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Buffett wins $1M decade-old bet that the S&P500 would outperform hedgefunds (aei.org)
786 points by yurisagalov on Sept 17, 2017 | hide | past | web | favorite | 312 comments

And I'm just going to self-promote a bit and say that the bet was registered via a project I worked on, the Long Now Foundation's project Long Bets:


We've been going since 2002: https://www.wired.com/2002/05/longbets/

We are happy to host bets of long-term significance, and the minimum bet is only $200/side. I am glad to personally help shepherd people who are serious about bets to make sure you get through the process.

I would especially like to see HNers making bets about the things we argue a lot about. Bitcoin! VR! Uber! If you're tired of people posting waffle on some topic where you have a strong opinion, then challenge them to put money down.

Long Bets is a good site to make a public statement but PredictionBook[1] or Metaculus[2] may be better to track predictions about things we argue about. Both sites calculate your Brier score, which is how you can know how well calibrated you are.[3]

Since prediction tracking and aggregation sites use reputation instead of money, they scale to a higher number of predictions. As proof, there have been only 747 predictions and bets on Long Bets, while gwern alone has made[4] 2275 on PredictionBook. Furthermore, the Metaculus community prediction provides valuable forecast information,[5] much like prediction markets, while predictions on Long Bets don't count as Bayesian evidence of their own.

[1]: https://predictionbook.com/

[2]: https://www.metaculus.com/

[3]: https://en.wikipedia.org/wiki/Brier_score

[4]: https://www.gwern.net/Prediction-markets

[5]: https://www.metaculus.com/questions/track-record/

Sure. These things have different purposes.

The Long Now's mission is to foster long-term thinking broadly. We don't care as much how well-calibrated a particular individual is. The point of Long Bets is to generate discussion, argumentation, and consideration. That's part of why we require each bettor to make a case for their side: we're less interested in who was right or wrong than how and why someone was right or wrong.

I hope that people also use those sites. But I would love to generate some clear, dramatic bets about controversial topics here. The Buffett bet is a great example. People every day are putting money into one investment or another and have been for a long time, and there's no lack of data on results. But because of this bet a great number of people have thought about these specifics, as well as the many interesting related issues. I'd love to see that around more topics.

On https://longbets.org/register/, it says that "Long Bets registration is temporarily disabled. Please check back soon."

Why is registration temporarily disabled? Can I get an email notification when it's back up?

Good question! Somebody took over running the technical side of that some years back, so I haven't followed it closely. I'll ask.

But if anybody has a bet they'd like to get registered, just email me and/or them.

What email should they use?

From the website linked in his profile:

Contacting me

The best way to contact me is via email; try my first name at this domain.

You can also write to longbets@longnow.org - but we will have the registration open again shortly (within weeks).

Dan @ Long Now

If longbets.org was really serious about long-term bets, it wouldn't be restricting years to only 5 digits. Haven't they heard of the Y100K problem?

If they had only used 4 digits, then in eight thousand years or so, longbets.org would have felt really stupid about having to hire a historical programming re-enactor to show us how our ancestors used to adjust the width of a database column.

But luckily they used 5 digits. 5 digits should be enough for anyone.

The 5-digit display year is definitely in keeping with our mission, which is to get people to think longer term. But under the hood, I represented all dates as 64-bit longs of ms since epoch. So I believe the farthest date the current code can represent is 17 Aug 292,278,994 AD. By that point the earth's day will be an hour longer [1], so whatever sucker has inherited this project will have bigger problems than just the size of the field.

[1] https://en.wikipedia.org/wiki/Timeline_of_the_far_future

What is the Y100K problem. More importantly, who would they pay out at that point when both parties are dead

I'm pretty sure that's a joking reference to the Y2K problem: https://en.wikipedia.org/wiki/Year_2000_problem

Payout are to the bettor's selected charity. Or, if that's gone, the closest one we can find.

What if you want to bet they find a cure for death?

We would totally accept that bet. The closest bet we have right now is bet 11: “At least one human alive in the year 2000 will still be alive in 2150.”


The tricky part is coming up with a clear agreement about what "cure" and "death" mean here. But there's a lot of good discussion around e.g., the extropians, so I think a solid bet could be created.

Does "Brain in a Jar" count? How about a Ghost in the Shell? More likely this is a bet on if Cyrogenics finally works out.

You mean for that bet? Good question, and not one I'm likely to have to answer. But from the arguments, the spirit seems to be about traditional meat-brain-in-meat-body life.

Or do you mean for your own? This is between you and the person you bet with. If you have a firm opinion, definitely find somebody on the opposite side and see if you can put together a bet.

this utterly rules. like, i want to fly to your current location to give you a fist bump. in my utopian dream world, every political pundit has to put their thoughts on here.

Next you're in SF, definitely look me up. A couple years back the Long Now opened a cafe and bar, so we even have a good place to meet for the fist bump:


Even if they get funded by special interest groups to spew the group's narrative, at least this will be a quantization of how correct or incorrect the pundits are.

this would separate the wheat from the chaff with regards to special interest groups.

Crazy question: how can/does longbets interact with people's estates? Meaning -- what happens when one of the bettors is dead when the bet is settled?

No, it's a great question.

We take the money up front and deposit it in a long-term investment account. Each bettor picks a charity, and the initial bet plus half the gains go to the winner's selected charity. (The charity thing is to get around US gambling laws.) If if that charity doesn't exist anymore (which is plausible given our longest current bet settles in 2150) then we pick a charity that's close in spirit.

> We take the money up front and deposit it in a long-term investment account

A minimal-fee S&P 500 index fund, I hope. I think Buffett just proved that anything else would be fiscally irresponsible.

That's a very cool project! Congratulations on keeping it going for so long!

Cool. Put your money where your mouth is.

I'm not sure why this is getting downvoted; that's exactly the point. We get people to stake money and reputation, which makes them very careful about making clear, specific claims. There is a whole lot of mouth around the future, but very few testable predictions. We could have tried creating an apparatus for rigorous predictions, but everybody understands a bet.

This does not surprise me.

My personal experience with hedge fund managers is that they are good salesmen that peddle their financial expertise to clients, convincing them of their financial rock-star status (usually gained through a lucky investment or two). Paulson is a classic example. Wealthy individuals buy into it, especially those that are less educated (e.g. those that have inherited money), and happily allocate away their money to these guys. Once the funds grow to a certain size, then they might consider pitching their investments to pension funds, and their money pot grows, as does the nominal value of their fees. By the time they have pension funds on board, their investments get less and less risky, eventually looking more and more like a basket of standard commodities or a standard equity index! Thus, the value they add also becomes smaller and smaller.

In my opinion, the hedge fund industry is a bit of a farce, but there are a small number of firms that do have a secret sauce that works sometimes (rarely forever though). In my experience, the firms that tend to make consistent money are the market makers, rather than the speculators.

Nothing works forever but there are funds like Renaissance Technologies' Medallion which may just be getting heads for a long time but rather seem to have some secret sauce that works for a long time. Usually though they're not very large and don't seek out investments.

I think that's an important point. The problem good funds have is not finding more capital but being able to manage it without cannibalizing their own returns. Anybody trying to sell you a hedge fund is probably not selling a very good one.

Yes, Renaissance is an exception. I would argue that their nature of their strategies almost puts them into a pseudo market maker category (I've personally never worked with/for them, but I hear much of their strategy is statistical arbitrage, made possible by favourable transaction fee set ups and fast, colocated execution infrastructure).

Plus apparently some dodgy "creative" tax code interpretations around short-term/long-term gains.

Is it dodgy? You buy a share in a fund, that fund buys and sells, should you pay capital gains on every sale that fund makes? I don't think that has any precedent. You pay tax when you sell your share.

The type of strategy they employed isn't something small time investors could. It was a complex option scheme essentially buying options on their own short term trading.

While what you're saying is true, in fairness there are two caveats:

1. Virtually all profitable strategies run by hedge funds are inaccessible to small time investors nearly by definition, because they have more capital and lower capacity constraints,

2. The partnership you're talking about with Deutsche Bank doesn't account for most of their returns, and was only in effect in the last decade, not decades before.

Any info on the colo'd infrastructure?

Unfortunately not, I'm afraid. I would guess they have much of their execution infrastructure in the same data centre as the exchanges they execute on.

There's a considerable early period (1980s, 1990s) when Renaissance was turning up amazing profits when electronic trading largely didn't exist. That would suggest other methods.

Perhaps they were just market making back then as well? See this link: https://www.wallstreetoasis.com/forums/is-renaissance-techno...

There are several options that have noting to do with competence that allow for such returns. The most obvious is feeding the fund using another fund. Luck is another as the best returns from the largest outlier taking high risks looks great especially if you ignore large initial losses.

Look at their past performance, luck is just too unlikely for their string of successes.

Supose they had a 10% chance the fund is worth nothing in a given year. Over 20 years there is only ~12% chance a given fund makes it but taking such risks significantly boosts returns. Further, assume many such funds and you are only looking at the lucky ones.

This is why you need to make predictions of performance ahead of time instead of analyzing past performance.

