Evidence Based Finance

Stick with value.
Wait for mean reversion.

The Bubble Has Not Popped This post updates our value spread with data through the end of 2022. The fourth quarter of 2022 saw value recover from the bout of temporary insanity that gripped some portion of the market over the summer, but the spread ends 2022 very much still in rarified territory – at the 94th percentile, t...

The spread between growth and value is back at an all time high and Cliff Asness asks if everyone out there is "Cray Cray".
Any mean reversion between growth and value will continue to be favourable for the evidence based value investor.

Value Spreads Are Back to Tech Bubble Highs: Is Everyone Out There Cray-Cray? This adds another three months of data to the May entry in our series of value spread updates. Over the past two months, some portion of the market went temporarily (I hope) insane, punishing value, as we measure it, to the point where the value spread has retraced most of its modest gains since the...

Part 4: Asset Allocation market timing

CI claims that “Active managers will respond to changes in the markets and the economic cycle by adjusting the allocation of their portfolios to reduce volatility and improve results. Investors with passive investments are more likely to be missing out on this crucial aspect of investing.“

We know from SPIVA reports that most active funds do not have “improved results” – particularly relative to their benchmark. However, do active funds have reduced volatility? While active management underperformance of returns becomes common knowledge, this claim that active funds provide a smoother, less volatile return has taken hold.

On its face, the claim seems absurd. They are claiming to own fewer stocks, taking on more risk to try to achieve outsized gains, but that, even with more risk, investors should expect less volatility/smoother returns.

S&P researched this claim in their research paper “The Volatility of Active Management” and found that “Over the full sample period, an average of 80% of U.S. funds and 65% of European funds demonstrated greater volatility than their category benchmarks” Their sample period was from 2007-2015, so it included the 2007 &2008 market correction.

www.spglobal.com

Part 2: The potential to outperform

CI notes although both have fees “that active management offers the potential to outperform the market benchmark, while a passive portfolio will under-perform the index due to fees and expenses.”

This is true, active management has the potential to outperform. But how often do they outperform a benchmark and can they do it consistently? No.

There are mountains of evidence across all markets that show roughly 20% of funds tend to outperform the benchmark over 10 years, the evidence can be reviewed in my article “The case for passive low cost investing”. Importantly though, this idea is made moot with William Sharpe’s rationale that because fees are so much higher for actively managed funds “the average actively managed dollar must underperform the average passively managed dollar, net of costs.”

The case for passive low cost investing | Evidence Based Finance Simple math proves the value of low cost index investing over expensive mutual funds.