a bank or private equity firm?T

QuoteOriginally posted by: TrevorAnd when or how did lender's/banks become active investors.The day CitiGroup's loan portfolio stopped mirroring the S&P 500. Or was Yukos a recent index add?Just out of curiosity, would you advocate duration and company capital-weighted indexing as a way to manage a loan portfolio?Would you at least agree with the popular notion that Sandy Weill "invented" CitiGroup?

"The day CitiGroup's loan portfolio stopped mirroring the S&P 500. Or was Yukos a recent index add?Just out of curiosity, would you advocate duration and company capital-weighted indexing as a way to manage a loan portfolio?Would you at least agree with the popular notion that Sandy Weill "invented" CitiGroup? "Duration has nothing to do with equities. I don't know where this comes into the argument. There is no equivalent to duration in the equity world and S&P does not use it as a criteria for selection in the 500. Debt products do tend to require informational advantage and some can be gained through careful research, given the vastly larger universe of debt issues and the relative size investors must play in versus stocks.Are you aware that Vanguard offers funds that are not index funds?? Seriously it's true. You can look it up on This WEBSITE! "The problem then, obviously, is a lack of payment flowing to the people who mine, create, and extract information and insights, and flowing from the people who enjoy the benefits of an efficient stock market. The problem is the lack of a payment structure, to prop up a supply chain to increase the pool of "all known information" which is reflected in stock prices."If you view an efficient market as a public good and people who invest in index funds as free riders then you clearly have a misunderstanding of economics. People who participate in the stock market are not required by law to participate. They are paid for their contribution to the pot of knowledge when they trade. If the price for their knowledge isn't right, they shouldn't trade. That is the mechanism. No need to redo this. "Let's suppose that, for every investor that switches $100 from an index fund to an active fund, returns on the S&P 500 go up by .000001%. So by switching to actively managed, that investor increases his returns .000001%, and increases his management fees by 1%. In other words, everybody makes more money, but one individual bears the cost."Okay, this is a gem. You are saying that by switching from the S&P 500 to an actively managed portfolio both the S&P 500 and the actively managed portfolio increase returns. Do you have a plausible mechanism by which this works or shall we accept this as just a thought exercise? In either case you make a fairly strong argument for index vs. active...the investor incurrs extra cost for the managed portfolio without any extra return. Gee these index guys are assholes. " The job of a mutual fund manager must be to extract and manufacture new information which no on else has - private information. "Mutual fund managers have demonstrated an extraordinary talent for either being unable to do this...or to use your blackjack analogy, they have seen more cards come off of the deck but don't understand the optimal standing and betting strategies. The record of the mutual fund industry speaks for itself. There is substantial evidence that actively managed funds do worse than the market as a whole. "The active managers are picking which stocks the index funds will hold. If indexes have any alpha, it is a result of investment selection by active managers. No index has EVER bought a stock which wasn't invented and built by an active manager. "No active manager has ever invested in a company that wasn't envisioned, pitched and birthed by an entrepeneur. If you're not out there developing new products, dreaming up new services or putting together a business plan, then you're a parasite. Fuck investors, fuck fund managers, fuck index fund managers. Okay, now I get it. Again new companies are like debt products, there are lots of them and they require a lot of special understanding. These companies get nurtured and financed long before an active manager sets eyes on them."Ultimately, the comparison is, do investors do better investing in an index collective, or hiring managers such as Warren Buffet to develop inside relationships, and manufacture asymmetric information? People in a collective always do better for themselves, the less work they do - once you are in a collective. But people in a collective also always do worse, for having entered into a collective in the first place."Okay...now we are finally at the nut of your screed. Communism is bad, capitalism is good. Commies are bad, libertarians are good. Index investors are mindless commies. Active managers are.....hmmmmm. Your profound statement on people in a collective is too deep for me. Seriously...either that or it's a totally invalid comparison.Person A has two choices...Choice 1 enter a collective, choice 2, don't enter a collective. Person A chooses door number 1 and goes into a collective. In the collective person A again has two choices, choice 1 work hard, choice 2 don't work hard. Person A chooses to not work at all and somehow becomes better off than if he did choose to work. Okay that's fine...Person A has more leisure time and just as many goods. I guess that works if you have a very distorted view of these things. I don't think people were allowed to play ping pong all day under Stalin, but I can go check. Person B has the same two choices. Stays out of the collective and works hard. Person B succeeds. Hooray for person B. Could it be possible that person A really doesn't view his entire existance as being tied up in his participation in the stock market and therefore sees little value in spending a lot of time trying to figure it out?? If person A doesn't value the information that a portfolio manager is creating at 1% per year should Person A be required to in order to pay his fair share?? Sounds like collectivism to me.