PS: A standard trick is to start 20 funds and the 'best' one has high returns. Create another 20 funds to have a new 'best' when the old one reverts to the mean. Thus you need to analyze total returns weighted by funds size of a company not just individual funds.

This doesn't reflect how the industry actually works among funds that have alpha.

Clearly funds try and avoid going broke. However, many funds also have losses much greater than the market including the one we are talking about.

The truth is risk is hard to measure accurately and most Alpha is simply risk hidden from their investors.

Which is why a statistically significant Alpha takes more than a single funds past performance. And how someone just lost a 1 Million dollar bet on this crap.

Not so unlikely if you consider survivorship bias.

Actually yes, it's still quite unlikely. If you formalize your thesis here and actually do the calculation, you'll see that the chance of a fund achieving a consistently annual average 70%+ return over 20+ years is overwhelmingly unlikely to emerge with the number of funds that existed in the same time period.

"Survivorship bias" is a meme that is commonly thrown out, but to date no one I've challenged on it has empirically demonstrated that this accounts for the emergence of ultra-successful funds. Model this out a bit - what is your single unit of trading to judge and what is your time interval? How many other participants are there in the same interval, and how is each unit judged? You can't just judge on an annual basis - no firm has an actual 50% chance of beating the market each year. Funds like Renaissance make hundreds to thousands of trades each day. Moreover, different firms have different chances of beating the market each year.

Basically, I want you to rigorously formalize how a firm like Renaissance maps to monkeys throwing darts at the wall, because as much as people like to use these analogies (coin flipping, etc), they're never empirical. How do you account for a firm that beats the market by an overwhelming margin for 2 - 3 decades and never having a return poorer than the market (and in fact only rarely being down per quarter or month).

EDIT: Elsewhere: https://news.ycombinator.com/item?id=13797635

They don't consistently average 70% returns.

Feel free to list the years they had over 70% returns vs less than 70% returns.

That was a misnomer, you're right. But that doesn't meaningfully impact my point. An average annual 70% return, some years greater (notably, 2008) and some years lesser, but only a very small number of down quarters or months in the same time frame.

Don't forget to include the preceding 30% drop which reduces both the total returns directly and rate of return as the fund operated over a longer period.

Further, they stopped publishing returns suggesting an even lower long term average.

So, you are looking at a biased subset of a funds returns not total returns which greatly shifts the probability's.

The trick is that any non-illegal investing strategy has finite potential, because it is exploiting some sort of mispricing by the market. Eventually either your buying and selling will correct the mispricing, or other investors will catch on and start doing the same thing, spreading the profits thinner among a larger crowd.

This means that if you want to continually beat the market, using any strategy beyond an impressive gut, you need to be continually developing new tricks and strategies, finding new market mispricings to exploit as your old ones dry up. It's like juggling: someone who is skilled or lucky can keep the balls in the air for quite a bit of time, but eventually you're going to run out of tricks, and the best you can hope for when that happens is returning to average returns.

Renaissance is an exception at levels that makes me wonder if it isn't a cover for other methods or operations.

Howw many sigmas divergent is it?

It's a highly profitable market maker more than a long term investment fund.

I'd really like to see deets. I've looked, somewhat, and what I've found (including Jim Simon's very few talks) have been ... pretty uninformative.

You're not going to see details. No one who works there (or at similar firms) has any incentive to give away that information. If you come across people who work at one of these firms, you'll find they are extremely cautious about saying much of anything about their work.

The comments you see on forums like this one are just best guesses - educated guesses, but generally underinformed and relatively out of date. I personally consider it a fluke that RenTec is as famous as it is - other comparable firms like TGS have far less notoriety (and are probably better off for it).

> This does not surprise me.

It shouldn't. That anyone would take a basket of hedge funds and think it would win vs the market is madness. Active investment is negative sum due to fees - it's essentially implausible for hedge funds on average to generate alpha.

There are plenty which do. There are lots which actually simply provide alternative Betas, or smart betas, or whatever. Some of them have genuinely reasonable fee structures! Finding those funds and even getting access to give them your money is really problematic (and often results in another layer of fees to "access providers").

> it's essentially implausible for hedge funds on average to generate alpha.

Only if they're playing fair. But, wink wink, you should really wink wink invest in my uncle's fund, he knows a wink good strategy, but if you enjoy plausible deniability you'll just fork over the dough without asking too many questions.

But it turns out that uncle, a former NASDAQ chair, was running a pyramid scheme the entire time...

I expect that you are right about a significant number of funds (I would say most long-only funds). But a decent chunk of the industry exists because investors want higher-sharpe investments than the market even if they don't beat a bull market and/or investments that will remain uncorrelated with the market.

This is a reason why a lot of money is flowing into quant funds despite the overall outflow, because most quant strategies do great in volatile markets (but mediocre otherwise) where other funds are the market+fees.

Money is flowing in because they think they can pick the funds with true alpha, but they can't.

Yes, my reply was focusing on equities as the s&p was referenced in the post. There are other kinds of funds that do reasonably well; distressed credit shops seem to have done okay in the past few years, although that's starting to tail off now as there are more players in the market.

I've only dabbled a little in cryptocurrency exchanges, so the terms seem to refer to the same thing to me, but maybe it's contextual? Forgive my ignorance, but can you explain the difference between market makers and speculators?

Think of a market maker as a used car dealer. Alice has a car that she wants to sell today and Bob wants to buy a car, but he won't be ready to until next week. The dealer will buy Alice's car today and hold it until Bob wants to buy next week (for a profit of course). Thus the dealer is making a market for Alicia to sell her car, and for Bob to buy one, without the two having to having to meet in time or space.

Market makers perform a similar function on illiquid stocks, where there may be more sellers than buyers at one moment but more buyers Jan sellers the next.

Speculators are simpler. They're the guy who buys Telsa roadsters because he thinks they will be a collectible soon.

A market maker takes both sides of the market, and makes money on the spread.

IE, a market maker would have a standing order to buy 1000 shares of microsoft stock for 29.99$ and then have a second standing order to sell it for 30.00$ at the same time. If the market is on average buying and selling randomly, the market maker makes .01$ for every pair of buy and sell trade.

A speculator is someone who takes only 1 side of the market. IE, they buy 1000 microsoft shares, hoping that the price will increase, or sells 1000 shares hoping that the price will decrease.

You have market makers where you don't have an exchange, or where there is very little liquidity. Usually a bank but not always. They are there to "make a market", i.e. to offer liquidity to clients. Speculators take a directional position. Market makers make money on the bid/offer.

The exchange is not a counterparty. You have market makers there as well. Even in very liquid markets, it may be common to trade against market makers, just at a tighter bid-ask spread.

I understand a lot of the top performing hedge funds operate via insider information.

Is your understanding that they operate via illegal insider information, or access to information that is very difficult to achieve?

To be clear: I have mined and sold data to hedge funds before, including well known ones, and from that work I derived two conclusions:

1. It is fundamentally possible to beat the market consistently and legally by exploiting information asymmetry, and

2. Most hedge funds, especially the most successful ones, do not operate via illegal insider information (and will, in fact, fly into a compliance department initiated lock down on a security if, say, an overzealous data vendor compromises confidentiality).

Basically, I'm asking for clarification because as stated, I disagree with your assertion here. There are legal grey areas and some people are outright criminal, but overall I wouldn't characterize the top performing funds as being wholly or even close to partially dependent upon insider information, let alone at a systemic organizational level.

> I have mined and sold data to hedge funds

Are you able to tell more about what types of data this was? I'd be interested in hearing more. I love the story of hedge funds using satellite imagery of parking lots to predict retail store strength

> Are you able to tell more about what types of data this was?

I mined data in the real estate, QSR, automotive and airline sectors (and a few peripherally related ones). We would identify a source of data that was a demonstrably strong proxy for a specific company's revenue (that is to say, if we broke out a naive timeseries of the data it would map nearly 1:1 to earnings results each quarter). Then we would collect this data en masse, writing software over a custom crawler and infrastructure, bespoke to each case. During ingestion we'd process and normalize the data and dump it in a database. Once we had a significant amount of data we'd build a forecasting model, which could be very straightforward ("how many products have they sold this quarter", for simpler companies) to very complex ("can we reverse engineer the amount of business which is now online" or "can we determine the undisclosed amount of business being done in this specific region"). This analysis (and not the data itself) constituted the product - we never even provided the data directly to the hedge funds.

Once the crawling and analysis was mature, we'd incubate it for a few quarters while building interest; then, after showing a very strong mapping over several quarters, offer it as a data product. It was not uncommon to achieve <5% or even <1% margin of error for forecasting earnings announcements on a quarterly basis.

The data was always public and legal, though challenging to identify and difficult to effectively crawl. It was typically derived from very uncommon sources, and would range in complexity from the extremely simple ("we can crawl sequentially incremented integers from this third party that appear to map to products sold by this company") to the very sophisticated and complex (e.g. "we've collected a zero sum distribution of ad partners and their spend on the network, are more partners churning off, and is this a better or worse outcome for the company?"). I've spoken about this in comments here before.

