People always argue about how “efficient” the market truly is. Only academic, ivory-tower geeks believe in efficient markets right? My longstanding opinion is that no, markets are not 100% efficient, but it’s a tough, cutthroat world out there. Especially over the long run. Here’s yet another reminder to put in the anecdote folder.
This WJS article (paywall) talks about Jack Meyer, a superstar manager of the Harvard endowment that went on to run a high-profile hedge fund called Convexity Capital. Unfortunately, his hedge fund has lost over a billion dollars (!) of client money recently, in fact losing money every one of the last 5 straight years.
This recent bout of poor performance has altered Mr. Meyer’s worldview… of other managers (emphasis mine):
Mr. Meyer has often told smaller endowments and foundations that ask for advice to index 75% of their assets and use board connections to access world-class active managers for a sliver of their portfolios. He says he used to think 80% of active managers didn’t add value but now thinks it is closer to 95%.
Convexity is in that remaining 5%, he said.
Matt Levine of Bloomberg has a funny yet wise take on this:
I assert that 100 percent of active managers believe that only 5 percent of active managers add value, and that 100 percent of active managers believe that they are in that 5 percent, or at least say so in interviews. Otherwise why come to work every day? But that means that 95 percent of them are wrong. If you’re looking for the ones who are wrong, I guess one place to start would be among the ones who lose money five years in a row.
That 5% number reminded me of this quote from Charlie Munger of Berkshire Hathaway (source):
I think it is roughly right that the market is efficient, which makes it very hard to beat merely by being an intelligent investor. But I don’t think it’s totally efficient at all. And the difference between being totally efficient and somewhat efficient leaves an enormous opportunity for people like us to get these unusual records. It’s efficient enough, so it’s hard to have a great investment record. But it’s by no means impossible. Nor is it something that only a very few people can do. The top three or four percent of the investment management world will do fine.
As Josh Brown puts it, edges are ephemeral. Okay, so somewhere around 4 out of 100 people *whose job it is to add value*… will actually add value. Sounds like a tough job, but something to consider when they come asking for your money.
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This is a very interesting group of articles. Beating a benchmark is really hard – and you never know whether you were simply lucky or good. It looks to me that this investor made excess returns when volatility increased ( 2007 – 2011). The past 5 years have been different than the preceding five.
Even if you were good indeed, conditions can change, which is why you need to adapt as well. Plus, if you do terribly for 5 years in a row, do you continue plugging away, or do you throw in the towel? It is possible that his strategy was just “being lucky at the right time”. But, if it is not, plugging at it could be a good option ( of course it is psychologically impossibly hard to be wrong for 5 years, even if you may be proven right eventually).
Convexity’s strategy uses some really complex options trades to earn returns from fixed income and currency volatility. Then they overlay that return using futures onto the end-investor’s choice of market index such as the S&P 500. So yes, they have underperformed the market in each of the last five years but prior to that they had outperformed by around 6% annualized and their since-inception track record is still positive. Basically what happened was in the aftermath of the financial crisis central banks around the globe snuffed out volatility in the bond markets by first lowering rates to zero and then buying up huge volumes of sovereign bonds and other securities, and Convexity’s strategy doesn’t work well in that kind of environment. They may (or may not) be more successful once again once central banks withdraw from the capital markets in the coming years.