I didn’t pay this much attention but now even finance textbooks and some of my former professors are saying this. My question is keeping in view all that, should one embark on the CFA journey if they are really into public investing? See the screenshot, it’s from one of the books on valuation.
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I too, have heard deep revelations, like how the earth is flat
I think it’s really hard to outperform consistently outside of small caps. Apparently some funds can do this – Einhorn has done it. But he hasn’t beaten the market latel and that’s with a world class infrastructure. I think the market is as efficient as it has ever been due to the rise of technology over the last 15 years and then the subsequent rise of quant shops.
I think, in general, if you want to distill this down to a sound byte I would say this:
There are 7,700 US listed companies (primary listings only, this excludes secondary listing foreign stocks)
About ~4,500 are above $20mm of cap (really hard to buy below that level and many of these are just shells or companies about to go bk).
Only about 1,700 of these are above $1B of cap – this is “institutional Wall Street”
That leaves 2,800 below $1B of cap, of which about 2,200 are below $500mm
This last category is what I call the Abyss – most institutions can’t invest below this level, but there are 2,200 stocks available here.
Most of these stocks are invisible. They don’t have analyst coverage (or have sparse coverage) and they don’t regularly attend conferences. The only way they get traded up or down is based on results that show up on screens.
The game is front running the traditional screens. If you could, for example, find a way to reliably identify earnings beats and misses or guidance revisions, then you could place the trade before these factors become “known” – however, quant funds are also trying to do this. We took a hybrid approach, identifying both qualitative and quantitative factors. The qualitative stuff is really interesting and hard to screen for, that’s the challenge and the opportunity.
There are only a handful of things a stock can do: The results can get better, they can get worse, the company can get bought, or it can go bankrupt. That’s about it. After a while you begin to quickly dismiss possibilities or at least likelihoods. You can look quickly and say, “XYZ is this type of stock, and these are the relevant questions, can I get an edge there if I try? No? Next.” If you look at a few hundred a year from a carefully filtered list, you will find mispricings below $500mm, that is a guarantee. Of course it takes several years of good experience before you can even really step up to the plate, but it can be done.
Small cap managers and their ability to consistently outperform indexes or passive strategies is a myth that has been debunked.
Do you have a source for this?
Active managers and their underperformance versus indexes is not a new concept. It has been happening for decades. During this long period of time, interest in the CFA program has grown substantially.
Its not a new concept, but its a very misunderstood one. People look at the average of active managers and, for reasons that can't be good reasons, assume that that's an indictment of active investing. As long as some of them can consistently beat the market, its a valid way to invest. No different than any other field really; most pursuits have outsized returns to a small few who excel.
Market efficiency hypothesis is bullshit. Good active managers will always have a place in public markets and anyone who says otherwise is a tool. The reason the majority of active managers unperformed is because there's so much competition and many are basically replicating the index they're benchmarking against with a few changes they think are "differentiated". There are still outliers who crush it by comparison and will likely continue to do so until their edge gets eaten away by more competition from equally talented managers. The whole point of a good hedge fund for example is to create returns that are HEDGED against the market and provide consistent compounding or uncorrelated returns compared to the market. If you throw all your money in an index, when that index tanks your fucked. Period. No UHNW or institutional asset manager worth their salt wants that to happen on their watch, hence seeking out the best active managers to get those uncorrelated returns.
Where this goes as far as the value of a CFA. Eh, I have friends at AMs who have it and friends at top hedge funds who don't. It's a good signalling tool if you don't come from a finance background, and for some firms it's a requirement. But at the end of the day it's just a tool and therefore its utility is defined by whatever your trying to achieve.
EMH is not bullshit.
Secondly, I’m talking about traditional asset managers, not hedge funds.
Yes and no.
If someone is selling you a trading program for $49.95, don't buy it. There is no free lunch.
But some people can beat the market.
If you have the ability to invest with Sequoia at 2 + 20%, do it. But they are probably closed to new capital.
If you have the ability to invest with a consistent 2 Sharpe fund at 2 + 20, do it. But they are probably closed to new capital.
The market isn't necessarily efficient, but the guys with edge usually have more capital than capacity.
A guy with the integrity to say "We've run out of capacity, I'm kicking out some of your money because further investment is going to hurt our performance"... that's a fund you want to invest in for the long run.
