
Even God Would Get Fired as an Active Investor (2016) - elemeno
https://alphaarchitect.com/2016/02/02/even-god-would-get-fired-as-an-active-investor/
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phkahler
This is silly. The author points out the problem of making short-term
evaluations of a long-term strategy and yet he never actually says that. Also,
his hypothetical omniscient "god" can see 10 years into the future but doesn't
allow himself to rebalance the portfolio more often than 5 year intervals. I'm
not sure what point he's trying to make or why.

~~~
strebler
I think he's just pointing out how hard it is to be a good active investor,
basically exactly what Warren Buffet thinks (and won that bet over).

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jasode
_> how hard it is to be a good active investor, basically exactly what Warren
Buffet thinks _

In broad brush strokes, yes. However this blog post uses a different math
scenario.

\- Warren Buffett's premise for winning the bet was the hedge funds' 2%
"management fee" and 20% carry. Therefore, any attempt to beat Warren's
passive investing starts with a _handicap_ of minus-2% and has to have bigger
positive returns that overcome it.

\- This essay is about long-term "God clairvoyance" of _eventually_ being
correct is negated by short-term negative returns which make people "fire"
God. E.g. the investor might have a 2-year lockup of his funds before he can
redeem them. E.g. After 2 years, the investor sees that the hedge fund is
losing money -- but doesn't realize that it's a _temporary_ dip. Therefore, he
redeems his money (aka "fires God") and never got see that God was ultimately
correct.

(Or put another way, if the lockup period and the fund's entire lifetime were
exactly the same, the blog post couldn't be written.)

~~~
kevinmchugh
I've seen (and implemented in code) some pretty brutal liquidity algorithms.
I've no doubt God could use such algorithms to always ensure positive
performance on those dates on which liquidation is possible.

Funds might be locked up for two years, and afterwards only redeemable on the
first day of the fiscal quarter. On the first liquidation event, only 25% of
the funds are redeemable. If you submit notice on the first day of the next
fiscal quarter, 33% is redeemable, followed by 50% and 100%. If you miss a
quarter, the sequence starts over.

That one is not even terribly complex.

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Nokinside
This is the basic risk vs. return tradoff in investing lesson. Risk in stock
market can be reduced with diversification and longer time-span.

Don't listen active investors unless they have most of their own money in the
scheme and manage your money on the side (like Warren Buffet does). Figuring
out winning market strategy and selling it as a service to others and living
off management fees indicates that the winning strategy involves separating
fools from their money.

~~~
eru
And thanks to competition between capital suppliers (ie you) the successful
active managers will raise their fees until they eat all the excess return.

The only escape from the efficient market is investing in markets that are
such small pockets and difficult to reach that professionals ignore them. But
that's almost impossible to square with diversification.

~~~
dsacco
_> And thanks to competition between capital suppliers (ie you) the successful
active managers will raise their fees until they eat all the excess return._

What actually tends to happen in practice is the really successful active
managers cease accepting money, because they can effectively print it. All
strategies have capacity constraints and managing investors is not so fun. If
you can generate positive returns without needing to pool risk, you don't need
investors anymore.

~~~
eru
Yes. Same effect in practice: you can't give your money to people who produce
above market returns after fees.

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cujic9
Probably not a surprise, but this also applies to value investing.

If you construct a perfect portfolio using god-like knowledge of a company's
performance as measured by _future free cashflow_ then you will also have
drawdowns and down years.

Makes you think about how the market has mutated from its original purpose
over time.

~~~
eru
And obviously you would have those years: unconstrained optimization for
future free cashflow differs in general from any kind of optimization that
introduce the constraint that you can't have down years.

(There are only a few instances where optimizing for two different things, eg
maximum flow in a network and looking for the minimum cut, produces the same
answer. And those cases are mathematically significant.)

~~~
cujic9
I'm making the point that these two optimizations _should_ be fairly similar,
but they are not.

~~~
eru
Perhaps similar, but not exactly the same. So with a bit of datamining, you
should see arbitrary differences.

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kelnos
The thing I don't get here is, if I'm God, then aren't I going to sell off
right before the drawdowns and then buy back in at the local minimum?

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bluGill
Can you?

I can sell every stock I have tomorrow and nobody will notice I'm small
potatoes that nobody on wall street cares about. When you have a significant
amount of money it isn't that easy.

It is just easy for me to get 40% returns every year, just put everything into
the one stock that will be up the most tomorrow morning. In just a couple
years of God like foresight though I can't do that: I will be worth so much
that my very act of buying/selling stock will change the price. Every time I
start a trade stock for that company will stop trading while wall street tries
to find buyers/sellers for my stock. The stock might be selling at $10/share,
but when I actually buy the price is $20/share.

For a few years I can counter that by splitting my orders between several
stocks, but each time I have to do that my returns go down just a little.
Eventually even that runs out: after 60 years of 40% growth I would be worth
more than all stocks in the world combined.

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ChuckMcM
This is the money quote (no pun intended): _" These results highlight the
fickle nature of assessing relative performance over short horizons."_

How many times have you told a fund manager, "Gee your fund lost 10% last year
when the S&P500 was up 8%, how did you manage that?"[1] Only to move all your
money into some other fund and have it get worse returns than the one you
moved your funds out of? The point the article tries to illustrate is that
evaluating a fund's strategy should be separate from evaluating a fund's
returns. And if its strategy is sound, then even if it under performs other
metrics over a shorter term, it out performs over a longer term.

And yet there aren't really any investors who are willing to 'take it on
faith' and stick around for 10 years to see if their strategy is sound.

[1] Ok probably not a lot but I did get to ask one this question. They did not
respond effectively.

~~~
wbl
Since you are comparing to the S&P 500 anyway, why pay the extra fees?

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IshKebab
TL;DR: If you look at the best stocks, measured by 5-year performance, they
sometimes go way down within those 5 years (mainly because of recessions). Not
very surprising.