This is still very doable, and I still do this sort of work for personal research (and profit). However, the work I do is now much more quantitative - I'm currently taking a similar approach for baskets of equities with the goal of forecasting macroeconomic trends (e.g. subprime auto loans) instead of the earnings results of individual equities. To give a very specific throwaway example (because it doesn't violate an NDA and it no longer works): it used to be possible to pretty accurately forecast large tech retailers' product sales each quarter (like Apple) by reverse engineering FedEx and UPS tracking numbers.

Would you be able to describe how your data was normally priced? I'm sure it is very context dependent, but I'm very interested. For example, let's say you have information that allows you to forecast the earnings of a publicly traded company to within 1% MoE; for how much could you sell this information (either one time, or periodically) to a financial company?

I once briefly chatted with a man who ran a company that used satellite imagery to predict crop yields. I found it amusing how rather than providing this information to farmers ("It looks like you're going to produce only 60% of what you did last year, time to cut some expenses!"), there was so much more money in providing this information to hedge funds and trading firms. Morality aside, the potential for technology like this is exciting.

It's kind of cool how the combination of big data, scraping, statistics, etc. allows this small niche of analytics to thrive. I have a decent background in most of these subjects, and this seems like a very freelance-able job, so I'd love to dabble in this area and learn how it works.

> I'm sure it is very context dependent, but I'm very interested. For example, let's say you have information that allows you to forecast the earnings of a publicly traded company to within 1% MoE; for how much could you sell this information (either one time, or periodically) to a financial company?

It is context dependent, but I can give a basic idea. In the example you've given, high four figures per customer per quarter, assuming you just give them a deliverable report once a month and the data is turnkey enough that many customers (30 - 40) can "subscribe" to it. For a fund that wants something more boutique, like exclusivity or a specific company, five figures becomes the floor.

The nature of the business is significant upfront work (setup of data collection and analysis model) followed by infrequent tweaks going forward. Lucrative data on a single hot company could be sold for mid - high six figures per year with very high profit margin for as long as the data is available and the analysis model is both functional and interesting (i.e. delivers an insight not already priced into the market).

How do you approach a customer once you have the data? I imagine you will build a relationship with your customers eventually, but when you're just getting started, do you just ask a potential customer via mail/email/phone if they want to meet and discuss your data of company X?

I'm also curious as to the level of "polish" that you are expected to provide. Let's say you know how many widgets Acme sold this last quarter. Is that by itself enough information, or would you need to calculate projected expenses / other stuff to actually be able to deliver an earnings estimate? What if you just had projected revenue?

Thank you!

> it used to be possible to pretty accurately forecast large tech retailers' product sales each quarter (like Apple) by reverse engineering FedEx and UPS tracking numbers.

That's great. Were tracking numbers vendor-specific in some way? So you could, let's say, order an iPhone once a week and get an idea for how many iPhones (or total Apple products) were sold in that time period, just by using the tracking numbers? Was it dependent on geography in some way?

Yes, yes, no.

Reminds me of the British figuring out how many tanks the Germans made in WW2 by a sampling of the serial numbers.

That's genius! But then you have to buy a lot of iPhones, right? I suppose you can sell them on, and if you're getting ~$10k per quarter, it's OK. Or did you use a different approach?

What changed BTW? Did the format of tracking numbers change?

> But then you have to buy a lot of iPhones, right?

Just two per carrier would do: one at the start of the quarter, and one at the end. Earnings dates happen weeks after the quarter ends, so you'd have heaps of time to peddle your analysis around.

You cannot perform above average without an information asymmetry. This asymmetry may be either because you found "bug" in financial system or insider information or custom data collection. The test for "good" funds is essentially what information asymmetry they have. If their answer is "good fund managers", "years of experience", "past performance" etc then it's not concrete asymmetry and most likely won't work over longer term.

Buffett clearly disproves this theory. The reason is it's ignoring the overwhelming impact of bias and mal-incentives. Hundreds of thousands of investors have professional training in valuation techniques Buffett uses. But 99% don't make the same use of that skill as Buffett does, for reasons that include

1) they can't buy in to using valuation as their sole investment criteria. They want to be "smarter", thinking they can see things others can't using psychology or charts or other pseudo sciences. 2) They fall sway to Mr Market ( read the Ben graham parable). 3) They can't sell value to clients and only want a strategy clients will pay for. 4) Buffett spends a great deal of time trying to make decisions free of bias. A CFA program teaches you nothing about this, but it's critical to good valuation work. For example, WEB does not want to know the stock price of a company he's analyzing until he's made his valuation estimate. He doesn't want to be biased into giving a too high valuation to a company he loves just to ensure he can buy it.

Lastly, there is a meta level to value investing. A great valuation at a current price isn't enough if the company lacks a competitive moat, or management can't be trusted to treat shareholders well. First level cigar butt value investors never learn this.

Or perhaps Buffet has an information asymmetry. Don't you think when he is interested in buying a company that may not even be in the public market that the meetings, tours of facilities and financial due diligence represents a significant information asymmetry. This information is probably available to any who seek it but not practically to most.

Well first, Buffett still buys lots of shares in public companies. His first few decades were almost entirely public companies. Second, any investor running an investment fund can make offers on private businesses, and get the same tours.

Its not an informational asymmetry, it's what you do with it. Walter Schloss is another great example. Beat the market by 5% a year for over 40 years, did it buying exclusively the doggiest public companies. He was the ultimate cigar butt hunter. His advantage wasn't information Wall Street didn't have, it was his willingness to use information Wall Street wouldn't, to invest in opportunities they would not.

Buffett does have one informational edge, his experience and judgement. He knows how value works, he has total confidence it works, and he never panics, even when down 50% in 2008. He never leverages himself in a dangerous manner, never gives someone else control over his decisions.

That's the whole point of a mutual fund (of any kind). You're paying them to do things you couldn't possibly justify given the size of your portfolio. If all they're doing is sifting through quarterly reports they're not providing much value for your fees.

This is sometimes true, and in my opinion, happens more at the smaller, unregulated hedge funds where the volumes can go undetected.

I used to work on Wall St, and nearly every hedge fund was a client of our company. This is absolutely true.

There is no single Wall Street vendor who has nearly every hedge fund as a client, unless perhaps you are talking about a major exchange like NYSE. Even that is probably not a valid because of the huge number of firms doing smaller volumes via third parties (and having no direct relationship with the exchange).

Or perhaps you worked at Reuters or similar, in which case you would not have much visibility into the funds.

So are your two sentences related in any way?

He worked at Starbucks and would overhear traders bragging about their crimes in queue.

My understanding is that trading on non-public info isn't a crime unless both parties benefit. The behavior I'm referring to was sharing tips with the expectation of getting tips in return at a later date. As far as I know, it's not possible to prove that's illegal.

Also, it's not like actual illegal behavior is uncommon when it's hard to prove, and it's not like a lot of people aren't proud of it. Watch Jim Cramer's interview with Jon Stewart as an example and the reaction to Wolf of Wall Street as another.

In business school, a friend asked me to recommend firms where he could do some quiet insider trading by tipping off relatives who would trade on his behalf. He ended up at MF Global.

There aren't statistics on this kind of thing, but my experiences have all told me succeeding as a hedge fund requires breaking the same rules as everyone else, not unlike doping in pro sports.

>My understanding is that trading on non-public info isn't a crime unless both parties benefit.

Trading on non public information for a gain is going to land you in hot water with the SEC.

These two lines on the SEC site [1] define this.

>Corporate officers, directors, and employees who traded the corporation's securities after learning of significant, confidential corporate developments;

>Friends, business associates, family members, and other "tippees" of such officers, directors, and employees, who traded the securities after receiving such information

1. https://www.sec.gov/fast-answers/answersinsiderhtm.html

The SEC has established two precedents in this arena to satisfy the "personal benefit" or quid pro quo requirement:

1. Bribery, or a monetary reward,

2. Friendship and good relations.

In both cases there must be an unbroken chain of confidentiality compromise. If you legitimately come to know non-public material information about a company and you didn't acquire this information through your own or someone else's confidentiality agreement, you're fine to use it.

Information asymmetry couldn't be functionally and profitably exploited if it was literally illegal full stop. You just have to acquire it without breaking a confidentiality duty to your own company and without aiding and abetting someone else in breaking such a duty (e.g. they tell you and you trade).

It was a cheap, useful data vendor and research firm and lost most of its clients during the crash. I don't know if it regained its market share, as I left shortly after.

I'm surprised that anyone is surprised by my statement because it seems like an open secret. I don't think most of it is illegal, but sharing of non-public info is very, very common.

Reminds me a little of traffic. Yesterday I was cruising down the highway in the leftmost lane, going about 80 with a line of other cars. The other two lanes were actually more clear, but cars were going much slower.

I notice this one car, weaving in and out of traffic in these two lanes, trying desperately to get ahead, constantly cutting people off. They did this for 40 miles, weaving in and out, sometimes getting ahead of me by quite a bit, sometimes falling behind.

If they had just stayed in the left lane and cruised, they would have arrived at their destination at exactly the same time.

My point is, it seems to be human nature to be bad at estimating long term averages, whether it be stock picks or just driving down the road. Checkout lanes are another example that comes to mind.