If you have edge, the best place to invest is your own strategies. Stick your eggs in one basket (with some cash and ETFs on the side to be sure) and watch that basket... carefully. But, at some point you are going to run out of your own capacity to write code. So you hire people to work on stuff. And at some point, you run out of ideas. So you hire people for that too.
Usually, the more smart people you get in a room, and the better the platform, the better the overall performance. And it becomes a virtuous cycle. More outperformance attracts more people and more capital.
So what it really boils down to... is culture. Especially the people at the top. Are they good people to work for? Can you trust them? Are they nice people to work with? Is it a hire and fire culture, or does the firm hire carefully, and allocate risk carefully? How do you mitigate the conflicts of interest?
At most funds, the vast majority of the management fee goes to the PMs and the owner. But it's actually the rank-and-file alpha devs who generate a lot of the PNL. And a lot of the large multistrat funds underpay those guys.
So, there are a lot of pieces that need to line up, but the rank and file guys actually drive a lot of the value at a fund. If you can build a 2 Sharpe signal, if you have a typical quant's humility (or at least you're more arrogant for others or your ideas than you are for yourself), and there's a good cultural fit which is critical, we should talk. The only other question is the execution platform. You're not going to beat the market by executing through a sellside broker-- you need something better. The big successful firms have their own infra for execution. The good news is that there is a LOT of high quality execution infra out there, and the multistrat funds don't have a monopoly on that.
A lack of correlation to the market certainly reduces risk but does nothing for returns other than to reduce them, as evidenced by results of market neutral funds. Their results are terrible on a relative basis and they charge well above average fees.
There is no evidence to support your implication that active managers will save you during down markets. Your crystal ball is just as fuzzy as the next guys. Of course, there are specific managers who beat the market and save you in down markets. However the challenge is identifying them before they achieve the great results.
EMH is not bullshit. There are three forms of EMH...Perhaps you have an issue with the strong form of EMH, which implies that you would wasting your time with fundamental and technical analysis (as well as inside info).
Again, are those the largest multistrat funds, or are those the funds that you can get your money into?
You are consistently asking others for evidence on this thread while not providing any evidence of your own.
"A lack of correlation to the market certainly reduces risk but does nothing for returns other than to reduce them, as evidenced by results of market neutral funds. Their results are terrible on a relative basis and they charge well above average fees."
This paragraph only makes sense if you can back it up. First you're claiming reduced market correlation hurts returns. That certainly doesn't make obvious sense on its face so support is needed. Then you're claiming market neutral funds have terrible results. That's definitely been the case lately while the S&P has been ripping, but how did they do in the financial crisis? And more importantly, how are the best ones doing? If someone is under-earning the S&P by 2% in the boom of the last few years (so still quite positive returns) but would also protect you in a downturn, that sounds like a pretty good fund.
You make a good point and indicate why a lot of active funds underperform. Fees plus heavy benchmarking. If your fund is 80-90% replicating an index and only 10% or so of true discretionary then the fees are going to be well above any alpha.
To see if guys can outperform you’d need to be looking at funds that only hold 10-20 positions.
That point may or may not be valid but the likely outcome of a very concentrated portfolio would be greater volatility, which would result in lower risk adjusted returns. I would be interested in seeing data on how concentrated funds compare to the indexes over time.
Am I crazy? I didn't think hedge funds consistently used hedging strategies, or not in decades. I thought the name "hedge fund" was basically an archaic term from their founding. Aren't modern hedge funds more than happy to invest in literally anything that would achieve high returns?
As someone who is in the Asset Management Industry in an advisory capacity, who primarily uses index funds for retail clients... I don't believe the CFA value is going away anytime soon. - Will it make you more educated as a personal investor and that for your clients? - I argue Yes. - Will it provide you with confidence in your profession and work? - I argue yes - Will it give you more credibility over the next guy/gal who doesn't have it? - I argue yes - Can it be used outside of the investment arena? - Yes.
Acting management will never go away. When too many people index, there will be price inefficiencies and excess returns to be exploited, which will lead to an increase in active managers. When there are too many active managers, prices will become more efficient and returns will decrease, leading towards a shift in indexing. It's a pendulum that will swing back and forth based on investors trying to act in their rational self-interest.
