Morgan Stanley’s Gerard Minack is arguably the most underrated strategist on Wall Street.
His two-page “Downunder Daily” reports were must-reads for anyone looking for a clear, straightforward perspective on the state of the markets.
While we’re sad to hear that he’s retiring, we love his last note.
“Investing is an unusual profession: perhaps the only one where amateurs have a good shot at beating the pros,” said Minack as he opened his note today.
He tackles the long history of how actively-managed mutual funds (i.e. funds that try to beat the indexes) almost always underperform the indexes. Here’s a chart from one of the many studies showing the history:
“Amateurs normally stand no chance against professionals,” he writes, noting that most of us would be unlikely to play tennis better than Roger Federer or golf better than Tiger Woods.
“Investing is different,” he continued. “None of this would matter if achieving index returns was extremely difficult. But an industry’s been built on indexed funds that seem capable of replicating index returns at relatively low cost.”
So why are the pros still in business? Minack summarizes:
…The good news for the professionals is that many amateurs persist in trying to beat the market and, in aggregate, they seem to do a significantly worse job than the professionals
The biggest problem appears to be that — despite all the disclaimers — retail flows assume that past performance is a good guide to future outcomes. Consequently money tends to flow to investments that have done well, rather than investments that will do well. The net result is that the actual returns to investors fall well short not just of benchmark returns, but the returns generated by professional investors.
So, you have two things going on here: 1) Investors think actively-managed funds that have done well in the past will do well in the future. The chart above demonstrates why this type of thinking puts you way behind the curve. 2) Investors, because of behavioural biases, will load up on the highs and sell at the lows. As a result, investors will underperform the very investment that they are investing in.
This second point is extremely important. Minack demonstrates this in two charts.
In this first chart, the green line shows investor flows, which shows that investors buy high and sell low:
This second chart demonstrates the implications of the mistake made above. It shows investors’ dollar-weighted returns. In other words, it shows what happens to returns when an investor buys high and sells low.
In this example, an investor who bought the index for $US100 in 1997 and waited patiently would have around $US150 today. However, the person who followed their gut, and traded with market fluctuations would have lost 75%.
In short, amateurs may be able to beat the investment professionals, but most do far worse. This keeps professional investors in business (and that keeps people like me employed, which is nice). But it means that returns to investors typically lag benchmark returns by a long margin. The outlook, in my view, is for low returns ahead, as measured by common benchmarks. If investors continue to receive materially worse returns than those benchmarks, effective returns are likely to be derisory.
In other words, people like Minack have jobs because you’re probably stupid.
So with that, Minack announced that he was leaving Morgan:
I’m retiring from Morgan Stanley, so this is my last note. Thanks for the brickbats and bouquets over the years — at least I knew you were reading. I’ve always said that those that can, do; those that can’t, broke; and if you can’t broke, consult. On that basis I’m off to do the latter, after a three month break.
We’ll miss him.
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