Morningstar Strikes Again

The Morningstar advisor website features a comprehensive analysis of the failure of active managers to outperform their respective indices despite the bear market conditions when active managers were supposed to shine:

Bearly' Winning


by Daniel Culloton | 03-03-09


This is the big one; a bear market so fierce and unrelenting that it'll expose index funds for the dumb investments they are and allow active managers to show their quality.

Or maybe not.

I recently looked at how actively managed funds have fared versus similarly styled benchmarks thus far in this the worst stock market crash since the Great Depression. What I saw probably won't end up in any actively managed fund's marketing materials. While the typical active manager has beaten certain benchmarks from when the major market averages peaked on Oct. 9, 2007, through the end of January 2009, the victory hasn't been clear-cut. Also the typical stock-picker's inability to beat the Standard & Poor's style benchmarks in most categories undercuts the argument that active managers would hold up better in a severe downturn by favoring so-called higher-quality stocks.

....

Advantage, Market
There have been individual managers, management teams, and strategies that have limited the damage during this bear market. As the bear market drags on, active managers collectively also could improve their relative standing somewhat. And losing 37.1% in an S&P 500 fund instead of 37.2% in an actively managed large-cap blend fund shouldn't make anyone feel happy. But the average active manager's absolute and relative performance so far makes it hard, to paraphrase Vanguard founder and index fund creator Jack Bogle, for the active funds to claim superiority over the market averages.

But talk about disconnect !the same website contains an article about an "undiscovered" active manager with great returns and the curren issure of the affiliated magazine Morningstar Advisor contains an article entitled "Four Picks for the Present" three of the four funds are actively managed,

I Think We Have Heard This Song Before...

from the LA Times


Getty slashes operating budget after severe investment losses
By Mike Boehm
Los Angeles Times Staff Writer
March 15, 2009

The J. Paul Getty Trust, envied as the economic Goliath of the museum world, is cutting its operating budget nearly 25 percent for the coming fiscal year -- an emergency response to investment losses that have totaled $1.5 billion since July and nearly $2 billion since mid-2007.

President James Wood said the financial stability of the Getty, the world's richest arts institution, could "fall off a huge cliff" if it delayed drastic cuts and hard times continue.

The Getty relies almost exclusively on investment earnings to cover expenses for its two Los Angeles art museums as well as the research, art-conservation and grant-making operations that extend the trust's reach around the world.

Its investment portfolio dropped 25 percent during the last half of 2008from $6 billion to $4.5 billion. ....


..... James Williams, the Getty's chief investment officer since 2002, said there was no plan to change the investment strategy the trust has pursued since the middle of this decade, betting heavily on "alternative investments" such as hedge funds, private partnerships, raw materials and "distressed" companies trying to emerge from Chapter 11 reorganization. Williams said the Getty's approach, which de-emphasizes holdings in publicly traded stocks and bonds, was safer because it allows greater investment diversity.

The strategy is known as the endowment model or the Yale model, in deference to the university that pioneered it in the 1980s, reaping huge returns and begetting many imitators among universities and other nonprofit institutions that can afford to invest huge sums over a long term. Williams said that over the past year and a half, the Getty has tried to minimize what he considers the approach's two pitfalls: investing in ventures that are loaded down with debt and tying up too much money in assets that are hard to sell quickly.

I will give them credit for the alight adjustment. But I still dont understand why it was so distateful for these institutions to do what I recommend to individuals keep funds needed in the next 3 years or more in very stable liquid assets like short term bond funds or tbills.

The Definitive Reason to Turn Off That Business Channel

Cramer vs Stewart mano a mano. Here's the full interview as posted on the Comedy Central Website including outakes not shown on the program :

stewart "we're both snake oil salesman to an extent"

cramer: "I don't disagree"....

stewart: "I know you want to make finance entertaining, but it's not a f#### game"....

Cramer: "There's a market for it (shows like "Fast Money")
Stewart: "There's a market for cocaine and prostitution too."

