Active Investor's performance

Doesn’t really matter who makes money, that’s the great thing about it, it’s all about corrections and elimination of all but the tiniest inefficiencies.

Ben Felix has a video on it, it seems the threshold for passive investing overcoming the corrective power of active investing is enormous…and if it ever did then the inefficiencies created would quickly become very obvious to active investors, who’d take advantage of them and therefore correct them. In essence even a tiny amount of active investing is enough to keep the market largely balanced.

And the idiots too :slight_smile:

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That comment piqued my curiosity.

A quick search tells me retail ownership of Tesla is ~55%. For the wider stock market it is ~20% and increasing

I doubt many of those retail investors have looked under the bonnet and understood what they see. 55% on $500 Bn market cap is huge.

Online platforms democratize stock ownership but anything new brings unexpected consequences. I wonder if in 20 years we will be talking about the “retail investor driven crash”


I don’t think anyone is an idiot. Everyone looks at their ability to understand things based on their experience and life story. Sometimes they are right, sometimes they are wrong.

I do. Anyone acting out of their circle of competence is basically up shit creek without a paddle. That’s why we have professional licensing to design and build buildings, fly planes, treat disease, represent in a court etc etc etc, because they safeguard us all from quacks and charlatans. But often the biggest quack when it comes to money is ourself!

You say “looks at their ability”, I doubt it, a lot of hare brained idiots in the world have no idea of their abilities, but they are supremely confident about them. It’s called the Dunning-Kruger effect. They are also rarely looking inward to critically assess what they’re actually good at vs what they are stone cold ignorant. COVID-19 showed us just how much opinionated trash is out there.
You also say " to understand things based on their experience and life story", that’s got nothing to do with investing, though. Only about how their emotions, built by their experiences and life story influence their decisions…which we know is actually detrimental.

Being an index investor is actually smart because it acknowledges ignorance. Socrates said “The only true wisdom is in knowing you know nothing”, it was true nearly 2500 years ago and remains true today.

I am not being combative towards you, hope I don’t come across like that.

I was just defending the active retail investors (as most of the people on the forum are index investors)

Not because I am one of them. But because they have a place in the market and without them market won’t function.

By the way - I do agree with your comments. Lot of people don’t know what they are doing but that’s the only way to learn for them. They will know.

You are not being combative :slight_smile:

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Yes, we agree, we need the active investors, I just pity most of them because history has shown that most of them underperform us lazy index investors :wink:


Actually for argument sake

I was thinking on average half of active investors should underperform index. But the other half should outperform.
Assuming Retail active investors don’t pay TER of active ETFs, they might have a 50% chance to beat index.

I think it was Prof. Merton in of the RR podcasts, that said he doesn‘t even see the market get inefficient when approaching 99% passive.

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has it? it wouldn’t surprise me, but i wonder if we compare the same things given that index investors also under-perform the index.

i wonder what the stock-picking penalty would be compared to an index investor who nonetheless is subject to making the same mistakes (e.g. buying index during manias and selling in panic).

Like, buying high and selling low?

No . I was not referring to trading. But long term picks

I mean all active investors (through selection of stocks) put together should form a market. So average market performance should mean someone is outperforming and someone is underperforming… isn’t it?

a passive investor could be on the other side of the transaction.

I have mixed feelings on this topic.

On one hand I see on a daily basis a lot of investors opening a new position “because such-and-such influencer said so” or “because this head-and-shoulders pattern is going to make me rich” without even opening an annual report or doing the slightest homework on these companies.

I kind of like this competition because, investing being a game of luck and skill, in the long term all the luck cancels out and most of them are going to the slaughterhouse.

That’s probably why the general position of this forum is “active investors are just losers that will just take a lot of fees for nothing”. And in a lot of cases, that’s true.

But I also know many good investors who like to stay out of the spotlights with very good track records.
I was attending last Monday a workshop by Joel Cohen from Mitimco (one of the capital allocators responsible for allocating the funds of the MIT endowment), and around 25 such emerging fund managers attended.

