Good reads from around the Web.
One issue with chasing the so-called return premiums – that historical tendency for certain kinds of shares to deliver above market returns, even to passive investors who simply tilt their portfolios thataway – is that you have to stick with them through thick and thin.
As my co-blogger The Accumulator has advised:
…think of your value fund like a sardine net. You’ll catch some of the shoal but not the whole lot.
Some days (or years) you won’t catch anything, but when you do it will make for a nice, tasty lunch.
The point is all the return premiums – value, momentum, small cap – have good and bad years, or even decades.
Tilting towards these factors already means flirting with active management.
Ditching a premium that’s going through a cold spell for a hot one that is probably due to turn cold too amounts to French kissing one of the worst traits of active investors. You can expect your returns to dip accordingly.
Yet sadly, research suggests that actively courting disappointment seems to be exactly how many are using the Smart Beta funds designed to capture the return premiums.
Not so Smart, buddy
Take the study conducted by Empirical Research Partners and quoted by the fund managers behind The Value Perspective blog:
What Empirical has done is to look at two relationships – first, between past performance and where investors put their money and, second, between where investors put their money and subsequent performance.
As you can see from the chart below, for eight out of the 11 categories of smart beta strategies analysed, there is a very strong positive correlation between past performance and future fund flows, with those directing money towards yield-type exchange traded funds (ETFs) apparently the most prone to invest with at least one eye on the rear-view mirror.
Uh oh! According to this research, investors in these funds aren’t reaching sober conclusions about the best way to add a little extra juice to their portfolios over the long-term.
They are just buying what’s gone up lately.
This wouldn’t matter if chasing hot funds produced higher returns.
But as the article goes on to show, that doesn’t happen at all – most amusingly in the case of mean reverting momentum funds!
As Kevin Murphy, the blog’s author says:
‘But guns don’t kill people, people do’ is a line less likely to settle an argument than provoke further discussion and yet it is not impossible to imagine an advocate of so-called ‘smart beta’ investments – strategies that try to build on simple index-tracking products by focusing in on a specific factor, such as growth, momentum or value – using a similar refrain.
“But smart beta products don’t make bad investment decisions, investors do,” they might tell a doubter.
To which we would reply – as we would to anyone trying the gun line – “OK, but they do make the job a lot easier.”
While it’s no surprise that these professionals argue you’re better off using actively managed strategies if you want to pursue a value strategy (well, they would say that, wouldn’t they?), I think their warning is well put.
Remember that all the academic research that backs up return premium investing talks about achieving incremental returns over time.
It says nothing about hot hands trading ETFs like George Soros on a stag do in Vegas.
The return premiums are whispering flighty things, with their real world performance already potentially set to disappoint those seduced by the academic findings.
Indeed some, such as Monevator contributor Lars Kroijer, think there’s no case for investing in them at all.
But if you’re a passive investor set on swallowing their lure, I’d strongly suggest The Accumulator’s lazy long-term fishing approach is the way to go.
From the blogs
Making good use of the things that we find…
- FOMO and the art of not caring – Abnormal Returns
- Socially responsible investing [US but relevant] – Can I Retire Yet?
- Quick review of the Vanguard All-World High Yield ETF – DIY Investor
- China to be bigger share of indexes [Canadian but relevant] – CCP
- 12 lessons from Todd Wenning about investing – Total Return Investor
- Lessons from Phil Fisher – Investing Caffeine
- Investing in stability – Richard Beddard
- When risk and return really matters – A Wealth of Common Sense
- Maximize living, not total return – Simple Living in Suffolk
- Ridiculous spending in the UK – The Escape Artist
- Valuing the UK housing market – UK Value Investor
- How to sell a house – Mr Money Mustache
- Why the well educated should save more – Oblivious Investor
- How one woman left the rat race – The FIREstarter
Product of the week: I was reminded about Abundance by an article in this morning’s Guardian on green investing options. Abundance brings local renewable energy projects to the notice of investors who buy debentures paying around 7-9% a year. It acts as matchmaker and middleman, and also takes care of the post-investment administration. I like the idea and motive, but the disparate nature of the projects increases the already notable risks. Can the average investor (i.e. you and me) really calibrate the differences between a ‘variable return debenture’ backed by a wind turbine in Gloucestershire and an ‘income growth debenture’ that’s backed by a solar project in the North East?
Mainstream media money
Some links are Google search results – in PC/desktop view these enable you to click through to read the piece without being a paid subscriber of that site.1
- Charles Ellis defends active management (…) – CFA Institute
- Spin the bottle [Search result] – The Economist
- Bond proxies: Can you afford not to own them? [Search result] – FT
- Luck: A fund manager’s dirty little secret – MarketWatch
- Jim Rogers sounds irritated that we still haven’t crashed – MarketWatch
- Howard Marks: The ‘uncomfortably idiosyncratic’ billionaire – Observer
Other stuff worth reading
- Mini-bond debacle raises questions [Search result] – FT
- Inside The Queen’s Crown Estate money machine – ThisIsMoney
- How auto-enrollment is helping the pension picture – ThisIsMoney
- Where do pensioners get their cash? [Infographic] – The Guardian
- Investing lessons from Thaler’s Misbehaving – Advisor Perspectives
- Can reading make you happier? – New Yorker
- The exhausting super rich circuit – New Yorker
Book of the week: Richard Beddard wrote a belated review of Money, Blood and Revolution this week, so here’s a belated pointer to what sounds like a decent thesis. Author George Cooper likens the economic system to the body’s circulatory system, and blames the slow recovery and rising inequality on money clogging up in the wrong parts – principally with the rich and their assets and bank balances – while failing to reach the poor and young.
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- Note some FT articles can only be accessed through the search results if you’re using PC/desktop view (from mobile/tablet view they bring up the firewall/subscription page). To circumvent, switch your mobile browser to use the desktop view. On Chrome for Android: press the menu button followed by “Request Desktop Site”. [↩]