The Daily Show With Jon StewartM - Th 11p / 10c

Intro - Brawl Street: Get Read to Buy Low! And Sell Die

Daily Show Full Episodes
Important Things w/ Demetri Martin

Political Humor
Jim Cramer

The Daily Show With Jon StewartM - Th 11p / 10c

Jim Cramer Interview Outtake Pt. 2

Daily Show Full Episodes
Important Things w/ Demetri Martin

Political Humor
Jim Cramer

The Daily Show With Jon StewartM - Th 11p / 10c

Jim Cramer Interview Outtake Pt. 3

Daily Show Full Episodes
Important Things w/ Demetri Martin

Political Humor
Jim Cramer

The NY Times on the Quants

Seems Everyone is "discovering" the role that the failure of academic financial modles had in the debacle in the financial markets. The NYT presents a nice overview.
and my favorite observer Nasem Taleeb is mentioned as on of the lone critics

Bere is an excerpt

Another consequence is that when you need financial models the most — on days like Black Monday in 1987 when the Dow dropped 20 percent — they might break down. The risks of relying on simple models are heightened by investors’ desire to increase their leverage by playing with borrowed money. In that case one bad bet can doom a hedge fund. Dr. Merton and Dr. Scholes won the Nobel in economic science in 1997 (pictured above) for the stock options model. Only a year later Long Term Capital Management, a highly leveraged hedge fund whose directors included the two Nobelists, collapsed and had to be bailed out to the tune of $3.65 billion by a group of banks.


Afterward a Merrill Lynch memorandum noted that the financial models “may provide a greater sense of security than warranted; therefore reliance on these models should be limited.”

That was a lesson apparently not learned.

Respect for Nerds

Given the state of the world, you might ask whether quants have any idea at all what they are doing.

Comparing quants to the scientists who had built the atomic bomb and therefore had a duty to warn the world of its dangers, a group of Wall Streeters and academics, led by Mike Brown, a former chairman of Nasdaq and chief financial officer of Microsoft, published a critique of modern finance on the Web site Edge.org last fall calling on scientists to reinvent economics.

Lee Smolin, a physicist at the Perimeter Institute for Theoretical Physics in Waterloo, Ontario, who was one of the authors, said, “What is amazing to me as I learn about this is how flimsy was the theoretical basis of the claims that derivatives and other complex financial instruments reduced risk, when their use in fact brought on instabilities.”

But it is not so easy to get new ideas into the economic literature, many quants complain. J. Doyne Farmer, a physicist and professor at the Santa Fe Institute, and the founder and former chief scientist of the Prediction Company, said he was shocked when he started reading finance literature at how backward it was, comparing it to Middle-Ages theories of fire. “They were talking about phlogiston — not the right metaphor,” Dr. Farmer said.

One of the most outspoken critics is Nassim Nicholas Taleb, a former trader and now a professor at New York University. He got a rock-star reception at the World Economic Forum in Davos this winter. In his best-selling book “The Black Swan” (Random House, 2007), Dr. Taleb, who made a fortune trading currency on Black Monday, argues that finance and history are dominated by rare and unpredictable events.

“Every trader will tell you that every risk manager is a fraud,” he said, and options traders used to get along fine before Black-Scholes. “We never had any respect for nerds.”

Efficient Market Theory Redux: Just Because It's Flawed Doesn't Mean You Can Pick A Manager That Will Beat The Market

From the Economist

THE GRAND ILLUSION
Mar 5th 2009


How efficient-market theory has been proved both wrong and right

THE past ten years have dealt a series of blows to efficient-market
theory, the idea that asset prices accurately reflect all available
information. In the late 1990s dotcom companies with no profits
and barely any earnings were valued in billions of dollars; and in 2006
investors massively underestimated the risks in bundling together
portfolios of American subprime mortgages.

There is now widespread acceptance that investors can behave
irrationally, creating very large anomalies. Take the momentum effect, the practice of buying the stockmarket's best performers over
the previous time period. A study by the London Business School found that,
since 1900, buying British stocks with the best momentum would have turned GBP1 into GBP1.95m (before costs and tax) by the end of last year; the same sum invested in the worst performers would have grown to just GBP31. In efficient markets, such an anomaly should be arbitraged away....

But it is important not to throw out all the insights of
efficient-market enthusiasts. Although it is theoretically possible to make money by outperforming the markets, it is extremely difficult in practice.
That ought to have made investors suspicious of the
smoothness of the returns of Bernard Madoff, who has been accused of a vast fraud. His strategy, as advertised, might have produced less
volatile returns than the index, but the absence of negative months
suggested almost perfect market timing.


