beating the market - not what it used to be

[tede02]

I thought it was interesting when Buffett noted at the AGM that Ted and Todd have basically matched the S&P500 since inception. I continue to hear more and more managers talk about how much more competitive the investment game has become over recent decades. Munger has talked about it repeatedly. Bill Nygren had some interesting comments at a "Google Talks" event and another very successful fund manager I follow wrote about this in his 2017 annual letter. It really is remarkable how difficult it is to out-perform especially when you consider the virtually unlimited resources that some of these firms employ. It makes me think, what chance do I have? Then again, in a somewhat strange twist, it seems like the little guy probably does have some advantage comparied to the institutional constraints that exist with asset pools particularly above $1 billion. This subject has increasingly been on my mind. 

[rb]

With all due respect, and I really don't mean to be offensive. All that you've wrote is bullshit.

 

Firstly, value investors tend to badly in frothy markets. So in these times frustration is inevitable.

 

Secondly, by definition stock returns are lumpy. You don't get returns or out-performance on demand. And definitely not on your schedule that you can put neatly in a powerpoint.

 

Thirdly, the more things change, the more they stay the same. Value moves around and you just have to go where it is. In the 40s and 50s net-nets were awesome. In the 90s and oughts plenty of value in the small caps. In the early 2010s large blue chips were value as hell - easiest thing ever!.

 

In 2011-2012 I was buying Microsoft and Cisco around 8x earnings. I put 25% of the portfolio in Microsoft in the $24-$26 a share range and 15% of the portfolio in Cisco around $16-$17 a share. Now those thing are about 3x plus a load of extra dividends. Is that not out performance? We these names something that nobody knew they existed? No. The funniest thing is that around 2012-2013 I've read a J.P. Morgan research report in Microsoft where the analyst significantly raised the discount rate on Microsoft because the discount on the stock was so great that it wouldn't be possible.

 

Also while I picked Microsoft and Cisco, around that time I've strongly considered buying a lot of Google. At that point it was trading around 12x PE ex cash. I decided against it because I didn't think they could maintain attracting the level of engineering excellence they got in the past. Or some nonsense like that. Nonetheless it was on sale big time! Berkshire was selling around book or 1.1 book around that time.

 

So please tell me what amazing resources and technology do these supposed firms have today that they didn't have in 2012 and they weren't able to take advantage of bargains then but today they're scooping up all the value?

[DTEJD1997]

There is not a doubt in any fiber of my being that an INTELLIGENT, PATIENT, DISCIPLINED investor can beat the market averages.  I know they can do this over long periods of time too.  I personally know people that have done this.

 

There are also bargains to be had at almost all periods in time also.  Obviously, some times have more bargains than others, and some times are easy to operate in than others.

 

You can also do incredibly well just finding/executing 1 or 2 ideas a YEAR.

 

Of course, if you are limited to mega-caps and are managing  hundreds of millions or billions,your task is going to be that much more difficult.

 

Most of the time, you are going to have to deal in small/nano cap stocks...but not always.  There have been times where I've found nano-caps that are just "lead pipe cinches"....way better than buying Google at even 10X earnings even.

 

I've been investing for 25+ years.  I got started early in life...beating the market has always been difficult, but always possible.

 

 

[rb]

 

Of course, if you are limited to mega-caps and are managing  hundreds of millions or billions,your task is going to be that much more difficult.

What you are saying is true. The more pools you can wade in the greater the probability of finding bargains. That's just math.

 

But if you were to take Berkshire, most of their greatest hits Coke, Gillette, Wells Fargo, AmEx, BNSF, etc were large, well known companies. Nobody stopped anybody from from buying these firms. So these bargains were there for the taking. The takers just didn't show up.

 

Similarly when I was buying stakes in Microsoft, Cisco, Berkshire at ridiculous prices I'm sure some of the people I was buying from were some of these really sophisticated investors with supposedly really advanced capabilities. So I don't actually have such a high opinion of them.

 

One other I didn't mention in my original post. I don't think this obsession we have with beating the market is a good one. I know that as investors it is a way to measure how good we are. But it can become damaging. If you're really focused on beating the market, you'll start to try to do things to beat the market. That's not good. You should just try do your best to get good, safe returns. If they beat the market, that's great. If they don't, well... there are worse things in life.

[Valuebo]

RB summed it up nicely. I was in my early 20's in 2011-2012 and completely new to investing but even I could see BRK and MSFT were at a decade low valuation. In another thread I've said we will see this valuation gap for BRK again. Maybe as often as once every 10 or 15 years and despite the fact that BRK may have a $1T market cap by then. Human flaws don't go away completely because of the wisdom of the crowd, no matter how many people look at the problem at hand.