QuoteOriginally posted by: RowdyRoddyPiperDuration has nothing to do with equities. I don't know where this comes into the argument. There is no equivalent to duration in the equity worldI'd be willing to risk $5 to get $15 back, that the first equity-valuation model you were taught in college was the two-stage dividend discount model. Duration is an important consideration in equities, often examined in the form of a P/E ratio. And the duration of the S&P 500 is replicated by index investors. But anyway, I merely meant to consider what would be required for CitiGroup to become a passive investor by not discriminating as to asset duration. If my suggestion is silly, how would you envision the ideal "indexed" portfolio of debt? Would it have to match only the companies, but not the duration?QuoteOriginally posted by: RowdyRoddyPiperDebt products do tend to require informational advantageI'd be curious to hear an argument as to why you need more of an informational advantage to buy the bonds, versus the stocks, of the same company.QuoteOriginally posted by: RowdyRoddyPiperIf you view an efficient market as a public good and people who invest in index funds as free riders then you clearly have a misunderstanding of economics.You know that I view price tickers as an area of commerce that is under-developed and has a lot of maturing to do in the coming years. The SEC supervising and micromanaging the evolution doesn't help. What market is more developed, currency, which has almost no arbitrage relationships, or stocks which have plenty of arbitrage relationships, but where it is illegal for Island ECN to disseminate their book? But please, clarify my misunderstanding.QuoteOriginally posted by: RowdyRoddyPiperthe price for their knowledge isn't right, they shouldn't trade.This completely misses the point. Sure, people in North Korea don't have to work. But what if you want them to work, and they would work more if you paid them more? In another words, what if the price truly doesn't reflect the benefit of marginal knowledge? Assuming they supply the right quantity for the price, what if we want a higher quantity? What if more of their knowledge would be useful, if only there a way to pay for it and stimulate more production? Then our inability to pay, and their staying home, becomes our problem. Let's say we made it illegal for doctors to charge for medical care. There would be a lot less medical care provided. If you then introduced a pricing system, by allowing them to charge, you would get more of something you want. There are things where it is hard to develop a price system, such as urban noise pollution. But in investments, buying inside information has been made illegal. And no, I don't have to describe to you exactly what supply chain might develop if the SEC didn't chill diversity, to be confident that something interesting would develop absent the mob-driven regulation.QuoteOriginally posted by: RowdyRoddyPiperThat is the mechanism. No need to redo this.That is the mechansim required by law, not one that formed spontaneosly. A competing mechanism might form if it weren't illegal. You might discover you like the new one better. If not, as you say, then you wouldn't have to participate! Why would you want to fix the price paid at zero, and then tell those who would only provide goods at a higher price, that we don't want their business? When you say "that is the mechanism," you ignore that a different mechanism might set a higher, and more accurate price.QuoteOriginally posted by: RowdyRoddyPiperPeople who participate in the stock market are not required by law to participate.Sure, but there is a large degree of crowding out by the government promoted SEC monopoly. It's kind of like public schools, where people who go to private schools still pay public-school tax. But it's even worse because the government is not perpetually harrassing people who send their children to private schools.QuoteOriginally posted by: RowdyRoddyPiperYou are saying that by switching from the S&P 500 to an actively managed portfolio both the S&P 500 and the actively managed portfolio increase returns. Do you have a plausible mechanism by which this works or shall we accept this as just a thought exercise?What is the difference between "plausible mechanism" and "thought exercise?" An index fund buys whatever someone else has bought. Suppose there were one person selecting stocks, and 250 million people copying him. Since he would only have time to do due diligence on the stocks of 10 small companies, the entire planet would be confined to investing in only those 10 companies. If the combined sales of