Dare to Be Different

Topic: Pearls of Wisdom

John C.A. Stevenson CFA

August 11, 2017

Image used with permission: iStock/masterzphotois


Print & Share

Print

Dare to Be Different

The financial media love to write stories about how improbable it is that a firm like Nexus might be able to do better than the stock market.

In October 2016, The Financial Times ran a headline that exclaimed that “99% of Active U.S. Equity Funds Underperform.”1 As shocking as that sounds, perhaps it should be no surprise since academics traditionally have told us that the stock market is efficient as all information is quickly and completely discounted in stock prices. The implication is that “alpha” – the amount by which a manager beats the market – can only be the result of luck, not the result of sustainable and repeatable skill. Even Warren Buffett, one of the greatest generators of “alpha” of all time, recommends that the average investor avoid active management and use low-cost index funds.

All of this is frustrating to those of us at Nexus as it is clearly at odds with our experience. Not only have we beaten the market in the past, we are confident that our investment approach will allow us to do it in the future. Not every quarter or every year – we know we’ll have bad patches – but we are confident we will be successful over time. Are we kidding ourselves?

We recently came across an investment piece that tackled this issue head-on.2 To start, the data reviewed in the paper simply don’t support the contention that it is hopeless to think you can beat the market. An analysis of 2,933 equity mutual funds tracked by Morningstar in the U.S. show that a meaningful number of funds do beat the market. Anywhere between 30% and 43% of these funds beat their respective benchmarks over every measured period between 1 year and 15 years.3 Moreover, the author then linked this data to a paper written in 2009 by two Yale School of Management professors in which they first described a now-popular concept called Active Share.

We’ve discussed Active Share in the past – it is the fraction of a portfolio that is different from the relevant stock market index. Active Share of 0% means that a portfolio is a perfect mirror image of the index; 100% means it shares nothing in common with the index. What Cremers and Petajisto discovered was that nearly a third of all US equity funds had very low Active Share – they were little different from the index, or “closet indexers”.4 More significantly, they discovered that Active Share significantly predicts performance relative to the relevant benchmark. Low Active Share funds often underperform, which makes sense as how would one expect to outperform if there is little difference from the index and a fee is charged for the service? Conversely, high Active Share funds typically do outperform, and the higher the Active Share, the greater the chance of outperformance. This makes us feel better. Nexus makes no attempt to follow an index and our portfolios have high Active Share. So maybe our confidence about the future isn’t so crazy after all.

1 The Financial Times, October 24, 2016.
2 Jim Atkinson, “The Pursuit of Average”, Guinness Atkinson Investment Management, July 2017.
3 The analysis looks at 1, 3, 5, 10 and 15 year periods ended June 30, 2017.
4 Martijn Cremers and Antti Petajisto, “How Active is Your Fund Manager”, Yale School of Management, March 31, 2009.

More Like This...

See another CRM2 blog post that may be of interest to you.

CRM2: The Nexus Approach to our CRM2 Reports

Topic:
CRM2
Excerpt:
With changing securities regulations coming into effect, investment firms are now required to provide individual investors with specific additional in

More Like This...

See another Foundations & Endowments blog post that may be of interest to you.

Charitable Giving Made Easier

Topic:
Foundations & Endowments
Excerpt:
Giving to charities and supporting our community are important to us at Nexus. We donate a portion of our management fees back to the charities and

More Like This...

See another Human Interest blog post that may be of interest to you.

The Case for Openness – An Open and Shut Case?

Topic:
Human Interest
Excerpt:
From time immemorial, mankind has been open. Open to new ideas, open to trade, and open to migration – the three critical ingredients for progress.

More Like This...

See another Inside Nexus blog post that may be of interest to you.

Embracing the Golden Years: A Journey of Reflection and Wisdom

Topic:
Human Interest, Inside Nexus
Excerpt:
It was an otherwise slow mid-afternoon trading session on the “old” floor of the Toronto Stock Exchange at 234 Bay St. The dog days of summer had

More Like This...

See another Investments blog post that may be of interest to you.

From Vineyards to Portfolios: Cultivating Long-Term Wealth

Topic:
Investments
Excerpt:
My wife and I have been stymied so far this summer in getting to the Niagara region for our annual weekend of cycling through the vineyards and

More Like This...

See another Pearls of Wisdom blog post that may be of interest to you.

“Work, Work, Work, Work, Work, Work”

Topic:
Pearls of Wisdom
Excerpt:
This has been a busy year. I’ve had lots happening on the home front (a wedding!) and lots going on at the office (too long to list!) Managing work

More Like This...

See another Tax Planning blog post that may be of interest to you.

Saving in my Professional Corporation – It’s a Great Idea!

Topic:
Tax Planning
Excerpt:
The ability for professionals in Canada to incorporate their practice has existed for some time. Doctors, dentists, lawyers, accountants, and other

More Like This...

See another Wealth Planning blog post that may be of interest to you.

Dentists Get Their Financial Check-Up: Nexus attends the 2022 Ontario Dental Conference

Topic:
Wealth Planning
Excerpt:
In early May, we had the opportunity to attend the Ontario Dental Association’s (ODA) Annual Spring Meeting (ASM) in Toronto. Now in its 157th year,

On a Side Note…

See another CRM2 Nexus Notes Quarterly article that may be of interest to you.

No posts found.

On a Side Note…

See another Foundations & Endowments Nexus Notes Quarterly article that may be of interest to you.

Charitable Giving Made Easier

Topic:
Foundations & Endowments
Excerpt:
Giving to charities and supporting our community are important to us at Nexus. We donate a portion of our management fees back to the charities and

On a Side Note…

See another Human Interest Nexus Notes Quarterly article that may be of interest to you.

Worth 1,000 Words

Topic:
Human Interest
Excerpt:
A little humour makes the world a better place.

On a Side Note…

See another Inside Nexus Nexus Notes Quarterly article that may be of interest to you.

Where Have All the Boutiques Gone?

Topic:
Inside Nexus
Excerpt:
Many small, once independently managed, firms have fallen into the clutches of larger organizations such as banks, institutional money managers and

On a Side Note…

See another Investments Nexus Notes Quarterly article that may be of interest to you.

Don’t Worry, Be Happy

Topic:
Investments
Excerpt:
A recent article by David Brooks in The Atlantic magazine argues that, despite the heavy shroud of pessimism that envelopes most of our current

On a Side Note…

See another Pearls of Wisdom Nexus Notes Quarterly article that may be of interest to you.

Pearls of Wisdom

Topic:
Pearls of Wisdom
Excerpt:
Reading is one of the principal occupations in our profession. As we digest a wide range of material, interesting ideas and surprising facts – some

On a Side Note…

See another Tax Planning Nexus Notes Quarterly article that may be of interest to you.

A Nexus Feature on: First Home Savings Accounts (FHSA)

Topic:
Tax Planning
Excerpt:
The FHSA is a registered plan to help Canadians save for their first home and could play a role in either your or your adult child’s overall wealth

On a Side Note…

See another Wealth Planning Nexus Notes Quarterly article that may be of interest to you.

From The Editor: Planning for Long-Term Care

Topic:
Wealth Planning, Living to 100
Excerpt:
As part of our Living to 100 series, Nexus hosted a client event in June featuring guest speaker Karen Henderson, an expert in long-term care planning