Some people think you should not be in the left lane unless you are passing at that moment. In some places, there are even signs saying "keep right except to pass". Perhaps this person was driving aggressively because they were enraged at the line of traffic on the left. Which is to say, they may not have been doing it for a quantitative benefit as you assume. This might strengthen rather than weaken the analogy to the stock market though...since it could be that people invest in hedge funds not to increase their average return but to reduce the regret of not owning "winners" and having something to talk about.

It's not just some people. It is actually the law in most states (albeit a seldom-enforced one).

Don't cruise in the left lane.

I wish this were true of most states in the USA. It’s certainly true in many parts of Europe.

I don’t have an especially authoritative source, and the first map I found was made seven years ago, but I don’t think things have changed much:


Only the green states would map to “don’t cruise in the left lane”; the laws in the majority only say you shouldn’t drive slower than normal traffic in the left lane.

Thanks, that helps explains why my driving experience is so poor. There isn't a national standard for the protocol so everyone gets together and has impedance mismatches.

That's being overly charitable though; self-driving cars, even with different protocols, won't suffer from the rubber-necking or phantom slowdown issues. Their algorithm designers might even be smart enough to relieve the pressure of virtual blockages by going a little faster than the speed limit on the outbound side(s) to relieve the pressure wave.

I recently took a road trip from CA to NY and back. As soon as I got out of CA, people were obeying the "left lane is for passing" idea -- except Vegas.

I spent weeks in highway driving bliss with pretty much everyone obeying this rule. Then when I came back, and hit CA, I was immediately pissed off at traffic -- nobody was following this rule. But at the same time, the traffic is usually so bad it makes this rule meaningless, so I think we just forget about it after a while.

That map is out of date. Oregon is now in the green group.

Good to know!

This is such a problem in Utah that last time I was there, the traffic status billboards over the freeways just said, "Camp in the mountains, not the left lane"... and the left two lanes were full with the right lanes empty. If I hadn't been driving I would have taken a picture to savor the irony.

Most people cruise at a speed that is faster than everyone else in the other (non-left) lanes.

But, please don't be the car that is cruising at 60mph in the left lane. It is a leading cause of accidents.

Ie speeding?

Some states are 70mph, and most cops won't pull people over unless they're doing 10-15mph over.

Unless you are just really unlucky XD

Not sure why the downvotes. (Some states are 80mph actually!)

Speeding enforcement in the United States is fairly loose, with usually roughly a 10mph buffer. (The exception being various "speed traps", atypically mostly rural towns that rely on ticket revenue for an outsized portion of their town budget.)

I think this adds to the problem with left lane issues; even if the "true" speed limit is 80mph, if the "posted" speed limit is 70mph, some people will do no more than 70mph no matter where they are.

Yes. Speeding will result in frequent overtaking. Hence the use of the overtaking lane.

Does that mean the left lane should be unoccupied if everyone in the other lanes are driving at the speed limit?

That certainly depends on how the law is written. Where I live, the wording is that you are recommended (and on certain roads, required) to stick to the rightmost available lane – which means that you're certainly not breaking the law by driving at the speed limit on the leftmost lane if all the other lanes are already at full capacity, which also makes perfect sense to me. (However, exceeding the speed limit would be against the law in any situation, unless perhaps where you could avoid an accident by doing so – although that may be hard to prove.)


No. It should be unoccupied if nobody is passing. If it is empty on a particular stretch, somebody will decide to pass.

But if everyone is driving the speed limit no one can pass.

you can exceed the speed limit by a certain amount while passing. at least here.

I'd like to see where that's written into a statute book; doesn't sound correct.

It's in the book you have to study when you get your license here in Texas :) you can exceed the limit by 5mph. Have a nice day!

You too!

The reason that I said I'd like to see where it's written into statute is that I can't think of a reason why it would be legal. It sounds like driver folklore rather than law.

Having a speed limit that can be exceeded simply for overtaking (rather than by emergency services) means the practical speed limit then becomes "the limit + 5" in traffic, which increases the chance for collisions (for no reason I can think of).

I'm of course open to being shown otherwise! I couldn't find anything searching for "Texas passing speed limit" or variations, but my license is European, so I'm not sure where to look.

Maybe on a state by state basis as I just googled it and you can't do it in California.

I specifically said "at least here."

This doesn't apply at all in most of California. We need the left lane for capacity, not flow regulation. Also left lanes are frequently diamond lanes, so you're basically telling people not to carpool.

"left lane" is colloquial for the passing lane. It means the left-most lane in a group of equivalent lanes, not the HOV/reserved lane

In most places that have rules relating to lane use, it means every lane that isn't the rightmost lane, excluding lanes reserved for a special purposes (HOV, etc.).

A lot of the capacity issues end up being just a lot of cars clustered in an area. If you are able to escape the bunch there tend to be nice stretches of open road. Flow regulation would help avoid clumping of cars by making sure the left lane is not used for cruising.


That typically means the right lane is turning into an exit lane.

I don't drive, but as a passenger, it is my understanding that the left lane is the fast lane and the right lane is to remain empty or mostly empty so cars can enter and exit the highway?

Please correct me if I'm wrong. Regardless, if I ever get my license, I'm pretty much always going to avoid the highway as my anxiety cannot handle those speeds.

The left lane should be the one generally remaining empty, and used for passing.

In my opinion the problems we have with traffic are a mismatch in expectations. If we are walking down the sidewalk and you stop in front of me I can simply say "excuse me" and walk around you or you may step to the side. It's a common human interaction and we all understand it.

This is impossible in a car because we are isolated from each other. To handle this we make rules for each situation that if followed would result in the most efficient use of the road.

The idea of drive right/left lane to pass is that nobody has to say "excuse me" to pass the car in front of them because that's impossible. In the same way it is not polite to stop on a busy street to "let someone in" from a parking lot or to let the car to your left at a four way stop go first. The rules are there so we can predict what anyone else will do.

In reality we all learn a different set of rules or have a different understanding of them so it all falls apart. Arguing about the specific rules doesn't make a lot of sense in reality because for any of them to work we all have to do the same thing and I don't know of anywhere that makes drivers take more than one skill test in a lifetime.

Yeah, driving culture needs to be a part of driver training. Driving is simple enough that most situations we should expect predictable behavior.

It's the law to keep to the right in most states.

For instance, Washington state: http://app.leg.wa.gov/rcw/default.aspx?cite=46.61.100

It might be the law, but WA state is the poster child for left-lane bandits. Easily, with no doubt in my mind, the worst of the 50 states for a general contempt and ignorance of left lane (or lane discipline in general) protocol and law. IOW, it is not uncommon to see a line of cars in the left lane doing the speed limit or under, and a total two cars in the other lanes. Oregon is a close second.

The state police had a campaign a few years ago, stating that they were going to crack down on this. Not only did I not see any cops enforcing it, not a damned thing has changed regardless.

The mystery to me is how a geographical demographic of drivers somehow all got together and said, “fuck it, I’ll drive in whatever lane I want!” I know that’s not how it happens, but how does it happen? Taking the example of the worst drivers? Urban legend (“oh, no, it’s against the law to...”)? Some misguided attempt to stick it to The Man?

> The mystery to me is how a geographical demographic of drivers somehow all got together and said, “fuck it, I’ll drive in whatever lane I want!” I know that’s not how it happens, but how does it happen?

I think you have it backwards.

It's not that they're thinking "Fuck it, I'll drive in whatever lane I want!". It's that they were never told the proper thing to do, so they just have no idea that it actually matters.

Some people are actually specifically told the WRONG thing. I had a friend who was taught by his parents that if his exit isn't coming up any time soon that he should be in the left lane.

Every region says their drivers are the worst.

I’ve had motorcycle tires in 49 of our 50 states, and lived in a variety of regions of the country. I agree with your general sentiment, because boy howdy there are some bad ones everywhere you go, but I say with confidence that I have found where the worst drivers in the country live.

Where did you feel most comfortable with motorcycling? I've been looking to leave CA because driving here is getting worse every year.

Most comfortable? Canada. Seems like they take driving a little more seriously there. In the U. S., California is fine. Lane splitting is legal, drivers mostly competent and attentive, cops are about the right mix between lenient and slapping a ticket on you when deserve it. Even in places like L. A. I felt comfortable, even lane splitting with bags on. CA has its problems, but I like riding there. That obviously doesn’t match your experience, but I sadly haven’t ridden down to CA in probably three or four years. I also tend to kind of stay away from the Bay Area on the bike.

A lot of southern states are good, like North Carolina or Tennessee. Good mountain roads, reasonable drivers. And believe it or not, I’ve like riding in New York City. Don’t let the bike out of your sight lest it be stolen (I am dead serious about that unless you have some serious locking equipment). Obnoxious drivers, sure, but competent and it’s almost as if everyone knows that if we don’t cooperate at least a little, nobody’s getting home tonight. All of this of course is one giant sweeping generalization, so no one need trot out their personal list of exceptions.

But Seattle? I fucking hate driving in Seattle. It’s as if every single driver is sixteen years old on their learner’s permit with two months behind the wheel. There’s a reason one of the topics of the very first Portlandia episodes dealt with driving in the PNW.