 

Prices aren't only adjusted by rational arguments (and sentiment) of market participants. Often, arguments are also made up to correspond with the current price. Positive and negative feedback loops then feed on themselves, sometimes driving valuations to extremes. As RB stated in the case of MSFT: "This can't be right. Better change my discount rate to make this work."

 

Look at oil today. Silly how the narrative changes.

[Cigarbutt]

“Beating” the market is not easy and IMO is not getting easier.

 

Need to have longer term retrospective tools to self-evaluate.

 

I would say that, in certain instances, short term thinking may “justify” taking on more risk in order to maintain one’s edge.

 

From my perspective, there is an increasing level of competition in many already crowded fields and many participants are bright, educated and sophisticated.

 

When it gets confusing, perhaps some time should be devoted to what one doesn’t know.

 

On a related note, many reasons contribute to the difficulty of maintaining one’s edge.

 

Size is one of them:

https://qz.com/1216260/warren-buffett-doesnt-beat-the-market-anymore/

 

IMO, holding BRK is a relatively easy way to “beat” the market going forward. Over time, however, I think that the edge will tend to get smaller and more difficult to maintain.

 

[LR1400]

Someone is beating the market. The growth guys are/have been beating the market. Value not so much. But there’s still a link between the two.

 

Pick your poison based on personality. Plenty have been successful both ways.

 

Another aspect is, we rarely know what individuals do unless they write a book or an article. From reading about some of the growth/momentum guys they are as conservative if not more conservative than many on this board.

 

Value makes intuitive sense, by so does a company that rapidly grows earnings over and over.

[Guest longinvestor]

The “difficulty” with BRK’s beating the index over the past decade has pretty much to do with 2009. The index swung back +50% versus 30%. The self imposed 5 year rolling average comparison is washing off that delta as we speak.

 

 

[no_free_lunch]

I think it's a valid point, especially for us amateurs (assuming that's what you are).  Why spend the time if you can't beat the market?

 

People will tell you how they have beat the market and I am sure they have but when you look to audited statements, it is actually really tough.  Many of the managers I followed a decade ago haven't beaten the S&P or are neck and neck with it.

 

I think your best bet is to focus on a very small number of stocks and use index funds for diversification.  This is what I do.  I don't have hard and fast rules on the weightings but if I can't find a stock that I am confident will beat the index, I just buy the index.

[Sharad]

I think it's a valid point, especially for us amateurs (assuming that's what you are).  Why spend the time if you can't beat the market?

 

People will tell you how they have beat the market and I am sure they have but when you look to audited statements, it is actually really tough.  Many of the managers I followed a decade ago haven't beaten the S&P or are neck and neck with it.

 

I think your best bet is to focus on a very small number of stocks and use index funds for diversification.  This is what I do.  I don't have hard and fast rules on the weightings but if I can't find a stock that I am confident will beat the index, I just buy the index.

 

We small fish don't have to wade into the ocean, when there are plenty of ponds, where the trawler boats aren't in our way.

 

To beat the market, don't invest in the same spaces the big boys are. Find the short-term, one-off opportunities, find the small, obscure stock, and buy and hold for a really long time. Read everything you can about these investments, and know it better than everyone else. It's hard for the market to reach down to the small, obscure investments, because they are too small to move the needle. Understand the various investing accounts investors have in your country, and understand as much about tax law so you can earn returns efficiently. That's the edge smaller investors and hedge fund managers have.

 

Above all else, don't try to beat the market year-in and year-out. Just focus on the process and refine the process. Don't become outcome-driven.

[james22]

BRK has beat the market if measured by book value growth.

 

The market has simply become more expensive.

 

 

 

 

[Jurgis]

If you look at

, a lot of these people are outperforming. If you look at CoBF annual performance numbers, there's a bunch of people who outperform.

 

OTOH, it's still not clear how much of that is selection bias. And how much of outperformance remains after fees and taxes.