those companies was $3 billion, and the combined assets of the 250 million investors were $3 trillion, then clearly they would get a bad return giving all their capital to those 10 companies! Obviously, as the ratio of stock pickers to total assets increased, the returns to the total portfolio would increase. The optimal level of equity research would be discovered when the people spending money on research no longer got their money back. The tighter the feedback loop between people paying for research, and people enjoying the benefits of it, the better the weighing of costs and benefits, and the more optimal level discovered. Surely you would not argue that returns would be better if everyone indexed, and no one stock picked. If you concede that an optimal level would include some large proportion of stock pickers, than you must begin to debate under what incentives that level will be discovered.QuoteOriginally posted by: RowdyRoddyPiperMutual fund managers have demonstrated an extraordinary talent for either being unable to do this...or to use your blackjack analogy, they have seen more cards come off of the deck but don't understand the optimal standing and betting strategies. The record of the mutual fund industry speaks for itself.If you mean to point out that people have done no better on IPO's since the introduction of the SEC than they did before it, I agree with you. I'm not the one pushing the SEC and the Investment Company Act. I'm the one arguing that it is awful, but that the solution is to move towards a more dynamic and diverse system, rather than towards index funds. The record of index funds speaks for itself. What is the dollar-weighted return of people who have invested in them over the years?QuoteOriginally posted by: RowdyRoddyPiperThere is substantial evidence that actively managed funds do worse than the market as a whole.Physically impossible. This would require that active managers own some stocks that indexers don't own, or vice versa. If the indexers own stocks which no active managers own, and they are being held for the sole reason that the price is high, then they must be holding stocks based purely on inertia. In reality, when the active managers sell down such stocks, the indexers must adjust their portfolio to continue to mirror the active managers. Anyway, I'd like to see you link your evidence that the market as a whole does better, the larger the proportion of assets held by indexers. The highest-capitalized indexers have been beaten by so many different people, and so many different benchmarks. QuoteOriginally posted by: RowdyRoddyPiperNo active manager has ever invested in a company that wasn't envisioned, pitched and birthed by an entrepeneur.But investors discriminate more than entrepreneurs do. Very few people are so well-rounded, as to have a choice between opening a pumpkin farm, or a nanotech company. Given that an entrepreneur doesn't really have a choice in what he promotes, he can be said to have gotten lucky when he succeeds. Whereas an investor who chooses between a larger variety of business opportunities, over a series of many such decisions, can be credited with deciding which business model is the right when he is successful.QuoteOriginally posted by: RowdyRoddyPiperThese companies get nurtured and financed long before an active manager sets eyes on them.The index fund is a light at the end of a long tunnel. If it shines indiscriminately, businesses at the far other end of the tunnel are nurtured with less discrimination. Like a coupon discounted from far in the future, it all feeds back through the system.QuoteOriginally posted by: RowdyRoddyPiperI don't think people were allowed to play ping pong all day under Stalin, but I can go check.You might want to check if the people who were supposed to monitor whether they were playing ping pong, were also allowed to play ping-pong all day. After all, Stalin himself couldn't afford to watch 10 million cameras at once like Big Brother. The only monitor which is vigilant on location 24/7 is survival, and it is only present under the price system.QuoteOriginally posted by: RowdyRoddyPiperCould it be possible that person A really doesn't view his entire existance as being tied up in his participation in the stock market and therefore sees little value in spending a lot of time trying to figure it out??Sure, most people just put their money in a bank. A bank is intermediated debt. One of the things which makes the US special is disintermediated equity. But I think the natural balance has been distorted, to where there is a relative lack in the intermediated equity portion of the spectrum.