Thank you for that insightful reply. It's like you were reading my mind or something. I have been considering moving out of CA and Seattle, New York city, and a few places in Canada have been at the top of my list. If I can figure out remote work I'd like to add Europe to my list as well.

I definitely concur that California in general is pretty great for motorcycles. With 2 jackets you can ride year round. People are well conditioned to lane splitting so they make room for even the largest of bikes. Where most people I know went down was turns in and out of strip mall parking lots. All very avoidable from the drivers side.

I ended up selling my bike a few months ago. The same commute I've done for years is just ever increasing. I've been considering going public transport for a while to regain my sanity.

I’m curious where you and other posters got the idea it’s the law in most states?

The only states west of the Mississippi for which this is true are Washington, Kansas, Oklahoma, and Louisiana. 10 if you look at the entire USA. Not nearly half by population or geographic area.

That doesn't really apply when the road is so busy that all of the lanes are full of cars.

It applies before with the goal of not getting to the point that all the lanes are full of cars.

Roads have a carrying capacity, or bandwidth, which at after a certain speed say 80mph, doesn't increase. Traffic is unavoidable once enough cars come onto the road at the same time such that they exceed this limit, and so you get traffic where people are speeding up and slowing down and that cascades back.

At the end of the day, there is no amount of rules that will bypass the fact that there is a hard limit to how many cars can pass through any given point at a certain speed.

That's true but the rules get us closer to that theoretical maximum.

This was tested in an experiment I can't find now. One group of drivers was asked to stick to one lane, the other group was told to switch lanes when possible to get ahead.

The outcome: as expected switching lanes gained next to nothing. But importantly the reported experience was significantly worse for those that stayed in one lane. So switching lanes doesn't reduce commute time but the perceived commute time - and that is not insignificant!

This however isn't a poor performance because of switching a lot - these funds make money but the managers keep too much of it. The bet was on whether someone who invested in these funds would do better than the S&P - not whether the stocks in those funds did.

That's because changing lanes is excited and camping is boring. This can be easily fixed by playing a game on your phone while camping.

This was tested by the Mythbusters television show. https://www.youtube.com/watch?v=ZefgUVg3qx0

Unless you only noticed that one car that was terrible at getting ahead. Better drivers might have passed you only once and you didn't notice them because you never saw them again.

I wish Waze had an "A/B test mode" where you can bookmark the current cohort of drivers around you, and then N minutes later see where they ended up. Whenever traffic apps claim my main route home is backed up and I end up taking some weird backroads, I wonder if I would have been better off sticking with the main route.

As it happens when one doesn't acknowledge Survivorship Bias.

This is a poor analogy, and will only serve to induce responses to the analogy rather than the topic at hand.

I think the weaving in and out behavior can be explained in some part by the boredom of just cruising in a single lane for miles and miles.

That being said, downvoted because the traffic analogy was very tangential to the point at hand and would only serve to derail conversation.

The analogy works even deeper -- I've seen articles talking about how large amounts of lane changing actually slows traffic overall.

For anyone interested in this bet, Ted Seides (the losing party) did a good podcast on the topic: http://capitalallocatorspodcast.com/BetwithBuffett/

My layman's understanding of hedge funds is they are better at hedging losses than increasing gains. So in good years they might underperform the broader market (e.g. gain 9% instead of 12%), but in bad years they should lose much less (e.g. lose 5% instead of 15%).

I think this bet was largely a bet on the broader market dropping after a long run-up (which would theoretically favor hedge funds), but instead the market kept rising more and more.

> I think this bet was largely a bet on the broader market dropping after a long run-up

Well the bet included the 2008 crisis. That looks like even this theory is contradicted.

Yes, this was the origin of the term "hedge" fund, but in recent ~decade has come to mean "actively managed investments" because the name sounded cool to people who don't know that the word "hedge" means something intentionally conservative and boring.

Yeah, it's hedgy.

Hedge funds aren't about hedging anymore.

Ted got the biggest market crash in last hundred years and still got trounced.

He can't admit the truth because it's destructive to his very business model.

Hedge funds as a group over time always trail the market because of their high fees. Funds of Funds layer yet another layer of fees, making this bet suicidal.

Ted Seides is a Wall Street con man grafting fees off poorly informed investors. He was delusional to make this unwinnable bet.

Has anyone done the analysis to see if the stock-picking by those managers was worth anything at all?

Obviously it wasn't worth the fees they charged. But if all those fees had been flattened down to the same expense as the Vanguard fund, would their advice have been worth anything over the index? To a first approximation, it looks like the answer is no.

Investments can have a dual mandate - high returns BUT also low volatility. Many hedge funds will admit their returns may not beat the S&P500, but will counter that their returns have lower volatility -- achieving more consistent gains over time.

To answer your question, sounds like the answer is still no, but it is worth noting that this whole conversation is ignoring the volatility side of the conversation.

But the opposing bettor got to pick the funds, it's not like Buffett forced anyone to pick funds with risk profiles less likely to result in beating the market.

Ted Seides got the worst market crash in a hundred years and still got crushed. Volatility and hedging never matter in the long run, fees do and Teds structure is a fee maximization device that's a winner for him but a loser for investors.

You are correct except that doing this over 10 years somewhat removes the 'ignoring the volatility' argument.

>>You are correct except that doing this over 10 years somewhat removes the 'ignoring the volatility' argument.

Only lessens it slightly. There are plenty of bad 10-year periods you wouldn't be happy with if you were 50-55 years old with all your money in stocks, not to mention an index fund tracking the S&P500 rather than the full index.

Obviously holding index funds that are primarily stocks is the play when you are younger, but risk-adjusted returns matter a lot more for someone with big money as they approach retirement. It's worth exchanging returns for lower volatility down the line. Not that I think this bet could have turned out any other way, of course...

Depends on whether there was a major market correction in those 10 years. A better betting period would be 20 years, which almost certainly guarantees 1 and possibly 2 or 3 market corrections.

Hedge funds would argue that they perform better in downcycles, possibly even with negative correlation to the market.

I would like to see them compare themselves to a stock and bond portfolio of similar volatility. Ordinary investors can reduce volatility with bonds for a lot less in fees.

I can't vouch for this source, but here's a claim that alpha is real: https://blogs.cfainstitute.org/investor/2016/07/26/is-active....

Buffett alone is proof enough that Alpha is real. The real problem is, how can you or I pick the next Buffett instead of the next Ted Seides? The answer, we can't.

The Superinvestors of Graham-and-Doddsville


And even if you luckily (or maybe skillfully) could, you'd most likely have a relatively small window of access before they no longer needed your capital unless you were a very large investor (on the order of a few years).

If it's just stock-picking as opposed to getting access to a wider variety of investments, then it's very difficult for active stock picking to be worth anything. If stocks are owned just by stock-pickers and passive indexers, then they own the same stocks in the same proportion.

The only thing active funds can do is invest in things that passive indexes don't, or better take advantage of the "dumb money". Things like high-frequency trading definitely count here.

Pure stock-picking though? Yeah, anyone who outperforms is on the other side of trades that underperform, so you're going to run into issues.

> Yeah, anyone who outperforms is on the other side of trades that underperform, so you're going to run into issues.

True, but it's not like the bet is already decided because of this mathematical fact. In theory the good pickers can predict the outperformers. It's a surprising claim that this is, essentially, not possible -- or at least only marginally possible to a degree that's cancelled out by fees.

If you average together a lot of stock pickers, you wind up with roughly a market-cap weighted index. If you average together everyone who holds stock, you wind up with exactly the market-cap weighted index.

Right. But it's still surprising that "experts" can't make a biased selection that is better than the exact average.

On average, basketball teams in the NBA score X points per game. You now get to pick 5 teams and average just their scores. I'd imagine in that situation it's pretty easy to beat the league average. Again, it's a surprising and non-trivial fact that this isn't the case in the stock market, roughly speaking.

That's not entirely the nuance of Warren Buffet's argument though. His argument is that the stock pickers have the deck stacked against them on total returns to the investor due to high fees. So maybe they do actually do better than average, but that it's likely not "2 and 20" better.

See my post above the one you replied to.

But the hedge funds in Buffet's bet did make those wider variety types of investments.

It's interesting that while the S&P did beat these hedge funds, Buffet's own Berkshire Hathaway (BRK.B) seems to have beat the S&P handily[0], with an increase of ~130% from $77.93 in 2007 to $179.89 today.

I know Berkshire isn't actually a hedge fund, but is very analogous to a giant mutual fund, albeit one that takes a very active ownership role in the companies whose shares it owns.

0:http://quotes.morningstar.com/chart/stock/chart.action?t=BRK..., look at the 10-year chart.

Yup this is the optimal strategy. I figure that one out a couple decades ago.

Index funds will almost always outperform actively managed funds. They are the best choice for the layman investor. An excellent book on this topic is The Little Book of Common Sense Investing by John Bogle.


"Rest Estate always goes up!"

"Index funds will almost always outperform actively managed funds."

Convenient investment vehicles should not stop you thinking. Index ETF were a great idea. But now everybody is pouring tons of money into them. Not sure this is a good idea, at least not on the scale how it is currently done. A stock is priced by supply and demand. There are stocks where there is basically very little real trading. Only ETF and some HFT funds. Yet, the stock is rising with the index. What happens in a downturn? What happens if this stock drops significantly more? Every ETF has to re-balance to reflect this fact, easily leading to a feed-back effect.