Active > Passive yeah i'm a deep value guy
Username checks out.
Even if we remove HFs, passive mgmt just piggy backs on active. This isn't a bad thing, necessarily. For the average joe putting in 401k money it should always go to a ETF. However, for large scale endowments/pensions, etc. active mgmt makes more sense, at least for part of the allocation. Also, if active mgmt were to go away, who would be sending the price signals for the etfs to follow. Another point is, the explosion of passive has also coincided with a massive bull run. Lets see what happens in a down market and through cycle.
A final point would be equity vs credit. You can't really do passive HY effectively vs an active manger.
It entirely depends on what type of investing you are doing. Active trading for generation of revenue to be used tomorrow I agree that fundamental analysis will go away. However for long term investing fundamental analysis will still be critical. Just because much of the analysis will be done with systems, be it software with human interaction or AI, the fundamental analysis will still be done.
Passive outperforms the AVERAGE of active funds. That should suprise nobody. Because if you take all the active traders,you basically get the market. So obviously, their combined trading activity should match the market, before fees. Then you take the fees out and voila, they underperform the index. Basic stuff.
But that's just the average. If you're an above average manager, you can outperform. In fact, any above-average manager should outperform GROSS of fees. Once you factor in the fees, you now need to outperform by more of a margin.
And thus, most managers underperform. That doesn't mean there's anything wrong at all with active management. All it means is that it's a tough game where only the best survive because they're able to beat the high hurdle rate of market + fees.
This is basic common sense. Anyone who would look at that easy-to-understand reality and conclude "active management doesn't make sense" is just not getting it. Its no different than saying trying to make it to the NBA or make it to Hollywood doesn't make sense. For the few who can do it well, it makes a ton of sense.
It makes a ton of sense for who? Going based on your analogy, you're saying active management makes sense for the fund manager? Umm, yeah...
The question is, does active management make sense for the investor?
We keep talking about the exceptions of the fund managers who beat the market. Do they? Remember that beating the market = returns superior to the market with a risk profile the same as or less risky than the market. I highly doubt there are many active fund managers who consistently beat the market with the same risk profile.
Risk profile has a lot of problems with it. What's your measure of risk? Volatility doesn't quite work as you probably know.
Furthermore, the risk-based argument has generally worked more in favor of active managers. When hedge funds were routinely criticized in the headlines of 2015-18 for getting crushed by the S&P, their retort was "but we took less risk." I'm not sure where I fall on that debate, it's case specific . . I probably more often side with the active manager but it depends. But introducing risk into the discussion generally works in their favor.
“Efficient market theory is a wonderful economic doctrine that had a long vogue in spite of the experience of Berkshire Hathaway. In fact one of the economists who won — he shared a Nobel Prize — and as he looked at Berkshire Hathaway year after year, which people would throw in his face as saying maybe the market isn’t quite as efficient as you think, he said, “Well, it’s a two-sigma event.” And then he said we were a three-sigma event. And then he said we were a four-sigma event. And he finally got up to six sigmas — better to add a sigma than change a theory, just because the evidence comes in differently. laughter And, of course, when this share of a Nobel Prize went into money management himself, he sank like a stone.” - Charlie Munger
I never understood the EMH opponents' use of Berkshire Hathaway as proof in their favor. It's comparing apples and oranges. Buying up controlling interests in companies and making managerial decisions isn't the same thing as traditional portfolio management. When you purchase a share of Apple stock, you have zero control of the course of that business. You can't arrange debt for them. You can't replace management. You can't direct the course of the business in any way.
I think the Berkshire argument is based on their performance in their non-controlling positions being a lot better than market performance.
Guys, this thread was about CFA. Would it be wise to not take it right away, wait 3-4 years and see where your interest lie or take it now and limit yourself to this narrow CFA relevant area that is in decline?
I've long felt the CFA is pretty irrelevant to most things. But I took level 1 on a hedging theory similar to what you're suggesting . . I wanted to knock it out because its a breeze and then you're only 2 levels away if you should discover later that its an advantage for your particular career track. The bang-for-buck is good on level 1 because its easy. Then you can sit on that (currently I don't think there's any expiration) and decide later on the rest of the program.
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