Many people believe that it’s impossible to achieve above-market investment returns over any reasonable time period. Sure, some lucky person, this reasoning goes, may beat the market for a year or two, but anything beyond that is highly unlikely. This belief comes from a number of sources: 1) the notion that the market is efficient, and that all stock prices already reflect all future expectations and 2) academic studies which show that mutual funds, in aggregate, tend to underperform the market adjusting for fees and taxes. These are powerful notions, and have led to a huge boom in the index approach to investing. Because you can’t beat the market, the logic goes, you might as well just own the market. Stock pickers in this kind of world are something as useful as a screen door on a submarine.
So imagine my joy (recall that I am a self-professed stock picker) this weekend when I read an article in Barron’s which suggested that skilled portfolio managers and stock pickers actually can make a big difference in performance. Huzzah! My entire career hasn’t been a waste of time!
In the article entitled (“The Alpha Advantage”) two professors from the University of Maryland conducted a study which showed that “good active managers do create value and their collective portfolio offers fertile ground for individual and institutional stockpickers.” The study concluded that one could beat the market by 4 percentage points by systematically harvesting the best stock selections from the fund industry. As with any academic study there are caveats and provisos – according to the authors, this method of investing would be expensive and difficult to actually implement in the real world, but still, it’s a rare bit of good news for those who think they can beat the market.
I do not have an audited investment track record that could be offered as evidence of my own stock picking prowess. On the other hand, I have never been burdened by the regulations and mandates most fund managers must deal with. So how have I done over the years in my portfolio? I have pretty accurate performance numbers for the last few years, and they look quite good. As I recall, 2006 and 2007 were pretty good years for me as well. The late 1990s were not great as I did not buy into the “paradigm shift” mentality of that era. In fact, I entered the year 2000 with the only sizable cash position of my career (35% or so). That was a good year for me too. So, my conclusion is a bit fuzzy – I think that I’ve done better than the market, but I don’t have hard numbers.
In all my years on Wall Street, it was my impression that everyone I worked with (mostly in research) had portfolios that consistently beat the market. After all, these were the people who knew the companies the best. These people spent all of their waking hours trying to figure out how best to make money in the stocks in their respective industries. These people determined their company’s investment rating on any given stock, and had the responsibility of convincing professional investors that their ideas were most valid and valuable. These folks could make great money for their clients and themselves. I suspect that their portfolios were nothing like the “middle of the distribution” ones owned by the indexers.
I would like to believe that in the investment business, like many other ones, superior performance comes to those who are smarter and work harder. Investment performance is not a common commodity and, as this study suggests, stock pickers are still an important part of above-market performance. It’s good to feel validated every now and then…