Some people betting on it: http://www.zerohedge.com/news/2017-04-09/horseman-global-unv...

Index funds have to outperform active funds and traders in aggregate by definition. It's not a claim or debate, it's simple math. After savings on taxes and expenses, indexes represent the average + a fair bit more than other options. There is no feedback effect, except that more people indexing will lead to more trading arbitrage opportunities, which people will take and which doesn't hurt indexers, who will continue to take the market average return plus what they save in expenses and taxes. As an aside: the last place to get financial advice is Zero Hedge. Try this instead:


This is true in aggregate, with the additional caveat of over an asymptotically long timeline. Part of the goal of hedge funds, or at least some, is to hedge investments so that you might not get hurt as hard during a recession as the market.

There can still be active funds that perform better than the market, or the market as measured by an index ETF. Unfortunately with the way funds are marketed, funds can often just employ survivorship bias so that all funds look very good. Also, index funds do not have to outperform active funds/traders by definition, because not only can active funds invest in assets outside of the index (other stocks, real estate, futures, options, etc.), but active funds can also have more profitable allocations. Obvious proof: if the value of every stock in the S&P 500 were now worth 0, active funds wouldn't, ergo active funds will not necessarily always be outperformed by indexes.

I think that for your average investor, indexes are the way to go at the moment, but it's not impossible for there to be a world where active funds are often better.

>This is true in aggregate, with the additional caveat of over an asymptotically long timeline.

This is true over any timespan. At any point in time the active part of the market holds the same stocks as the passive part of the market and thus has the exact same risk and returns. This is as true over a century as it is over a month.

>not only can active funds invest in assets outside of the index (other stocks, real estate, futures, options, etc.), but active funds can also have more profitable allocations

If your active fund is investing in different markets then it's not comparable to the index. If there's an advantage in investing in those assets the solution isn't to buy the active fund. The solution is to find the index funds that will also give you exposure to the same assets and buy those instead gaining the same advantage of the same returns with less fees.

>> Every ETF has to re-balance to reflect this fact,

Only market-cap weighted ones. And we are quickly moving away from such things with non-standard weightings and soon to be released actively managed ETFs.

I liked "A Random Walk Down Wall Street". That was the one that convinced me: https://www.amazon.com/Random-Walk-Down-Wall-Street/dp/03933...

Why do you think this is true? I agree that index funds are better for the average consumer at the moment, but I don't think that means they will always outperform actively managed funds. There are some theoretical benefits of an actively managed fund, as compared to an S&P 500 ETF (although these will largely be true of any index fund; also consider point 0: that the S&P 500 is "actively managed" by Standard & Poors, see more in [0]):

1. An actively managed fund can make so-called "hedged" investments, or simply "hedges". For example, let's say there are 3 big carriage producers in the S&P500, but there's a lot of hype about this new "automobile" invention. We want to make money regardless of whether automobiles replace carriages. Unfortunately, there are about 20 different automobile companies vying for control over the industry, and only one of these is currently in the S&P 500. A hedge fund can spread investments between these companies so that, if/when an automobile company gets big, you're not overly exposed to the soon-to-be defunct carriage industry. Sure, the S&P is in some ways self-hedging since competitors will often both be included in the index, but it's ideally hedged for most things.

This may not be as much of a concern if you are simply looking to maximize returns over an indefinitely long time. But there are a lot of people looking for investment strategies that are less risky than the stock market as a whole: for example, people that are planning on retiring within the next 10 years.

2. Stocks don't always do well in every circumstance. How happy would you be if you invested in a Nikkei ETF 10-15 years ago? Sure there were troughs during then, just as there were in the S&P during that time, but you'll notice that even over relatively long timelines, most people wouldn't make much money from such an index. This leads directly to the next point

3. Hedge funds, to varying degrees, have assets outside of the stock market. These can include bonds (from treasuries which you might buy as an individual, to bonds with higher levels of risk, which you might not), real estate, options, commodities, futures, derivatives. They can also use leverage / trading on margin, which you probably can't/shouldn't. These asset classes provide other ways to hedge investments.

4. Hedge funds have better connections/information/technical ability than the average investor. This means they can talk to CEOs, respond to news faster or even instantly, or do analysis that's too complex for an individual.

I'm familiar with the Boglehead and /r/personalfinance canon, but I think they're focused on steering people away from hedge funds that your broker or "personal wealth advisor" suggest, which may average 6% yoy with a 1% fee. If it were possible for your average joe to invest in DE Shaw or Renaissance, I think that would be the ideal strategy (though, keep in mind that a large part of the reason these hedge funds are able to do so well is their size).

Also, I'm not sure how to prove this technically, but I'm pretty sure that the more the average investor gets invested in index funds, the more opportunity there is for actively managed funds to take advantage of the inefficiencies of the relatively static allocation of an indexed ETF.

[0] https://en.wikipedia.org/wiki/S%26P_500_Index#Selection_crit...

1. Diversify into bonds to reduce stock risk and volatility (either a Total Bond or Treasuries fund)

2. Diversify globally to avoid single-country political, economic and geographical risks (add Total International to balance your domestic stock)

3. If you really want to, buy a commodities ETF to further diversify (generally not recommended at more than 10% of portfolio and not a big deal either way)

4. But we've already seen that after fees they come out behind, so their 'better information' isn't translating into higher returns

The idea that 'too many indexers will kill indexing' has been around for a while and debunked for an equally long time. Here's a source for that:


At the end of the day, there's just no need to get crazy with things. Indexing works. It's reliable. You can sleep at night. I can't really imagine putting my money in the hands of a manager (or set of them). What if they get sick, or bored, or were just lucky early on? No need to add that layer of risk.

I feel like there's some cognitive dissonance surrounding hedge funds in popular culture -- on the one hand you have people saying that any outsized short-term gains seen by hedge funds are the result of some selection/survivorship bias, and on the other hand you have people saying that any outsized returns are the result of illegal privileged information (see the TV show 'Billions').

I realize that there are enough hedge funds out there that both things can be happening. It's too bad that there's so little visibility into the industry, it would be fascinating to see some kind of hedge fund taxonomy.

It doesn't have to be illegal.

Hedge Funds have access to CEO's, they'll go in and interview them. Ostensibly, the CEO cannot say anything that is not 'public information' - but if you think about it, then why would the Fund even talk to the CEO if 'all info is public'?

Because a lot of nuance can be gained from in person interviews. Little tidbits of information gleaned can make a difference.

I'm not hugely knowledgeable of that industry, so I can't speak of the 'for sure' bad things happening, but I know at least one manager who does this.

Funny: he totally does not believe that they really gain an edge over the public. Then I ask him why he bothers with the interviews and he doesn't have a very good answer. It's almost funny. I suspect his fund partners have a better clue.

So that's one thing.

Another - is that simply by having fewer regulator requirements, hedge's can do all sorts of things that bigger funds cannot.

As far as 'hedge funds not doing as well as the S&P' - well - the S&P changes, and it's made of pretty good companies. Also - a lot of funds come and go - it may not just be 'survivor bias' - some may very well just be dam better than others. Almost all of the gains in VC go to top funds, and there's tons of churn in the bottom 50%, but that is a different dynamic.

I think the rationale that you can gain nuance from in-person interviews about public information is where science and mathematics turns into wizardry and human bias nonsense.

If the evidence suggests access to CEOs like this works, there's probably something else going on. Maybe a bit more winking and "I didn't say this but..."

There's a whole lot of "X is bad, therefore any argument that supports the claim that X is bad is true and valid" when it comes to these matters. It's technically "affirming the consequent", but I think that fallacy gets another very tempting facet to it when it's enters the moral or ideological dimensions.

It is not really surprising that a large group of hedge funds underperformed the S&P500. In fact, William Sharpe made the argument a long time ago: in aggregate, active investors hold the passive portfolio and earn the same return as passive investors before fees, but lower returns after fees. In aggregate, this is always and necessarily true: https://web.stanford.edu/~wfsharpe/art/active/active.htm

It's so simple and obviously true yet a shocking number of people think it could be otherwise (e.g. if too many people index).

So clearly, for the individual, the optimal strategy is to simply invest in index funds and just wait.

But a new question that is being raised is: "what happens if everyone only invests in index funds?"

This has been answered a thousand times. Everyone will never invest in index funds. What will happen is more and more people will invest in index funds until there are so little people actively investing in the stock market that the ones that do are able to beat it. However, them beating it will only net (after their fees) the same returns as index funds thus striking a balance where index funds match the performance of active investors.

If either index funds or active investors (after fees) make more money, capital will move to the one that pays more until they balance again. We have had way too many active investors for a long time which is why index funds have constantly outperformed active investors but eventually they will balance as more and more people move their money to index funds.

How does the active part of the market beat the rest of the active part of the market? Like, I could see the net fees of the active funds being equal to the underperformance of "dumb money" retail investors mis-picking stocks.

I'm not exactly sure what you are saying. Are you asking how active investors in aggregate can beat index funds despite their fees?