"I'd be willing to risk $5 to get $15 back, that the first equity-valuation model you were taught in college was the two-stage dividend discount model. Duration is an important consideration in equities, often examined in the form of a P/E ratio."Cash or money orders only. The first model that I learned was indirect equity valuation considering firm cash flows and firm debt. No biggie though, it was worth a shot. I also doubt that duration in equities is a consideration that is classified as important. How comfortable would be you immunizing an equity portfolio against interest rate risk. I'm not meaning to say that interest rates do not impact equity values, I am saying that to hang a number on it like duration is foolish. Payments are not known in advance and terminal value is sketchy at best. To reiterate, I haven't heard of equity investors entering into swaps to hedge out IR risk, but that doesn't mean it doesn't happen. There's no explaination for what people will do with their money."I'd be curious to hear an argument as to why you need more of an informational advantage to buy the bonds, versus the stocks, of the same company."If you are going to quote me please have the courtesy to use the complete sentence. I should have been more explicit on this point, the fact remains that I didn't say you need an information advantage to trade the debt of a company versus the stock of the same company. The thought that I am trying to convey here is that debt products come in much larger size and variety than equity products...true fact. There are something on the order of 7,500 equities in the US. There are somewhere over 5mm debt products in the US. I haven't adjusted this out for multiple issues by a single issuer but the number of debt issuers still exceeds the number of firms with public equity by at least an order of magnitude. Debt also trades in size that is much larger than a typical equity trade. Research pays off much better on the debt side precisely because you do not have "10,000 people trying to predict the weather (a paraphrase)" which is the situation in the public equity side."What market is more developed, currency, which has almost no arbitrage relationships, or stocks which have plenty of arbitrage relationships, but where it is illegal for Island ECN to disseminate their book? But please, clarify my misunderstanding."Okay let's get something straight here. I don't know that there are plenty of arbitrage opportunities in equities. If you knew they existed I doubt you would be here as much. The FX market dwarfs the equity market in the volume of trades. Also the number of currencies traded is much smaller than the number of equities traded. Look at a high volume stock and find the arb for me. I'm waiting."This completely misses the point. Sure, people in North Korea don't have to work. But what if you want them to work, and they would work more if you paid them more? In another words, what if the price truly doesn't reflect the benefit of marginal knowledge? Assuming they supply the right quantity for the price, what if we want a higher quantity? What if more of their knowledge would be useful, if only there a way to pay for it and stimulate more production?""If you mean to point out that people have done no better on IPO's since the introduction of the SEC than they did before it, I agree with you. I'm not the one pushing the SEC and the Investment Company Act. I'm the one arguing that it is awful, but that the solution is to move towards a more dynamic and diverse system, rather than towards index funds."Okay, so now your argument has been revealed...again...for the third time...in a different costume. You think that the SEC hinders the market's competitiveness. Insiders are insiders because they are put there either by shareholders or by someone who has been put there by shareholders. They do not own the inside information and therefore may not sell it without shareholder authorization. It is that simple. They have come by the knowledge through the benefit of working for the shareholders, if they are not satisfied with their compensation then they should either negotiate for more or find somewhere else to work. I don't agree that index funds are the best investment for every investor. I do think that they are the best investment for the passive investor who doesn't have the time or interest to keep tabs on a stock or a "fiduciary" in an industry that has shown a willingness to totally screw their investors. "Sure, but there is a large degree of crowding out by the government promoted SEC monopoly. It's kind of like public schools, where people who go to private schools still pay public-school tax. But it's even worse because the government is not perpetually harrassing people who send their children to private schools."Okay, this is nothing like public schools. In some small way I may have my tax dollars support the SEC, but it's really much smaller compared to the amount of property tax I pay. Plus I can just pretend that my SEC dollars are going to buy more ammo. If you are talking about companies, there is a simple way to avoid SEC harassment. Stay private....or even better register off shore. Again, I am not a big fan of the SEC, but I don't think they are totally useless. My biggest complaint is that they lead small investors into thinking it is safe when everyone knows enforcement is a joke. Should unregulated doctors be allowed to hang out a shingle? How about lawyers...should anyone be able to represent a client in a court of law??"What is the difference between "plausible mechanism" and "thought exercise?" "Plausible mechanism would mean that there is some plausible way that you think this works in real life. Thought exercise means "imagine if the world worked like this, no real proof for the underlying thought". This question was not meant to be a dig at you, it was meant to clear up where you are coming from. Back to the point. Okay then, this is a thought exercise. First question, are the 10 companies that the stock picker has picked the only companies out there. If so how is the stock picker any different from an index fund? By how he weights them possibly? If stock pickers are the only source of capital then how do these companies have value that the stock picker does not own? If there are other companies that the stock picker hasn't picked, why wouldn't the index buyer be in those as well?? Remember most index funds don't track the performance of a manager. They track the performance of the index."Physically impossible. This would require that active managers own some stocks that indexers don't own, or vice versa."An example may illustrate this: Your 10 stock universe. 