Wednesday, October 18, 2017

Howard Mark's recent G & D interview quotes

I enjoy reading the Graham-Doddsville newsletter.

Some pertinent quotes, relating to the issue of indexing and quantitative/AI factor.

Howard Marks:

“If people take their money out of active management, then active managers would fire all their analysts, and then the market would not stay efficient. Then the necessary condition is satisfied for active to work. The point is, I don't think this move is permanent, I think it's rotational.”

“Because every dollar that goes into a truly passive fund is invested on autopilot, the fund must buy the stocks that satisfy its criteria, and that’s without regard to value. That suggests to me that prices can go farther in diverging from value before they get corrected. Think about what would happen if 95% of the money went into index ETFs or index funds. Who would be setting prices? There’s something called price discovery, and it’s done by thoughtful buyers and sellers. The price of a security in the marketplace is set by buyers and sellers coming together, and seeing if they can find a place to transact where the buyer thinks it has good upside, and the seller thinks it doesn’t. Who provides that function if all the buying are on autopilot? People put their money in index funds, with the presumption that they’re minimizing error, but how much of your money do you want to have managed in a fund where nobody’s thinking about the price of the stocks or the weightings within the portfolio? The thing about investing is that the efficient market hypothesis says that price equals value. Active management is about the assumption that price sometimes deviates from value, finding those deviations, and then taking advantage of them. It seems to me that the fewer the people who are looking at value, the higher the likelihood that price can diverge from value. But that’s just a hypothesis.”

“None of this stuff is easy. The greatest quote in my book is from Charlie Munger, who said, “None of this is meant to be easy, and anybody who thinks it’s easy is stupid.” All this stuff is really complex. It’s easy to talk about, but it’s hard to implement. How do you tell the ones who are good but unlucky, from the ones that are bad? It’s not easy. It takes judgment. That’s why I believe that this whole thing can never be completely computerized, because I think exceptional investment success requires judgment, and I don’t know if AI can be taught to make those judgments.”

Dear readers, any thoughts?

Yours One-Legged


Anonymous said...

Well you're going to have some interesting effects playing out. Say myself and thousands of others like emerging markets, we can make a bet on that subsection of the world outperforming. That's an active asset allocation choice that will, all else being equal, shift global equitues to make EM more valuable. The global market will be the culmination if millions of such decisions.

What of "smart-beta"? One aspect is it's a new way to harvest more fees. Another is that you've got a mass of cash not invested along pure market cap lines.

The actual performance of the market as a result of all these vehicles with the active asset allocation decisions made? Not sure tbh but I think opportunities will persist, especially in smaller, more illiquid segments (equities or otherwise)

CC said...

To which I highly recommend the first two of this chap's series

Neatly sums up some of the above.

Index funds, particularly ETFs, are fantastic for expressing particular views/beliefs about the market that doesn't just have to be about lazing about while active managers engage in price discovery. On that note, you do see work arguing that the asset allocation decision as opposed to picking securities within an asset class drives the majority of returns. There are still a number of rubbish active managers out there who have perfected the business-side in sales etc whilst the investing skill has diminished. If you lack confidence in your manager/stock-picking skills why not go for the cheapest option?

Anonymous said...

Hi Peter, too much fearmongering by active managers lately with respect to the rise of ETF's. This is a structural trend, not a fad or rotational. Of course there's some part of it that may be rotational as some people moving into ETF's may be performance chasing. And a lot of the smart beta ETF's are fads, I'm referring to traditional ETF's. But a large chunk of the ETF trend is embedded and has now become the default recommendation of financial advisors, instead of putting clients into Colonial First State, Perpetual, etc they put them into Vanguard, iShares, etc. The growth rate will taper/stabilise eventually but I don't expect it to reverse.

Price discovery happens at the margin and you only need a small percentage of active to set the price. This has been happening already for a long time in commodities and other asset classes, there are huge volumes traded each day which settle based on a very small percentage of trades in a price discovery process. The ETF trend can run a lot further before this process will break. I don't think it will ever reach 95%, but it can go much further than where it current is.

Even before ETF's, and with lots of analysts and active managers, we have many examples of market effiency where prices can fall by 5, 10 or 20% in a day and recover that in the next 6-12 months. The presence of analysts and active managers does not ensure market efficiency, especially not in the short term.

Howard Marks is a great investor and has nothing to fear from ETF's. The ones who will be disrupted are the mediocre active managers who have been collecting outsized fees for performance that fails to beat benchmark net of fees. The market will move in the direction of performance based fees and index huggers will have to adapt and either sink or swim... The market will still function though.

Cheers, Adrian

Peter Phan said...

Thanks Adrian. A realistic, balanced and nuanced view which is impossible to find in mainstream press these days. I believe the nub of the issue is now going back to the age-old dispute on the validity of the EMH. The more things change, the more things stay the same. Wish I could say that in French, sounds much sexier. Regards, One Legged.