 

People here may believe it when they say that it's easy to outperform if you do XYZ (buy cheap large caps, buy cheap small caps, buy international, buy special situations, buy cheap great companies, buy jockeys, buy oil, etc.) and/or that the time of value investors will come (when market crashes, when there's inflation, when there's deflation, when there's recession, etc.). IMO even if we take CoBF population (which is already top 0.1%? top 0.01%? of investors), majority of CoBF population does not outperform and will not outperform even if they try to follow the helpful suggestions above. This is mostly substantiated by 5-year/10-year performance polls I had here accounting for survival and selection bias ( see http://www.cornerofberkshireandfairfax.ca/forum/general-discussion/performance-vs-index-5-years/msg260236/#msg260236 and http://www.cornerofberkshireandfairfax.ca/forum/general-discussion/performance-vs-index/ )

 

Disclosure: I have not outperformed. Please do not listen to anything I write here.  8)

 

P.S. I should link to racemize's http://www.cornerofberkshireandfairfax.ca/forum/general-discussion/update-of-evaluating-performance-essay/msg330465/#msg330465

 

[Hielko]

What makes you think that COBF is top 0.1% of investors? I guess there are a lot of people on this board that spend a decent amount of time, thinking and talking on investing. I don't think that necessarily translate into better investors, in some cases you just make things worse... (e.g. if you are not a good investor but trade a lot you become an (far) below average investor while you could have been average by buying some ETF's). It could very well be that the average COBF investor is (because of that reason) a below average investor. It wouldn't surprise me...

[Jurgis]

What makes you think that COBF is top 0.1% of investors? I guess there are a lot of people on this board that spend a decent amount of time, thinking and talking on investing. I don't think that necessarily translate into better investors, in some cases you just make things worse... (e.g. if you are not a good investor but trade a lot you become an (far) below average investor while you could have been average by buying some ETF's). It could very well be that the average COBF investor is (because of that reason) a below average investor. It wouldn't surprise me...

 

Clearly I don't have data to prove this. Just to be clear when I said top 0.1%, I meant "top 0.1% of total human population of investable age". Or "top 0.1% of total US/Canadian population of investable age". And I still think that's true. I think CoBF membership is likely better investors than 999 out of 1000 random people. But then if 50 or 100 of these 1000 random people just put money into market-cap based fund, then they might outperform half of CoBF... So perhaps my claim is actually wrong. 8)

 

Another way would be to look at how good CoBF members are compared to active investors. But that's probably not very useful because of two reasons: 1. the number of active investors is likely quite small (unless you count all the people who are forced-active investors since they have to choose funds in their 401(k); 2. even if CoBF members are good compared to other active investors, that does not say much if passive investors outperform them.

 

In any case, you make a good point.  8)

[villainx]

As well, BRK specifically would have performed better with a rational repurchase policy, more so with an outsider policy, instead of Buffett's blindspot for being the guardian of shareholder partners.

[james22]

I believe I'm a better investor today than 2000, but I sure couldn't prove it by recent year returns.

 

 

[Guest Schwab711]

If there is a gap between today and some arbitrary point in the past, I'm not sure the gap is as wide as you'd think. It's pretty tough picking individual stocks right now, but that is not the only asset class in the world. Risk-free interest rates are at 3% and various recent special situation opportunities have provided >3% in a few weeks or months.

 

I think what makes investing (stocks or whatever) so hard is the breadth of skills needed to process a tremendous amount of information, so that you can make accurate comparisons across stocks, then compare those expected returns (for given risk profiles) to other asset classes. It takes a lot of information and personal characteristics to have an idea of what kinds of industries to look at and when to look at bonds over stocks and so on. Sometimes folks get lucky if they were pre-pointed in the right direction to start, but to win over long periods you have to know how to read a compass.

 

We also have computers that are magnitudes faster than any time in the past, free or cheap software tools, an EDGAR with a lot of functionality, and all the other stuff out there that provides a willing person the information and tools to build out solutions to track all info they can handle. In 2000, this was not a possibility. As we move farther back in history, it's very likely your unknown unknowns would include a lot of seemingly trivial information you take for granted today.

 

I have a hard time believing folks would have any greater advantage at any point in history relative to today. Even if you know the right people or had money to buy information, you would almost certainly be competing against a much smaller pool of competitors.  The cost of information then was ~$250-$400 per S&P or Moody's manual. One for financial companies, one for regular. Trading fees were ~$25-$50 each way.

 

This game was meant to be hard since it consists solely of people trying to make more money than what is more freely available to them. Same as it ever was, imo.

[rpadebet]

We need to differentiate a bit here between outcome and process:

 

Beating the market is an outcome.

This game is far more enjoyable if the focus is on efficient capital allocation i.e. if you enjoy understanding businesses, their competitive dynamics, the environments they operate in, how they generate revenue, how they spend and how they invest, it is far more fun in my own opinion. This is true irrespective of the market conditions and price where it is trading at.

 

As investors we are only serving as cogs in that wheel trying to move money to the best utilizers of capital given prevailing prices. If we keep doing it right, eventually we might beat the market, as good capital allocations must necessarily triumph over bad allocation. Hopefully we are not doing it only to beat the market, that would just make us keep staring at the scoreboard.