5 are classified as large all balances equal 10mm, 5 are classified as small all balances equal 1mm. Index 1 has all 5 large. They return 10%, -10%, 20%, -25%, 15%. The return on the index is 2%. Index 2 has all 5 small. They return -15%, -20%, 35%, 45%, -25%. The return on the index is 4%.The return on the market is 2.18%Manager A picks L1, L3, L4 for a return of 1.6% which is less than the index as a whole. Manager B picks S1, S4, S5 for a return of 1.7% which is less than the index as a whole. Of course you can replicate a portfolio that whips the index, but the point is to illustrate that it is conceivable for many people to invest in a fashion that doesn't beat an index. I'm a total return guy myself so beating an index doesn't mean much to me. It's nothing to be boastful about. Add in fees and we are talking small returns. Okay now here's the catch. I of course am not saying that every single active manager does worse than the market as a whole. What I am saying is that in most cases the fees are not justified by the performance. Okay so now your argument is that the SEC should allow insiders to sell information (paid for in the form of trading profits) in order to get all that info out there?? Am I correct on this or not??

QuoteOriginally posted by: RowdyRoddyPiperAn example may illustrate this: Your 10 stock universe. 5 are classified as large all balances equal 10mm, 5 are classified as small all balances equal 1mm. Index 1 has all 5 large. They return 10%, -10%, 20%, -25%, 15%. The return on the index is 2%. Index 2 has all 5 small. They return -15%, -20%, 35%, 45%, -25%. The return on the index is 4%.The return on the market is 2.18%Manager A picks L1, L3, L4 for a return of 1.6% which is less than the index as a whole. Manager B picks S1, S4, S5 for a return of 1.7% which is less than the index as a whole. Who owns the float of L2 and L5 which the indexers don't own?QuoteOriginally posted by: RowdyRoddyPiperI'm a total return guy myself so beating an index doesn't mean much to me. It's nothing to be boastful about. Okay so now your argument is that the SEC should allow insiders to sell information (paid for in the form of trading profits) in order to get all that info out there?? Am I correct on this or not??My argument is that the absolute return of the market must be lower, the higher percentage of money is managed by indexers - even though the indexers may do better than the stock pickers holding the same portfolio.

At one time I though I could disprove the efficient market hypothesis based on the performance of actively managed hedge funds: I believed that I could prove that statistically it was impossible for the actively managed funds to be so BAD on average if the market were truely efficient. (This isn't such wacky idea: I thought that the little guys on main street have a much better idea of what's happening with their local companies then Wall Street. The average Joe knows when his company or his neighbor's company is kicking its competitors teeth in, or vice versa, whereas Wall Street receives information much later and after some massaging.) Unfortunately after I accounted for trading costs, and the fees, and the marketing costs, and the ..., I could Not conclude with 97.5% confidence that actively managed funds performed significantly worse than throwing darts. Part of the problem was getting a good grip on all the fees and costs (defined to be any way that money leaves the fund other than redemption), and the rest of the problem was constructing good track records for funds, since many of the worse performing funds got merged into the better performers, which effectively erases their previous track records.Of course one cannort use statistics to prove that an individual fund is a bad buy, but one can use statistics to estimate the per centages of actively managed funds that are worth their fees. Every study I've seen has concluded that such funds MAY exist, but they are rare at best, so the chances of an individual happening on one of these funds (without exhaustive investigation) is remote. Or to put it more succinctly, never have so few been paid so much for so little. A telling point is an article in a trade magazine for mutual fund managers. The gist of the article was that if your performance was less than the average of your peer group, then you were using the wrong peer group. Well, that I can understand. First we shoots the arrow, and then we draws the bull's eye; our performance is so much better that way.It used to be that the loose way that mutual funds used statistics (how can a majority of fund managers be contrarians?) allowed one to prove rigorously that 1 out of every 32 fund managers was a genius: 16 go long and 16 go short the first year. Fire the wrong 16 (except for the nephew of the founder. Put him in risk management). 8 go long and 8 go short the second year. Demote the wrong 8 to answering the phone. 4 go long and 4 go short the third year. Put the wrong 4 in compliance. 2 go long and 2 go short the fourth year. Promote the wrong 2 to the board or directors, ... .Fortunately the standards have changed. With the current short attention spans, roughly 1 out of 8 managers can be proven to be a genius. That's got to be good, having more geniuses, I mean.The practical side of this is that some firms incubate several mutual funds simultaneously. While these funds are closed to the public (which lets them take dramatic bets), the total amounts under management is often just a few million or even a few 100K per fund. By continually pruning the funds whose track records don't measure up (either dumping their assets into a brand new fund - which really amounts to just starting the track record over - or dumping the assets into a more successful fund) one eventually has a very few funds which have sterling track records. One then opens these funds to the public and goes for size. Such a deal!

