Here he is doing the Lord’s work
Think about this for a minute. It may seem very natural to you that people who pay large fees to a company to manage their wealth should expect that company to earn them a higher return than they would earn if they just stuck their money in a low-fee index fund.
But does this expectation make sense in the long run? Suppose you gave $1M of your money to a hedge fund with an awesome brilliant manager who was incredibly talented at picking bonds that were going to go up in price. Soon your money doubles to $2M, then to $4M, even as the average bond price goes up only a little bit. You keep your money invested with the same manager (paying the same high fee), assuming that he will continue to double your money in the same amount of time, again and again. But as the manager accumulates a bigger and bigger share of the total bond market, it becomes harder for him to beat the market average.
To see this, just imagine if your hedge fund manager did so well that pretty soon he was managing the wealth of every bond investor. In that case, it will be impossible for him to beat the market, because he is the market, literally. So it makes no sense to expect the same excess return (i.e. the same percentage points of market-beating performance) year after year.
This runs true for many things.
For example, the question is not whether or not health care costs will bankrupt the economy. That is nonsense. The question is whether the economy will become health care and whether that’s a good thing or a bad thing. whether we desire this outcome or not. [I, at least, should honor my own requests]
I also want to note that the meat of Noah’s post began with the phrase
Think about this for a minute
11 comments
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Sunday ~ February 12th, 2012 at 2:23 pm
Noah Smith
Minutes are valuable!
Sunday ~ February 12th, 2012 at 3:20 pm
Becky Hargrove
“whether we desire this outcome or not”
Priceless. What was that argument, now?
Sunday ~ February 12th, 2012 at 4:08 pm
Max
Funds as a group do “beat the market”…just not after fees.
The money flows from CNBC viewing rubes to investment professionals – to labor, not capital. Capital gets nothing because “alpha” is riskless.
Sunday ~ February 12th, 2012 at 4:10 pm
lfvoss
Excuse me? Funds as a group beat the market? How? Funds as a group ARE the market.
Sunday ~ February 12th, 2012 at 4:58 pm
Max
“Funds as a group ARE the market.”
Nonsense. Though granted they have been gaining (few decades ago funds were a tiny part of the market, now they are a big part) – still, hard to see how they can be 100% unless direct ownership of stock is made illegal?
Sunday ~ February 12th, 2012 at 5:18 pm
lfvoss
Individual stock owners do not own enough to set the price. Mutual funds, along with their actively managed pension and institutional kin, set the price.
Sunday ~ February 12th, 2012 at 11:07 pm
Max
Well don’t believe me, look at the studies. They all show that funds do outperform (again, that’s BEFORE fees) – which according to your theory is impossible.
Sunday ~ February 12th, 2012 at 4:21 pm
theeconomicfractalist
Saturation Macroeconomics: Gobbledy-Gook or the Real Deal?
Time for a new mathematical model, a new paradigm, for macroeconomics?
Is there a patterned science representing the time dependent evolution of macroeconomics?
The last paragraph of the Economic Fractalist main page http://www.economicfractalist.com/ ….
The ideal growth fractal time sequence is X, 2.5X, 2X and 1.5-1.6X. The first two cycles include a saturation transitional point and decay process in the terminal portion of the cycles. A sudden nonlinear drop in the last 0.5x time period of the 2.5X is the hallmark of a second cycle and characterizes this most recognizable cycle. After the nonlinear gap drop, the third cycle begins. This means that the second cycle can last anywhere in length from 2x to 2.5x. The third cycle 2X is primarily a growth cycle with a lower saturation point and decay process followed by a higher saturation point. The last 1.5-1.6X cycle is primarily a decay cycle interrupted with a mid area growth period. Near ideal fractal cycles can be seen in the trading valuations of many commodities and individual stocks. Most of the cycles are caricatures of the ideal and conform to Gompertz mathematical type saturation and decay curves.
For the Wilshire, the US composite equity index March 09 to October 2011 was a 4 phased Lammert growth and decay fractal series..
x/2.5x/2x/1.5x :: 5/13/10/7 months. That’s an empirical real system observation – available to all – of the time dependent workings of the macroeconomic system.
2005 was the description, the hypothesis – March 2009 to October 2011 was the empirical asset valuation evolution…
The flash crash on 6 May 2010 ….. does that not meet second fractal criteria?
“A sudden nonlinear drop in the last 0.5x time period of the 2.5X is the hallmark of a second cycle and characterizes this most recognizable cycle.”
Maybe this is all occurring by chance alone …. Likely…. Very very very likely ….not.
Sunday ~ February 12th, 2012 at 7:30 pm
q
nonsense about ‘being the market’. fact is that ‘the market’ with that fund manager managing it is far different from ‘the market’ without this.
Sunday ~ February 12th, 2012 at 8:04 pm
Noah Smith
Sure. But allocative efficiency (which is what you’re talking about) doesn’t change my point. If investors demand an excess return of 3% relative to an index fund, and the awesome manager takes over the market and raises the market rate of return from 2% to 5%, investors will promptly dump the manager for not making 8% (and put their money in an index fund).
Monday ~ February 13th, 2012 at 10:40 am
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