Some fund managers have beaten the markets over long periods. The problem is to identify them in advance. Picking them after
they have outperformed may be too late, as those who backed Legg Mason's Bill Miller have recently discovered. Why is this? Fund managers are human too and subject to behavioural biases. In addition, the larger their funds become (as their reputation spreads), the more difficult it is to outperform

The temptation has also been to assume that fees are positively correlated with performance--that if mutual fund managers charging 1.5%
are good, hedge-fund managers charging 2% (and 20% of performance) are even better. Because investors cannot beat the market in aggregate, all this means is that money is transferred from investors to fund managers. Even David Swensen, the man who led the drive into alternative assets at Yale University, thinks most investors should rely on low-cost index-tracking funds

Peter Lynch: I'm Confused

Peter Lynch, just after he retired from managing the Magellan Fund, as well as the legendary Warren Buffett, admitted that most investors would be better off in an index fund rather than investing in an actively managed equity mutual fund.
-- Burton Malkiel in A Random Walk Down Wall Street (p.144 in the 2007 edition)

Mr. Lynch said that even after this market decline, he would stick to the view that no one should hold stocks unless they could afford to lose an additional 50 percent. And he said he had not deviated from his faith in “bottom-down stock picking,” in which investors who have done their research buy shares of just five or six well-priced companies with strong balance sheets and “compelling stories.”

nyt march 7,2009

About those Expert Forecasts.....

beware,beware, beware:




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strong>March 8, 2009
Even for Market Veterans, It’s Uncharted Territory
By JEFF SOMMER NYT

AFTER the steepest decline since the Great Depression, unalloyed optimism among veteran stock market hands is hard to find.

Byron Wien, chief investment strategist at Pequot Capital Management, says he is an optimist. Yet he advises small investors to buy gold and corporate bonds, not equities, which, he said, may be too risky right now.

Barton M. Biggs, managing partner at Traxis Partners, a hedge fund, places himself in the optimists’ camp, too. Yet he advises well-to-do investors to arm themselves — with shotguns, if need be — against the possibility of a deepening downturn and accompanying “social unrest.” ......

What should investors do under these circumstances? Buy high-quality corporate bonds, which fell sharply over the last year or so, and which are likely to rise in a market recovery. That makes sense to Dr. Kaufman, as well as Messrs. Wien, Biggs and Lynch. Bonds have the merit of providing steady income, at rates that are now very high; they tend to be less volatile than stocks; and they have a higher legal claim on a company’s assets.

FOR investors with a truly long-term view, probably 20 years or more, the market will be worthwhile, they said, because stocks should outperform other asset classes. To one degree or another, though, they said investors should be extremely cautious over the short term.

Mr. Biggs said he thinks it’s “50-50” as to whether the economy begins to recover over the next year or “whether we are going into a depression and a deflation,” which could conceivably be as painful as the 1930s.

“If we’re going into the 1930s,” he said, “it’ll be survivalism, and we’ll have very substantial social unrest.”

Attention should be paid of course. After all this is major "expert" with decades of experience:

Buy American: Barton Biggs increasing holdings of U.S. equities
Traxis Partners co-founder says market is close to the bottom; shares ‘very, very cheap’


February 11, 2008 12:47 PM ET

Barton Biggs, co-founder of hedge fund Traxis Partners, said he's “gradually increasing” his holdings of U.S. equities because he doesn't expect a recession and shares are “very, very cheap.”

Mr. Biggs, the former global investment strategist for Morgan Stanley, said in a Bloomberg Television interview that the market is “at or very close to an important bottom'' and may be led higher by banks and brokerages when a rally occurs. Some financial companies may advance 20% to 25% over periods of two to three weeks, said Biggs, who helps manage $1.5 billion in Greenwich, Connecticut. The Standard & Poor's 500 Index fell 6.1% in January, its biggest monthly decline since September 2002 and its worst start to a year since 1990. During the month the index fell as much as 16% from its Oct. 9 record.

Financial companies in the index fell almost 21% in 2007, the worst performance among 10 industry groups and their biggest drop since 1990. They trade for 14.8 times profits, compared with an average price-earnings ratio of 15.5 this decade, according to data compiled by Bloomberg.

The S&P 500 trades for 18.1 times earnings, 31% below its monthly average this decade, according to data compiled by Bloomberg.

Mr. Biggs correctly forecast U.S. equities would rebound from declines in March and August last year. On March 16, following a 5% decline by the S&P 500 from its Feb. 20 peak, he said stocks were approaching a bottom and predicted a gain of as much as 15% for the index in 2007.

The S&P 500 rose as much as 12% from that level before retreating to end the year with a 3.5% gain.

On Aug. 16, after a 9% decline by the index, Biggs said it was bottoming and predicted a rebound. The benchmark rose almost 11% over the next seven weeks

.

Feb 11, 2008 DJIA: 12,182 S+P 500 1321 IYF (financials etf)86.71

March 5, 2009 DJIA 6626 S+P 50 683.38 IYF 24.10