QuoteOriginally posted by: PatI could Not conclude with 97.5% confidence that actively managed funds performed significantly worse than throwing darts...Or to put it more succinctly, never have so few been paid so much for so little.GOOD GRIEF!!!?!!First I have a guy arguing that a company can issue just as much stock regardless of whether anyone actually buys it!Then I have a guy who insists that capitalization-weighted index funds can own equal percentages of every company in an index, and yet have the remaining percentages which they don't own be unequal!Now we have a guy who, in the face of the fact that common stocks have outperformed every other investment category, declares that the people who picked the stocks have done nothing!Investment by throwing darts has never been tried because nobody would be that foolish! Suppose I were to give you in one hand the three trillion dollars of investor capital converted to cash. And in the other hand I were to give you the names of every company incorporated in the state of Delaware, as well as the names of every ambitious guy with an idea for a company. Do you really think that if you threw 1,000 darts, and divided up the money evenly based on the outcome, your returns would be positive?Do you think you could throw darts, and decide at random to swap the market cap of Microsoft and Marimba, and get the same results? Whom would the dart-thrower people even sell to if they were all throwing darts? I'd like to see them pick minimum sell and maximum buy prices with the darts, so that Marimba would move to double its current market cap before they gave up bidding and sat tight. Then Marimba could sell them stock at that price until their bank accounts were empty... and do what with it?!?And of course equities have a duration! If you wanted to liquidate Microsoft today - turn everybody's shares to cash at the closing price - could you do it? Just because the timing of earnings is not included in your option-pricing model, does not mean that, in the real world, those earnings don't arrive on a VERY RIGID time schedule. I'd like to see Microsoft arbitrarily double their 2005 earnings, and earn zero in 2006. They could lie and say they did it, but reality doesn't move as freely as words and equations! Sure, you can sell a bond today and call the duration zero, or say it doesn't have a duration. Then maybe you could get a job at LTCM! A stock gets paid coupons in the accounts of the company - which accounts you own!And of course there are more arbitrage opportunities between equities than between currencies. If I cannot find one, it is because other people are already enjoying them!

Throwing darts (on a capitalization weighted basis) IS equivalent to buying an index fund ... and the Wall Street Journal regularly runs contests of the "best" stock pickers against darts.Seriously: we have a class of people, portfolio managers who are paid to invest peoples funds. Every study I'm aware of shows that as a class, they do more poorly than index funds over the long term. Like anyone else, they should be required to prove (or at least give a quantitative evidence) that they create more value for their funds then they subtract from their fees. Even if they could do that, which every study I've ever seen says they cannot, we get into the question of tax efficiency. Index funds are very tax efficient since they rarely trade. This is worth an additional couple of per cent in return, at least for non-401K money.This is not a theoretical question. It is a perfectly straightforward empirical question: Is the expected value of the after tax return of actively managed portfolios (after all sales charges, loads, back end loads, management fees, 12-1b fees, ...) better than the expected value of the after tax return of index funds? Although one can always look at the past year or two years or five years and find funds whose "track record" beats the index fund (through the use of Twainian statistics), most serious studies have concluded pretty convincingly that the answer going forward is no. The fact that a whole industry is dedicated to the answer being yes does not change the answer.And what do you think is the expected long-term return of investing in equities? It's not 8.5%. It's closer to 3.5%, because in any serious study of equity markets you must include overseas markets: In 1900, the US and Argentinian economies were nearly mirror images, both with well developed markets. An objective investor would be hard pressed to choose between them. Yet the 100 year performance is radically different. And investments in the German economy would have been wiped out completely twice in this century. And in Japan, the Nikkei index is only a third of its value twenty years ago. There is no guarantee that the US market is not sitting where the Argentinian market was in 1900 or the Japanese economy was in 1980. And using fixed portfolio of stocks (instead of an index like the S&P 500 or DJ30 which changes its components) also results in lower returns.