~~~
rce
But if you also short the worst performing stocks, you still have massive
drawdowns. That is somewhat more surprising. I would like to see an
explanation for that.

Is it because the top decile stocks are higher beta than the bottom decile
stocks?

Is it because of the selection of rebalancing periods? I.e. if the big crashes
happen towards the end of a five year period then perhaps the bottom decile
stocks have already dropped significantly and have nowhere to go while the top
decile stocks have risen significantly and have plenty of room to fall.

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quantgenius
This is actually a well-known issue though probably never presented to a non-
trader audience like this before. As you raise your holding period, max
attainable returns and max attainable risk-adjusted returns decline very
sharply. This is why good quantitative hedge funds insist on short-term
forecasts and active strategies that trade frequently though not necessarily
HFT.

There are a number of other issues here. Even obvious things that a junior
analyst on a good desk would do in about 2 minutes haven't been done in order
to make God's returns look worse. For example, (I haven't tested this myself)
I suspect God would do MUCH better if God rebalanced 1/1260th of his portfolio
every day based on the 5-year forecast that day. (1260 trading days in 5
years), and God would likely have lower transaction costs as well.

There are also many issues with how they are constructing these God
portfolios. Portfolio construction and risk management frequently have a
bigger impact on investor returns than the quality of the forecasts.

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pbreit
Has anyone ever quantified the "self-fulfilling" component of index fund
returns? ie all the money automatically going into them and that everyone
knows that?

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lifeisstillgood
So if I get it, the God foresight would enable you to own the planet, at a
CAGR of 49% but the regular losses would scare the living crap out of you.

Aan interesting exercise in learning various financial libraries this seems -
and I would love to see what the end of year amounts would be for 100 dollars
invested in 1927.

I guess it’s just human nature - “yes God, you may have been right about every
5 year period for the past century, but this time it’s dofferent”

The Anti-VC statement

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lifeisstillgood
It is also interestingly about loss aversion - a truly rational person would
always take the cagr of 49% and damn the losses

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ikeboy
On these constraints, what if you bought a basket of stocks with the highest 5
year performance, conditional on never losing more than 5%? How much of your
return would be given up by needing to avoid those "risks"?

If you're going to evaluate god on something, seems only fair to allow them to
optimize for it.

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slaunchwise
If I were God, I'd buy on those dips that might get me fired. Then I'd really
feel like -- God.

~~~
incompatible
Why would a God like that need money anyway, or care about getting fired?

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unknown_apostle
This is related to why I firmly believe any amateur outside of Wall Street can
beat the crap out of this deplorable industry:

\- by focusing on great value, the proverbial dollar for 50 cents. This is
kind of hard work, you have to put in the time, which means you have to be
genuinely interested in "business" or you won't keep it up.

\- by not doing anything _unless_ you find a dollar for 50 cents. Wall Street
has to play all the time, you don't.

\- by holding a sufficiently long time. Of course you can't wait indefinitely;
sometimes just taking a loss e.g. if you find something else which is great
value.

\- by stomaching volatility

\- by _embracing_ volatility and, when you can, making sweet love to it

\- by keeping it simple. Your only "hedge" can be just trying to pay 50 cents
for a dollar. Having some crude heuristics for timing and taking profits.

\- by assuming every management team and big shareholder is constantly trying
to screw you over. Tolerating no bullshit. Trying to avoid being around
morally handicapped people (this applies to any part of life imho).

\- most relevant to the original article: by not tolerating anybody else's
opinion (which implies investing your own money and only your own money,
meaning you can. not. get. fired. Ever. And if you screw up, you'll learn.)

\- by avoiding tip givers and tip takers. Group think is a killer. But of
course, enjoying talking about general conditions. (My honest, very personal
take on current group think: "you can't go wrong with low cost index
investing". Which is not a bad idea in itself, until everyone starts doing it
and they flood the market with indices and dubiously structured trackers.)

\- once again, by not feeling you have to be part of everything which goes up.

\- by having a lack of stress (you will doubt a lot, get screwed by management
and big shareholders and have plenty of losers and lumpy payoffs)

\- by doing this for a very long time (as in: the 80s were _much_ easier than
the 201xs, maybe just because fewer people were watching. And back then they
were sometimes hiding profits instead of faking them. Today is the hardest
time ever, if I find something superficially good, probably something is wrong
with it. Personally I have very little self confidence today.)

\- being small, which means you can look in places the big guys who have to
move around billions can't look

\- staying on the "easy side" of the basic math of loss vs profit. I
personally would never short or sell optionality or stuff like that. Willing
to take a gentle thrashing but never ruin.

And necessarily:

\- by avoiding the show stoppers (start playing bridge, take a journey around
the world, get divorced, disease, death)

Everything else is bullshit. Or at least part of more complex or shorter term
or "trading" strategies with which amateurs can of course never do great.
Volatility is not risk. Concentration is not necessarily risky.

Edit: poured out some random thoughts and tried to clean it up later. Sorry
for the mess.

~~~
hacking_again
Why bridge?

Any good resources you recommend? How many hours per week do you think it
takes? I was thinking about playing one of those play money games for a year
or so.

~~~
unknown_apostle
Bridge: just a joke

Maybe the Burry list, in order:

1\. The intelligent investor, Graham & Dodd

2\. Common stocks and uncommon profits, Fisher

3\. Why stocks go up and down, Pike

4\. Buffettology, Buffett and Clark

but of course a lot of it is trends in accounting and legal issues. Which may
be hard to learn on your own.

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dandare
Speaking of which, how is that long-turn bet against China going?

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ianwalter
He died for your alpha!