Sorry. I'm asserting that active investors in aggregate own the exact same stocks in the same proportion as the fund that indexes the stocks they're picking from. So if one active investor outperforms the index, there has to be an active investor on the other side of their trades that has to underperform the index.

In other words, since the average active investor sets the average that passive indices track, how do they beat the average?

I propose an ETF that invests in ETFs and active investors...

OR, since index funds are constantly getting 401(k) money dumped into them and therefore establish a reputation for a type of asset that has guaranteed returns with no risk, will develop into a massive asset bubble that will eventually go kablammo and take the retirement savings of half of the world down with them.

You have way too much faith in people making well informed decisions.

You are missing the point. Once almost everyone invests in index funds, what will determine the price of stocks?

> Once almost everyone invests in index funds, what will determine the price of stocks?

there are hundreds or thousands of index funds, all investing in different subsets of the market. money flowing back and forth between those funds will shift the relative value of their underlying sets.

also all the other answers, such as, that's unlikely to happen.

>>what will determine the price of stocks?

Do you think active investors determine the price of stocks now?

The active investors who are left of course.

True with a caveat: they will never balance completely because of taxes and fees - active traders and funds will always underperform in aggregate.

You can't assume that we'll reach equilibrium in a different future situation given that we're not in equilibrium at the moment.

Matt Levine of Bloomberg has a newsletter called Money Stuff that talks about this concern a lot. There are certainly many serious people who take are worried that too much index based investing will / is leading to inefficiencies.

>> There are certainly many serious people who take are worried that too much index based investing will / is leading to inefficiencies.

It definitely is / will in the future, and they will be capitalized on. This isn't really a catastrophic event.

That column is really interesting and informative, I always check it out when he posts.

I don't think this is necessarily the case. I think if you're warren buffet, you should invest in index funds. If you're not warren buffet, this strategy runs the risk of being horrifyingly bad. For many people their job prospects may be procyclical - it's easier to get a job when the overall market is high and it's easier to get laid off when the overall market is in the pits. For these people, investing in index funds could lose money.

This gets back to time horizon and risk tolerance, which are independent of return.

These are two things you should think about when investing no matter what the vehicle is.

That never happens. There will always be people who want to be different from the herd. Any inefficiencies will take care of themselves.

>Any inefficiencies will take care of themselves.

Thats a ridiculous thing to say when the inefficiency here would represent your investments getting wiped out

making less money isnt the same thing as being whiped out.

This is the beauty of the capital markets. Shifting trends, money, assets from A to B will create new opportunities which will cause people to chase those - thus causing new trends and flows to emerge. So, I dont think we can ever get to a world where everyone moves all their chips into index funds.


this whole study is based on the equities market, and there are many many capital markets out there with much higher returns.

the individual? right, none of these markets are so optimal for retirement, they are optimal for great returns though

this study wasn't about the individual, it was about funds of funds that were picked pretty unoptimally and most likely were also in the equities market.

what is the individual to do? hey maybe your conclusion was right, but I don't find 85% over ten years to be great, even factoring in dollar cost averaging and dividend reinvesting. so there is the possibility for the individual to learn and take risk or find a fund that is more suited to the market you would like to get returns in.

If anyone finds this surprising I'd highly recommend reading 'Smarter Investing' by Tim Hale, which does a great job of advocating for index-based positions. With the exception of C, those fund-of-funds have done incredibly badly.

One of the interesting things Tim discusses is that this poor performance compared to market tends to make investors second-guess their investments (often for good reason looking at those returns), and buy into the fund that did well last year instead. So you're also getting into a sell-low-buy-high routine.

Question for financial types: For a few years I've owned a small selection of shares in FTSE companies (15 of them at the moment). I don't really do this scientifically, I just look for large, well-established companies where their shares look cheaper than long run, and buy those. (Partly I do this so I can see everyday companies that I own a tiny bit of). Is this practically equivalent to owning index-linked funds? Am I missing out? I plan to hold them for many years, and it's mostly "play money".

There's two parts to this answer.

First, the numbers thrown around are that once you own 15 diversified stocks you have reduced your portfolio risk by 70 percent. That's not bad. At this point your volatility may not be that different than a market index. Of course it's different for every set of stocks, but I think this is a safe-ish guideline. So in that sense you are not missing out a whole lot.

Second, and more importantly, it is very simple to put together 15 stocks with a low volatility, but also with very low returns. This is because the vast majority of the returns of an index come from a very small number of outperforming stocks. It's like the 90-10 rule. 90 percent of an index's performance comes from 10% of the stocks. Those aren't the exact numbers, but when you only pick 15 stocks, it is very likely that you will totally miss out on all outperforming stocks.

Here's an article that talks about this in more depth and uses real numbers: http://www.efficientfrontier.com/ef/900/15st.htm

>>This is because the vast majority of the returns of an index come from a very small number of outperforming stocks.

This is the only thing the parent commenter needs to read to understand why indexing is not equivalent to owning 15 stocks that theoretically reduce portfolio risk (my guess is that the stocks are highly correlated and have too high of weight towards IT and not enough towards boring fields like industrials).

Actually the opposite. Being in IT, I never buy IT stocks. They're mostly everyday brands and industries.

>>Being in IT, I never buy IT stocks.

That, ah, is even worse. Your diversification... isn't. Just because you have a job in IT doesn't mean that's adequate exposure. There is a large difference between a paycheck and investments in the large cap IT sector.

Why not? I do the opposite -- I only invest in stocks in industries I know something about. It's the only appreciable alpha I have.

I wrote out a whole response (then deleted it) with that link in mind - perfect example with the other commenter's number (15). Didn't even know Bernstein's old site was still on anyone else's radar!

When you hold a fund (an ETF specifically) you are letting the fund manager do a lot of work for you for usually very low cost (10-20 basis points a year). That work is mainly maintaining exposure to the index. A large-cap broad-based ETF will probably hold more names than just the 15 you are holding. The benefits of that are more diversification (potentially lower vol), and regular rebalancing. So crummy names get dropped out and good ones get added in - usually with no tax consequences for you. If you manage your own portfolio of 15 names - you might argue that you could generate tax credits for yourself (tax loss harvesting) which could prove beneficial in certain situations.

No it's precisely the opposite. You're gambling that you can beat the market for those 15 funds, index linked funds are gambling that the value of the market (index) as a whole will increase and will try to perform to the market. To do that they buy shares in all of the companies that are in the linked index (in proportion).

Okay so any leveraged real estate fund would have outperformed the S&P500, without the possibility of a sudden margin call

Any leveraged bond fund should have been able to as well, a carry trade from 2012 in European government bonds should have made many hundreds of percent

A futures fund should have been able to

A commodity options should have made monumental gains over the 85% that the S&P500 gave in 10 years, honestly should have made that in a month

A fund that did what Warren Buffet got rich doing, by buying up bad companies and improving, should still have gotten high returns

And finally, there were simply no cryptocurrency funds around!

The problem, I say smugly, is that these fund of funds were probably all macro funds with too many assets under management, making them hard to manage in the niche markets I proclaimed.

A fund with 1 billion AUM cannot manage that much real estate without eating into the management fees. There is not enough liquidity in the options market, and definitely not enough liquidity in cryptocurrencies.

But this unfortunately influences perception that "NOBODY" is able to make / promise more than 5% a year over several years. This is false but I'm not going to try to change your mind. Consolidating capital with someone managing <500k to around 25 million should be able to consistently take advantage of these less scalable opportunities for great profits. After all, it is how Warren Buffett himself got 100s of thousands of percentage gains in his hedge fund of $105,000.

The problem for the every-person is finding the one that succeeds rather than fails. Given that in the aggregate these investments so severely underperformed, we can conclude that on an weighted average basis, you were more likely to lose money than gain money.

No one disputes that some funds will over perform. The question is, which one? If you can predict that reliably, you will be rich.

Most people can't.

Not just predict which ones, but get them to take your money too. AFAIK, many of the ones that are performing really well don't want to expand their AUM that much and so don't advertise and won't take just anyone's money.

If you can predict that reliably and no one else can, you will be rich.

>>But this unfortunately influences perception that "NOBODY" is able to make / promise more than 5% a year over several years.

This is not what people think. What people think is that you have cherry picked a bunch of asset classes above and neglected others that would beat the US Large Cap index over that time frame, but you cannot guarantee that those same asset classes would handily beat the same index over the next decade.

If you can (Medallion fund type legends), then you aren't seeking my money, typically.

So do you mind telling us which funds have a 100% certainty of >S&P500 performance over the next few decades please?

sure, pretty much any options selling fund, pretty much any carry trade fund, pretty much any leveraged bond fund

you can sell options on the S&P index to amplify returns of passive S&P500 investing

if you blow up, you didn't manage risk right. rinse and repeat. the returns should be higher, especially over a decade.

Easier said than done: http://canadiancouchpotato.com/2010/01/26/the-trouble-with-l...

You basically have to continuously time the bull-markets for the decade.

a decent rebuttal but everything I actually mentioned would have beat the S&P500 over the last decade.

the only fund of funds that took warren buffet's bet happened to lose.