QuoteOriginally posted by: PatThrowing darts (on a capitalization weighted basis) IS equivalent to buying an index fund ...And therefore IS equivalent to a diversified portfolio of portfolio managers, who choose which stocks will be on your dartboard in the first place!QuoteOriginally posted by: PatSeriously: we have a class of people, portfolio managers who are paid to invest peoples funds. Every study I'm aware of shows that as a class, they do more poorly than index funds over the long term.What, exactly, is the difference between the holdings of portfolio managers taken as a whole, and the holdings of index funds? The only obvious difference is that index investors don't pay management fees. But you can't really call profits which indexers get as a result of not paying management fees improvements - since you couldn't get them without someone paying the management fees. But if index funds are beating the portfolio managers by more than the cost of management and rotation, then the performance difference must come from some subtle difference between the portfolios of the two groups. If this is the case, and all the indexers extra profits are coming from trend trading large stocks or some other subtlety in their holding period, then they should just do that, instead of indexing and getting that benefit by accident. But if there were some such trick, then somebody would have discovered how to do it without the general hassle of indexing.QuoteOriginally posted by: PatLike anyone else, they should be required to prove (or at least give a quantitative evidence) that they create more value for their funds then they subtract from their fees.They are picking the stocks which are in the index funds! If the index funds are making money, then these people are creating value!QuoteOriginally posted by: PatEven if they could do that, which every study I've ever seen says they cannot, we get into the question of tax efficiency.Hedge funds, small caps, insiders, senators... plenty of active managers have beat index funds. Of course, if you believe everything in the SEC database and end up holding Enron and Worldcom, I can't help you.QuoteOriginally posted by: PatThis is not a theoretical question. It is a perfectly straightforward empirical question: Is the expected value of the after tax return of actively managed portfolios (after all sales charges, loads, back end loads, management fees, 12-1b fees, ...) better than the expected value of the after tax return of index funds?For cyring out loud, you act as if they're holding different portfolios!QuoteOriginally posted by: PatThe fact that a whole industry is dedicated to the answer being yes does not change the answer.Do you honestly not accept the simple premise that if EVERYBODY indexed, then it wouldn't work? If everybody indexed, then how would we decide what was in the index? And if you accept the premise that the first person who switched to active management when EVERYBODY was indexing, would make more money by switching, then you have to accept that there is an interval over which people can make more money switching from indexing to active management. Empirical evidence suggest that we might have reached that inflection point around Spring 2000, as I stated in the opening line of this thread. You have to concede that if EVERYBODY was indexing, then they would ALL make more money, if they ALL switched to active management. You then have to concede that this still might be true even if only 90%, or 50%, or 20% of people were indexing. My SEC rant is something like a suggestion of how we might discover that sweet spot.QuoteOriginally posted by: PatAnd what do you think is the expected long-term return of investing in equities?To be honest, I don't think there is an "expected long-term return of investing in equities." God did not create an eternal fountain of random walks with a stationary upward drift, which unlimited numbers of people can jump on and off at any time, without having to find someone to take the other side! Millions of people spend millions of calories for every millimeter of upward drift. People who do think you can jump on and off and earn free money, don't so much push up prices when they buy, as they increase the total number of companies. And nor can they jump on and off at random times like picking a year with dice, but inevitably they jump on and off at the same time as everybody else, with whose incomes their own incomes are correlated.