 

Agree with Schwab in that the game seems to be as hard as it ever was. The tools have changed, but everyone has access to similar tools.

 

[rb]

We need to differentiate a bit here between outcome and process:

 

Beating the market is an outcome.

This game is far more enjoyable if the focus is on efficient capital allocation i.e. if you enjoy understanding businesses, their competitive dynamics, the environments they operate in, how they generate revenue, how they spend and how they invest, it is far more fun in my own opinion. This is true irrespective of the market conditions and price where it is trading at.

 

As investors we are only serving as cogs in that wheel trying to move money to the best utilizers of capital given prevailing prices. If we keep doing it right, eventually we might beat the market, as good capital allocations must necessarily triumph over bad allocation. Hopefully we are not doing it only to beat the market, that would just make us keep staring at the scoreboard.

 

Agree with Schwab in that the game seems to be as hard as it ever was. The tools have changed, but everyone has access to similar tools.

I agree with most of the above.

 

I'd also like to add that I think we're seeing a bit of a crisis of the soul/confidence about beating the market. I think this is brought on by the environment over the past few years of low volatility and increased correlation of stock prices. In such an environment it is indeed harder to beat the market. If stock prices are highly correlated you mathematically can't beat it. So if you think that this time is different, that we've had a paradigm shift and this environment will continue into the future. Then yes, you should sell your stuff, buy some vanguard idexes and go to the beach.

 

But, coming back to the idea of the process and what you actually do - I call it making money for the right reasons vs making money for the wrong reasons. There are still great companies and crappy companies out there. Over time the IV of the great companies will outperform the IV of the crappy companies. But if their stock prices move in tandem. Then the great companies will become very cheap compared to the crappy companies. Eventually this will be recognized and the cycle will be broken. Then good process/investing will be rewarded and bad process will be punished. Then the crisis of the soul will dissipate.

[Cigarbutt]

I believe I'm a better investor today than 2000, but I sure couldn't prove it by recent year returns.

 

To openly question one's performance is commendable.

Before capitulation, it may be helpful to revisit the Graham and Doddsville's list:

https://www8.gsb.columbia.edu/rtfiles/cbs/hermes/Buffett1984.pdf

 

Beside Mr. Buffett who is truly unique, most "successful" investors "suffered" relative under-performance for many years (often consecutive years).

What may be interesting is that, if you are right and have a strong inner score card, the periods of under-performance are often preceded, and followed by, remarkable out-performance.

 

Hope that helps.

 

[james22]

It's an interesting question, capitulation.

 

If 'this time is different' or it is simply more difficult to judge the intrinsic value of a technology business today against its market price, maybe momentum is the better strategy.

 

But when would one shift strategies? Every day is a day closer to the correction, yeah?

 

And could one shift strategies once value investing inoculated? I don't believe I could.

 

 

[Lakesider]

Not all returns are made equal.

 

If you return 10% using a low risk method its far more valuable than 10% of high risk. Value investing is a way of mitigating risk.

 

If I load up on Calls on FANG stocks I think I'm a genius till I blow up. Meanwhile the value investor chugs along making reasonable gains until their cumulative return overtakes those with higher risk.

[DTEJD1997]

Hey all:

 

I forgot to mention that most of the people I know who have beat the market over long periods have paid NO or little attention to what the market was doing as a whole.

 

They are looking for individual opportunities, and go from there. That is what they are focused, not what the DJIA is doing...and whether they beat it.

 

They are also investing for LONG time frames in general.

[Grant]

It really is remarkable how difficult it is to out-perform especially when you consider the virtually unlimited resources that some of these firms employ.

 

Suppose you're a small fund generating a lot of alpha. What happens? You attract more investor money. Because you invested your original capital the best you could, this additional money must be invested in less promising ways - i.e. the law of diminishing returns. As long as you generate alpha, you continue to attract more money which lowers your alpha.

 

This is why big hedge funds with unlimited resources have trouble beating ETFs. Just because it's hard for them doesn't mean it should be hard for you.

 

This said, I usually advise people to stick to ETFs except where they have specialized knowledge the market is unlikely to price in.

[scorpioncapital]

Many systems are rule based. Not sure about ai..but You would need to synthesise various forms of information and tie them to a mental model framework , like what munger describes. It can be as simple as usa will succeed. Having said all that , execution is in the details. And sometimes some luck. I've heard many investors have the right principles but unable to apply them successfully. An old bridge teacher once told me if you keep saying the right idea but making the wrong move you probably didn't understand the concept as deeply as you thought.