Tag Archives: investment

Is Hope For Active Management Right Around The Corner?

By DailyAlts Staff Investors are looking closely at the role of active management relative to passive investing products such as indexed ETFs, and for good reason: Between March 2009 and the end of 2014, less than one-third of active managers beat the broad stock market’s returns. Why should investors pay management fees for active products that fail to generate positive alpha? Perhaps they shouldn’t, but Neuberger Berman’s Juliana Hadas, CFA, and Andrea Pompili argue that the major factors that have contributed to active managers’ underperformance over the past five years are about to change, and that the investment environment is likely to become much more hospitable to active managers in the very near future. Ms. Hadas and Ms. Pompili make their case in the recently published whitepaper, Can Active Management Make A Combeback? “Post-financial crisis underperformance by active portfolio managers is easily explained and, we believe, only temporary,” they write, before outlining three major fundamental factors suppressing active managers’ returns: Unprecedented central bank stimulus leading to ultra-low interest rates; The magnitude of the bull market in U.S. stocks since 2009; and Flows into passive investment vehicles, such as index ETFs. Ultra-Low Interest Rates Ms. Hadas and Ms. Pompili argue that the Federal Reserve’s policy of keeping benchmark interest rates near 0% have created “valuation distortions in the market.” When companies can borrow at low interest rates, they can finance expansion with debt, rather than with cash flow from operations. What’s more, low interest rates narrow the valuation gulf between near term and more distant cash flows, making further out and more speculative cash flows comparatively more attractive than they would be in a higher interest rate environment. The good news for active managers is that the Fed appears to be preparing for an interest rate hike some time in 2015; quite possibly as early as June. Higher interest rates will result in higher financing costs, thereby sharpening the distinction between firms that have been generating profits with easy money financing, and those that have been generating profits through efficient operations. This discrepancy between companies will make it easier for active managers to beat the broad market’s beta returns, whereas the low level of return dispersion in the U.S. stock market over the past five years has made generating alpha difficult. The Stock Bull Market Since ’09 Low interest rates have helped propel the bull market in stocks since 2009, since low financing costs make it easier for U.S. companies to generate profits. According to Ms. Hadas and Ms. Pompili, 70% of the S&P 500’s returns over the past 20 years have been based on earnings, and with earnings generally easier to come by, there has been a low level of dispersion between U.S. large-cap stocks. Another way low interest rates have contributed to the bull market in stocks has been by suppressing bond yields, and thereby encouraging greater risk-taking by income-oriented investors. Stocks are generally viewed as riskier assets than bonds, and investors are taking on greater risk in the face of bond yields well below 3%. But with interest rates expected to rise later this year, that trend is likely to reverse, which should provide opportunity for active investment managers. Passive Indexing Trends With U.S. large-cap stocks generally trending higher over the past five years, it has been more difficult for active managers to beat the market’s “average” (beta) returns. This is a function of the math: If the S&P 500 returns 30% above the risk-free rate of return, and an active manager had a portfolio with a beta of 0.9, then the portfolio would have to generate more than 3% alpha to outperform the market. But if the S&P 500 only exceeded the risk-free rate by 5%, then an active portfolio would only have to generate a little more than 0.5% alpha to beat the market. In somewhat of a vicious cycle, this mathematical reality has led more investors to dump funds into passive index funds, but these funds are inadvertently momentum investments, since they’re market cap-weighted. Investors buying the SPDR S&P 500 ETF (NYSEARCA: SPY ), for example, buy into all 500 components of the S&P 500 in proportion to their index weightings, without regard to the specifics of each company. Large companies that get even larger end up taking up a greater share of the index. Should the markets turn, and active management delivers, then the trend of migrating to indexed ETFs may slow. Conclusion As Ms. Hadas and Ms. Pompili point out, the performance of active managers versus the broad market’s benchmarks tends to be cyclical and to improve during less exuberant bull markets. Once interest rates begin rising, the “valuation distortions” caused by “aggressive central bank easing” will likely reverse, in the view of the whitepaper’s authors, “creating a market environment in which underlying company fundamentals start to once again matter more.”

My Confessions As A Gambler And Why You’re Likely One Too

Summary What it means to be a gambler and you are likely one as well. Characteristics of a gambling investor that you should be aware of. Simple ways to avoid future losses that are easier said than done. I have a confession. I’m a gambler. Well, before you jump articles, let me explain what I mean by being a gambler. The Gambler Gamblers are “investors” who, more likely than not, invest in companies using gut feelings and baseless pseudo-scientific calculations to back their decisions. But more than that, gamblers are nervous, impulsive and tend to always jump the gun. Successful investors have their minds under control through experience, genetics, or just sheer will power. For years, psychologists have studied what constitutes human decision-making. They discovered that humans are pretty much systematically irrational. We tend to consistently act in an irrational manner in certain situations and when making certain decisions. When this discovery was later applied to investing, the field of behavioral finance was born. Rediff This Motley Fool article also tackles the phenomenon called cognitive dissonance: It’s the term psychologists use for the uncomfortable feeling you get when having two conflicting thoughts at the same time. “Smoking is bad for me. I’m going to go smoke.” Is it possible to become a real investor rather than just be a gambler? Yes. So How Do You Stop Gambling? First, recognize the need for improvement. Do not be content with what you already have. Always strive to know more and always strive for the best. If you don’t want to be a gambler, then you should get your emotions under control by knowing your tendencies when the going gets tough. Here’s a previous article I wrote about the need to understand your emotions . But what about the following? Blaming Wall Street Do you blame Wall Street for your investment decisions to feel better? Instead, learning from your failure can only improve you as an investor. Holding on to Losing Stocks Too Long Do you hold on to a losing stock just to prove you are right? Ask yourself, is this just a matter of stubborn pride or is there a fundamental reasoning to this decision. Wanting People to Say What You Want to Hear: Confirmation Bias Are you looking for articles or people to confirm your thoughts on a particular investment? Do you Google phrases like “no need for vaccination”? Naturally, since your keywords are so specific, the results you get will match what you want to find. Overconfidence – The Silent Killer Here’s the kicker. Overconfidence. Total certainty or greater certainty than circumstances warrant Get on a good roll and you feel like you can conquer the world. Confidence is important, but overconfidence is a killer. Bill Gates said: Success is a lousy teacher. It seduces the smart people into thinking they can’t lose. Lesson of the Day? Follow the chart below. Avoid being emotional, biased and overconfident. The side effect of this is that more people will like you too. The best advice I hear from veteran investors is to know yourself. Know your own quirks and be objective about it. Listen to different opinions by always having an open mind. Easier said than done of course. I’ve greatly reduced bad gambling decisions over the years with the use of checklists , processes, and cold hard facts with my analysis tools. But I’d be lying if I say that I was 100% perfect. Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it. The author has no business relationship with any company whose stock is mentioned in this article.