QuoteOriginally posted by: PatThis is not a theoretical question. It is a perfectly straightforward empirical question: Is the expected value of the after tax return of actively managed portfolios (after all sales charges, loads, back end loads, management fees, 12-1b fees, ...) better than the expected value of the after tax return of index funds? Although one can always look at the past year or two years or five years and find funds whose "track record" beats the index fund (through the use of Twainian statistics), most serious studies have concluded pretty convincingly that the answer going forward is no. The fact that a whole industry is dedicated to the answer being yes does not change the answer.Pardon my ignorance, but why past performance should be determined statistically? IMHO, past performance must reflect the manager's skills in certain market conditions. Some managers who perform well in bear market may not perform well in bull market. Whether we ignore the skill factor or not, at the end, we invest in managers who run these funds. Similarly, if you would have invested in innovative and skillful managers in Japan over the 90s, in spite of the depression, you could outperform the average S&P.

The reason that past performance should be determined statistically is that we are trying to test the claim: Give me your money, and I will invest it so shrewdly that the expected value of your investment gains (minus my fees and costs) and with a maximum allowed risk, will be better than you could do yourself.We have no way of testing this claim: maybe for the next 5 years selecting stocks according to 7 ray astrology WILL return superior returns. But the point is that exactly the same claim has been made by the fund industry for the last, say, 30 years, and you can prove whether these past claims came true. Mostly they did not. So why shoud we believe them this time?Saying that this fund did well in down markets and that one did well in up markets, and the other one did well when inflation was high and job growth was low, ... is known as selective statistics, or in magic as the "mulitiple out". Starting from today, are we in a bull market or a bear market?

Thanks for the answer.The problem with most statistical methods is the necessary of large data. In case and we need to identify if a fund manger is trully skilled or just exceptionally lucky, we then must have 66 years of monthly returns data to obtain 95 percent confidence in order to prove that a manager can beat the market by 2 percent on average (Harris). Given the market’s evolution (what was true yesterday may well be untrue tomorrow) and the life-span of an average fund manager, it’s clear that statistical methods alone are certainly not enough to separate skill from luck. If a fund manager holds an index and sell volatilty he can product additional return by writing OTM options so that he can outperform the index, possibly for years, as long as his options are not exercised. Although, such a strategy has no merit, and sooner or later the options will exercised, but for the time being the manager must be a genius. Alternatively, if we were to evaluate fund managers who have performed poorly on average, and discriminate between their skill and luck, we would discover some factors which adversely affect their portfolio returns. Typical negetive factors are: high management fees, frequently trading, lack of expertise, and inability to exploit positive factors due to certain investment policy. Even though these factors are important, they are mostly not visible to the average investor. Part of the problem is dealing with statistics and not being aware that there are real people behind the numbers…People in nearly every profession likely to use the same arsenal of strategies (business, marketing, etc…), thus their performance is below the average. The few who are performing above the average, say, the 15 - 20 percent of them have expectional luck and/or have a sort of comparative advantage. Fund managers are in no different a position from any other professionals. Therefore, finding if a comparative advantage do exist is the whole theory on one leg.

That's true for an individual fund manager, BUT:a) an extra 2% is about what I need to make up for tax inefficiency of the typical actively managed fund;b) one can certainly use statististical methods to answer the question: do fund managers AS A CLASS add value over and above their costs? All the studies I am aware of say that as a class they do NOT overcome their fees and expenses (and it is unclear whether they are better than broad based index funds even without expenses and loads factored in).For a mutual fund industry to say "on average fund managers are not worth their fees, but one cannot prove that our particular fund managers are dogs, so please fork over your hard-earned money" is blatant misuse of statistics. If, as a class, fund manager's purported stock picking and trading skills are not worth their fees, I think the only rational null hypothesis for an investor to make is to assume that any given manager is not worth his/her fees, and then ask for the hypothesis to be disproved.Besides, who could trust any industry that cannot see and police the abuse of a member signing up a company's 401K plan so that employees can eitehr inverst in a duplicate of the SP 500 fund, with a 1% "management fee" up front, 1% on each anniversary, and 5% exit load OR invest in their companies stock, with no other choices? Such a deal!