Wednesday, February 25, 2015

John Bogle on Investor Returns

Some things of note from a recent Vanguard study that's cited here by John Bogle:

- 90% of investors in traditional index funds are long-term holders, while only 80% of investors in ETFs are long-term holders.
- Investor returns in traditional index funds lag the returns of the funds by 150 basis points.
- Investor returns in ETFs lag the returns of the funds by 250 basis points.

Active Managers Losing Ground Can Thank John Bogle

So, in both cases, investor results are subpar compared to the funds and those who are less long-term oriented end up lagging by a greater amount. It's investor behavior that's mostly behind the reduced returns. The ongoing attempts to be in or out at the right time based upon market conditions ends up, too often, just subtracting from results. In other words, some variation of buying when the world seems less uncertain (when stocks are more likely to not be cheap or even expensive) and selling when the world seems more uncertain (when stocks are usually most attractive in terms of risk and reward). That's a tough way to get satisfactory results when this pattern of behavior is repeated over a longer time horizon. Lots of additional effort; less than satisfactory returns. A more consistent approach along with ignoring most of the noise would have yielded better results. Essentially, it's Newton's Fourth Law. The world inevitably swings from what appear to be favorable investing environments to those that appear much less so.

Market participants respond to these changing environments to an extent in a calculated way (efficient market adherents certainly tend to think so), but also to a significant extent based upon psychological and other factors.*

Cognitive biases and emotions can dictate price action in the shorter run.

Being among the not so large group that, over the long haul, can produce results that exceed a broad-based market index is easier said. It seems improbable that recognition of this reality will change behavior all that much. Instead, plenty of active market participants will continue trying to be in or out of a particular fund (or stock) at or near just the right time -- in an attempt to outperform -- despite the near futility of acting in such a way.**

Reduced activity can be a big advantage with a sensible portfolio -- built with specific limits and circumstances in mind -- that's purchased steadily over time.

Fear and greed -- or, more generally, the fact that participants can be less than than cold and rational especially in large groups -- isn't going to stop having a big influence on investor behavior anytime soon.

Assets get mispriced -- anywhere from big premiums to big discounts -- but this only becomes obvious to the vast majority of participants after the fact.

It's not that no one can time things correctly. No doubt there are exceptions who can do just that sort of thing. It's that, apparently, too many are overconfident that they'll be able to do so.
(At least based on the fact that most actively managed equity funds can't match the performance of an index fund.)

Bogle describes some of the more specialized ETFs -- those that are niche products and sometimes use leverage -- as the "fruit and nutcake fringe" and says that they are "poision for investors."

He also mentions the following:

- The SPDR turns over 7,000% each year. For perspective, he considers 3% to be stretching the limits of what makes sense.

- When it comes to the experts who think they can advise someone to be in a particular sector at the right time:

"Advisers or whoever saying you should get out of healthcare and into technology or into financials. That's a way to manage money that doesn't work. Who knows what will do best? I don't even know anybody who knows anybody who does." - John Bogle

What matters naturally is what the companies themselves produce in terms of excess cash per share -- the main driver of intrinsic value -- over time. It's the compounded effect of increased earnings that are at least mostly put to reasonably good use (incl. dividends and buybacks).

Multiples will expand and contract, but a good investment result shouldn't depend on a getting a great price when it comes time to sell.***

Of course, those who get a chance to buy something unusually cheap, hang in there for a very long time, can gain a big advantage if they're able to sell years down the road at a more normalized (or better yet, premium) market valuation.

Consider that possibility a bonus. That's more good fortune than most should count on.

In the end the whole process requires discipline -- incl. an awareness of limitations and acting accordingly within those limitations -- more so than brilliance.

Adam

Related posts:
Buffett's Hedge Fund Bet
John Bogle's "Relentless Rules of Humble Arithmetic", Part II
Index Fund Investing Revisited
Charlie Munger on Complexity, Hedge Funds, and Pension Funds
Why Do So Many Investors Underperform?
When Mutual Funds Outperform Their Investors
John Bogle's "Relentless Rules of Humble Arithmetic"
Investor Overconfidence Revisited
Newton's Fourth Law
Investor Overconfidence
Chasing "Rearview-Mirror Performance"
Index Fund Investing
Investors Are Often Their Own Worst Enemies, Part II
Investors Are Often Their Own Worst Enemies
The Illusion of Skill
Buffett's Bet Against Hedge Funds, Part II
Buffett's Bet Against Hedge Funds
The Illusion of Control
Charlie Munger on LTCM & Overconfidence
"Nothing But Costs"
When Genius Failed...Again

* Some efficient market true believers might argue otherwise. Another factor to consider when it comes to what sets near-term prices isn't business fundamentals or psychology but the possibility that a build up of excess leverage in the system (margin) leads to forced selling when the next surprise arrives. Intrinsic values may be mostly unaffected but near-term price action certainly will be.
** Attempts at timing the market or a particular stock has usually been a recipe for poor results caused by unnecessary and costly mistakes. Now, this is very different than buying or selling based upon how price compares to intrinsic value with the emphasis being on margin of safety and long-term effects. For those comfortable valuing stocks (i.e. partial ownership of a business) this can make a whole lot of sense. Otherwise, for those not comfortable valuing stocks, that's where index funds bought periodically come into play. For participants overall the returns can be no more than market returns minus frictional costs. Of course, it's certainly possible that the most active participants will perform better in the future than the past suggests, but some skepticism seems warranted.
*** Whether a basket of stocks via a fund or an individual stock, the changes to per share intrinsic value over the longer haul compared to the price paid upfront should represent a good result even market prices aren't generally selling at a high multiple of then current normalized earnings.
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