Wednesday, January 19, 2011

Four Videos

1. A young British dude tries to see if he can make a basic appliance like a toaster to demonstrate the advantages of comparative advantage, specialization and the fallacy of economic self-sufficiency.

2. Watch how a memory chip is made, starting in Utah, ending in Asia, and then available in your local retail store.

3. Dan Mitchell on how to save Social Security with Personal Retirement Accounts.

4. "Random Walk Down Wall Street" author Burton Malkiel appears on John Stossel's show to debate index investing vs. managed funds with a Fox Business reporter. I think Burton wins.


At 1/19/2011 4:12 PM, Blogger Taylor Frigon Capital Management said...

Hi Professor Perry -- love your blog -- long-time listener, first-time caller -- have to disagree with Mr. Malkiel and believe that his argument is fallacious -- in fact, I'd argue that the idea that analysis of securities is a waste of time contributed greatly to the 2008 panic (institutional investors fell for it as well) -- we discuss here:

and post our independently-verified active management record over the same period here:

Very respectfully,

Dave Mathisen
Taylor Frigon Capital Management

ps -- would you select the company where you work for your career using darts?

At 1/19/2011 8:50 PM, Blogger Hydra said...

Most companies offer competitive salaries and benefits, one way or another.

If one selected by dart, would it make much difference?

The anology is week because you do not have to interact with your equities all day.

At 1/19/2011 10:06 PM, Blogger Benji40 said...

Excellent post, the reason this is the first blog I check every day.

At 1/19/2011 11:50 PM, Blogger Buddy R Pacifico said...

This comment has been removed by the author.

At 1/20/2011 12:15 AM, Blogger Buddy R Pacifico said...

Indexing vs. Managed Funds:

If one looks at the iconic S&P 500 Index (SPY) then it is worthwhile to look at its long term chart. The historic SPY chart shows its peak in 2000 that took another seven years to return to. My personal opinion is that the S&P 500 committee gives to much weight to high PE/capitilization when bubbles are occuring.

Thus, the high during the dot com or internet bubble for SPY. A value oriented manager would get out of high PE stocks if he or she was competent. Other types of fund managers who are not Buffett type value investors probably don't beat

At 1/20/2011 12:39 AM, Anonymous Anonymous said...

Mr. Mathisen, to be fair to Malkiel and most of the efficient markets crowd, they do admit that there are a few standout active managers like Buffett who beat the market. They just say that it's difficult to pick Buffett out ahead of time and there's no guarantee he won't fall off a cliff someday, like Bill Miller did after beating the market for years. While I agree that some of the efficient market crowd goes too far, they are essentially making an empirical argument that is tough to argue with, ie almost nobody other than Buffett has beat the market consistently over a long time period. I actually think this is largely because most funds go about it the wrong way and there may be some truth to the notion that active managers inject discipline into the market which leads to the index funds' returns, but you can't argue with the subpar long-term returns for most actively managed funds over the last 50 years, when compared to index funds.

At 1/20/2011 10:17 AM, Blogger Buddy R Pacifico said...

The memory chip video states that thousands are employed in production. The video seems to indicate that thousands of humans are employed in Asia and thousands of robots in the U.S. Is the new frontier for productivity faster robots?

At 1/20/2011 11:02 AM, Blogger Taylor Frigon Capital Management said...

Good points. We have also argued in the past that the large mutual funds used as evidence that "few beat the market" are a poor proxy for active management. Due to their large size (and the assets in mutual funds are very concentrated in the largest funds and fund families), these funds are typically forced towards more "market based" decisions rather than "fundamental company-based" decisions (large mutual funds with tens of billions in assets cannot own smaller cap companies, and therefore are forced to select from the smaller pool of larger cap companies, and therefore in order to differentiate themselves must trade more on quarterly market movement rather than differentiating themselves by selecting different companies that their competitors don't own). To say, as some efficient market advocates do, that one should go to a completely market-driven strategy (such as indexing) because mutual funds (which are disappointing because they are more market-driven than fundamentals-driven) I think is a mistake. For further discussion of this topic, one could search our blog for posts such as "Dance of the Hippos" and the term "deworsification."

Also, the argument that it is hard to know which active manager will beat raises the point that we believe the average individual can do better than the market, if he puts in the required time and effort and selects good companies, so that he doesn't need to worry about finding an outside manager.

At 1/20/2011 11:15 AM, Blogger Taylor Frigon Capital Management said...

Finally, one further point from Mr. Sprewell's argument that "They [proponents of EMT] just say that it's difficult to pick Buffett out ahead of time and there's no guarantee he won't fall off a cliff someday, like Bill Miller did after beating the market for years."

In fact, active managers who beat the market typically do not beat it year-in and year-out, but rather in spurts. More than one academic study has verified that, of active managers who beat over long periods, almost all of them (over 90%) suffered through periods of underperformance of at least THREE YEARS. That is a startling statistic, but makes some sense when you think about it (see our post entitled "And now a word about annual performance numbers"). If you look at the records of outperforming managers cited by Warren Buffett in his famous 1984 address at Columbia, you will see this phenomenon in action. Thus, to say that because an active manager who outperformed consistently for years suffered through some underperformance is a bit of a straw man, in that nobody (at least not I) is arguing that in order to disprove the efficient market hypothesis one must beat the market over every single one-year period without ever experiencing any underperformance. I certainly would not make that claim using an interval of one day (you must beat the market every single day), so I would not make it for a relatively short period such as a year either. There are years in which the good companies one owns are simply out of favor, even if their four- or five-year prospects are excellent and will reward the patient investor. This is something that individual investors should carefully consider and understand, because impatience during those periods of underperformance can hurt their returns severely (most investors today, I fear, would have bailed out of the portfolios managed by most of the outperforming managers mentioned by Warren Buffett in that 1984 speech, which would have been to their loss).

At 1/20/2011 1:31 PM, Anonymous Anonymous said...

TFCM, I don't believe the returns are any better for most smaller actively managed funds over a longer time period, nor should the smaller funds be left out of a proper comparison. Also, presumably large mutual funds could still invest in smaller actively managed funds that can in turn buy small cap stocks. Well, if an individual investor can pick the stocks himself, perhaps he could pick the manager too. ;) The problem is that most retail investors are too clueless to do either right, but I think there is certainly a lot more scope for the minority of enlightened individual investors to either pick a sector to bone up on and invest in themselves or at least try to pick a handful of good active fund managers.

I agree that beating the market every single year is not a good measure, cumulative long-term returns is all that should matter. I just picked Bill Miller as an example because obviously if you beat the market for 15 years straight like he did, you're going to come out ahead in cumulative returns too, at least until you fall off a cliff and lose 75% of your gains, giving back all those returns. ;) Perhaps most investors' impatience is another reason why they'd be better off with index funds, where you'd be getting out of the entire market if you pull out early. In sum, the vast majority of investors in actively managed funds today would probably be better off going passive, but there's always going to be a small minority that is smart and knowledgeable enough to pick good active managers or invest themselves. I actually think the big opportunity these days is in seed investing, particularly tech, but sadly almost nobody is going after that right now. I hope to get into that myself someday.

At 1/20/2011 1:39 PM, Anonymous Anonymous said...

It would be interesting to see a breakdown of precisely why passive index funds have beaten most active funds historically. I would guess a lot of it is that index funds are exposed to positive black swans that most active funds cannot find, as they come out of nowhere. Another hypothesis is that active funds make it worse by just using crude or backward-looking metrics, overloading on large firms where there isn't much room for growth, or just turning over their portfolio too much. That's an analysis I'd pay to read. :)


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