ETFs are typically passive and have limits to the leverage. I didn't mention exchange traded funds.

Quibble... Buffet doesnt buy bad companies. He buys solid companies that have excellent management and for some reason are inexpensive at the time of purchase.

> We show that Buffett’s performance can be largely explained by exposures to value, low-risk, and quality factors.

That is, they used a factor analysis to decompose his performance by its correlation with academic "factors" which explain cross-sectional stock market returns.

In "Buffett's Alpha" by Frazzini, Kabiller, and Pedersen: http://www.econ.yale.edu/~af227/pdf/Buffett's%20Alpha%20-%20...

Not anymore. Before he became the baby boomer conservating investor guru he made his millions borrowing in leveraged investments to buy the "cigar butts" of the equities market. Companies which had poor management.

Any investment in the S&P500 that was as leveraged as the mentioned leveraged real estate or bond funds would have outperformed both the S&P500 and those two funds. It is easy (though not usually prudent) to create a leveraged investment in the S&P500 by buying it on margin.

Although there is still tons of money going to actively managed funds it seems to be more and more common knowledge that index fund investing is ultimately the smartest thing to do for personal finance.

Does anyone know what the risk factors are (if any) to this type of passive investing if EVERYONE begins to do the same thing?

I had an interesting conversation with a very smart investor last year, and basically his idea was that while active managers will sell certain specific stocks (less volatile stocks) to fulfill redemptions in the event of a decline and/or crash, ETFs will generally just hit an (automated) sell on everything across the board. So proportionally they will sell off significantly more volatile small and midcaps vs large caps.

Every since I have had that conversation, I no longer invest in passive index funds or ETFs.

>>basically his idea was that while active managers will sell certain specific stocks (less volatile stocks) to fulfill redemptions in the event of a decline and/or crash,

This is true and leading to very good insight.

>>ETFs will generally just hit an (automated) sell on everything across the board. So proportionally they will sell off significantly more volatile small and midcaps vs large caps.

This is absolute nonsense and something you hear from active investors pitching you an anti-index fund strategy. Index funds and ETFs tracking indexes will not have some absurd sell off that disrupts equilibrium, they will... just proportionally adjust to the index, since that is what they do.

Did your smart investor friend go into detail how this massive disruption could occur (what conditions would cause such a cyclical crash, because the only thing we have in our past that even comes close is the Great Depression, and had index funds existed then, it's not likely this activity would occur) or what the details are?

This is incorrect, especially with ETFs. With an ETF, the seller/buyer (the individual, not the fund) pays all of the transaction costs. So buying and holding an ETF doesn't expose you to the problems which the behavior of panicking investors^. The same is not always true for mutual funds.

caveat: Vanguard index funds may be special and this doesn't apply to the same extent because the ETFs are a dual share class of the larger mutual fund.

But you are still exposed to the market, which can decline significantly. People will withdraw money from their passively managed funds when the market starts tanking. We have no idea what will happen in the next 'fear trade' when everyone starts dumping shares.

Stocks can go crazy and this could create a death spiral on the ETFs, because an ever more frequent decline can lead to significantly more volatility in small and midcaps, and more people withdrawing funds from their ETFs, which in turn will cause more liquidations.

All reasoning (to some extent) is lost as to which assets to liquidate. Actively managed funds will generally liquidate assets that don't cause too much swings in share prices in a downturn. Liquidating $50MM worth of Google won't make a big difference, but liquidating $50MM worth of SmallCap generally will put significant pressure on the share price. On the flipside: imo it does create a significant buying opportunity when it comes to small cap stocks.

Tl;dr: in my view, the more money that ends up being managed passively, the easier it will become to beat the market as an active investor.

There are two concerns: transaction costs (tracking error relative to index return) and index return.

Those who believe in generally efficient markets want to capture the market return, however volatile, with as little tracking error as possible. Since the ETF holders don't actually sell any stocks when the prices decline, their returns are temporarily depressed. If and when prices recover so too will their value.

There is nothing unique about ETFs in this respect. Your critique is more about index funds in general, not ETFs specifically. ETFs practically differ from mutual funds only in things like transaction costs.

re your tl;dr: Sharpe's theorem shows that active investors will underperform passive investors after costs. Notice that this does not depend on the number of passive investors (and certainly at this point we're nowhere near any of the percentages of passively managed assets which people say may be worrying).

Overall, I do not think your critique is well-informed by the facts.

To each their own investment style (and there are many), but markets (in my view, and in the view of many others) are not efficient. (More than) half of what determines the stock price is psychology and herd mentality. It's not just numbers, and more an art than it is a science. Larger cap stocks however are generally priced more correctly than small- or mid cap stocks.

Second to that is that your returns will also depend on the risk you are willing to take. Investing through index funds and ETFs will correlate with a certain alpha, but that doesn't mean returns can't be higher if you are less diversified (and thus taking more risk).

Depending on the type of companies you are investing in, you might be comfortable taking a bigger risk with the goal of achieving a higher return.

Say you're working in technology and truly understand it, you can probably outperform the market significantly by investing in 3 to 5 technology stocks. Is it riskier? Yes. Is it worth it? Some people will say yes, others say no. And that is absolutely fine.

> Investing through index funds and ETFs will correlate with a certain alpha

Thank you for showing others that you do not know what you are talking about.

>>Investing through index funds and ETFs will correlate with a certain alpha

This sentence actually means nothing.

>>People will withdraw money from their passively managed funds when the market starts tanking.

Yes, some will. Many will also counter this by buying up the same assets as the price drops.

>>in my view, the more money that ends up being managed passively, the easier it will become to beat the market as an active investor.

This is absolutely true but also has nothing to do with your friend's legitimately unbelievable scenario.

So Buffett's $1M bet wasn't enough to convince you that passive beats active?

Hedge fund are basically a compensation scheme masquerading as some sort of smart money management thing.

What's great is that the debate of passive vs active will go on forever - There will be periods where one outperforms the other - sure. But in the end, net of fees - active cannot win consistently, on average. Its human nature to believe we can beat the casino.

ETF funds themselves do not buy or sell anything. They exchange their own units for the indexed basket of shares.

Why is that a problem? Because it gets less diversified?

For context the losers argument is that Buffet picked a good team in a good period and he would have a good chance in a second cycle. https://www.bloomberg.com/view/articles/2017-05-03/why-i-los....

A weak attempt at damage control.

He keeps reiterating his parole that experts who actively select assets know more then the average Joe.

Even though the average Joe just completely blew them out of the water over a whole decade :)

I agree that said experts probably don't know enough to justify their cost.

But if the conclusion one draws is that the US large cap stock market is the place to put your money for the next 100 years just because it was great the last 100 years, I think that's the wrong lesson. Of all the markets in all the countries in the world, and all the asset classes, the US stock market has been an outlier for a long time, and it can't continue forever. Like Moore's law, and declining interest rates, and population growth, every trend stops somewhere since it would otherwise eat the world. Generally right at the point almost nobody is left to bet against it.

There is no such thing as completely passive management - someone at least selects components of an index, and you at least choose which index and that is always going to be pivotal with respect to investment success. I don't think there is logically any way around some degree of deliberate selection of assets. All people can do is pay less for the illusion of expertise.

Isn't that last sentence the whole point, though? I thought that index funds didn't generally do better than actively managed funds in terms of raw returns, they just didn't do much worse, and the vastly lower fees mean that you come out ahead overall. The point of an index fund isn't to attain some sort of stock picking nirvana where nobody's really picking anything, it's just to get a fee of 0.04% instead of 2%, or whatever.

One could be cynical, and observe that US business interests have the world's largest, most agressive and equipped intelligence and military force protecting its interests - it can be an outlier just as long as a robber baron can...

Or one could be even more cynical, and observe that China appears to be pouring "hard" power behind decades of "soft" power build-up...

Reading his 'footnote' - he still does not seem to get it. The fact is precisely because of all these factors (among others) Warren was so confident in this bet. He knew the terms and the environment very well before taking on the bet. Calling the outcome the result of 'anomalous' market behavior is just denial at this point.

That's a pretty weird story. His "expert" ability at picking funds is what was being tested. He then goes on to give his "expert" opinion on why his expert opinion failed.

Yes, it's totally possible that Buffet just got lucky. But of the five stocks, over the 9 year period (45 data points), there are only 9 data points where a fund beat the S&P for the year. They all beat the S&P the first year, then for the next 8 years there were only four instances of a fund beating the S&P, and the S&P won for the other 36 data points.

If we were to assume that the funds vs the S&P was an equal playing field (each side had a 50% chance of winning), then there's just a 20% chance that Buffet just got lucky. But the point of actually paying a fund for advice isn't to just have equal odds, the funds are supposed to beat amateurs, and by a significant margin.

What we consider "significant" is obviously open to interpretation. But the most significant win a fund had over the S&P was in 2015 where fund C beat the S&P 5.4% to 1.4%, almost a 4x higher return. But the S&P had larger than 4x returns than the funds 12 times. I'm not exactly sure how to work all of that into a probability, but it's looking like the odds that Buffet just got lucky is pretty close to zero.

Typo on the 20% chance (that's actually the percentage it lost). The actual probability is about 1/(2^13).


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