I found several patterns about them

  • Most of them don’t want at all retail investor money. When you have a superior track record, you have the luxury of vetting your investor base, and the last thing they want is to have retail investors that will panic at the first drawdown, withdrawing their money and monopolizing the fund manager’s attention exactly at the periods when the best opportunities arise. One of the questions I heard being asked is “During the Covid panic in March 2020, were you a capital provider or a capital redeemer?”.
    As a rule of thumb, if a fund is marketed toward retail investors, it is more probable that the goal is asset gathering (generating fees) rather than investment performance.
  • Fee Structure: One very interesting thing about good capital allocators is that if they think that a manager is above average, then they want the fees to be structured in such a way that over the long term there is a reasonable expectation that half of the overperformance will go to the investor, and half will go to the manager. In particular, allocators were adamant in saying that the popular 2 and 20 structure (used by a lot of hedge funds) is completely wrong, because over time most of the overperformance goes to the manager. To give an idea of what is fair, they gave an example of a manager doing 15%/year, and charging 1% management fees, and 10% peformance fees over a 6% annual highwatermark.
  • Most of them had a good game selection (i.e, where are they likely to find the most opportunities?) For instance, some of them would restrict the maximum capital invested to a limit to stay small and keep investing in micro cap where competition from institutional investors is absent. Other would be hyper-specialized in a given sector structurally innefficient like biotechs: most investors stay away from biotech and financial companies because they are very hard to analyze and require a very specific knowledge.

I will end with a quote from Joel Cohen on Active vs Passive:

On passive vs active investing

I mean, I think the key to answering that question is, is it possible to have a sustainable competitive advantage in investing that allows you to outperform passive indices and generate great absolute returns over a long period of time? We still think that it is, and we see a lot of evidence of that in our portfolio and the managers we work with.

I think there’s no question that the investment industry has gotten more competitive, and certain advantages that you could have had 10 years ago, 20 years ago, 30 years ago, in terms of just like, knowing more about a company than other people or sort of having an advantage in figuring out what’s going to happen in the next quarter or the next year. That is an advantage that you could have probably had 20 years ago, and some people built a track record on that, that edge seems to have been competed away.

So I think the question for us is, are there other competitive advantages that you can build? And we think that there are.

I think the most notable one is that human behavior hasn’t changed a lot. We still are subject to the same types of biases, probably new biases. Humans are still naturally short sighted and have a very difficult time taking the five or 10 year view. And very few people take the time to build their business in such a way that they can take their five or 10 year view. And in our mind, that’s competitive advantage that’s not–doesn’t seem to be competed away, and maybe even is growing. And so we still actively allocate our entire portfolio.

But we’re also mindful that it’s gotten more competitive. And it’s harder to have the same kind of performance that people have had in the past. And so we always want to be looking back and sort of thinking about—are the things that were the case in the past still true today? And should we be thinking about having a passive allocation? But many still feel like the very best of the best investment managers can still generate outstanding, absolute relative performance.


It’s only a handful of stocks that drive the performance of an index long term. If you picked those ones, you will overperform. If not, you won’t.

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I am not sure how the math works.
Perhaps there is some research out there

But I see what you mean.

  • All stocks put together will have market average performance
  • however let’s say you make 100 subsets of these stocks , it’s not the case that 50% of them will beat the average. Most likely it would be a much smaller number

Right ?

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Something like this. Optimistically, maybe 1-2% of subsets will outperform.

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Great post. I would agree. Individual investor has following advantages:

  • Longer term outlook
  • Can venture into areas without big competition (e.g. smaller cap companies, companies that institutional investors cannot invest in)
  • Ability to invest during dips and sell at peaks (avoid bad instinctive behaviour)
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A passive index investor is by definition the sum of all participants, so on neither side of the trade over of the longterm.

Also the sum of all active investors are by definition exactly the market.

1-2% seems very low. But if <5% stocks return all the value then most likely your assessment is not far from truth.

This was a gross generalization on my part, essentially an echo of the “low-cost, broadly-diversified index funds are a key to success for most people”. I don’t know for a fact because I haven’t done the research myself, but I trust the research and data other have regarding active vs passive management.

That said, I am not a “VT and chill” zealot, @Julianek’s post on Quality definitely influenced me, and it was enforced by Buffett’s eulogy on Munger steering him away from cigar butts.

I have to admit I get WSB vibes whenever I hear “active investor”, and some of my anecdotal examples do little to dispel that. I’ve a friend who bought NVDA at $25 and is still sitting on it, not happy with having pulled 40x, because he thinks it will go to the m00n. And of course the crypto degenerates.

Ultimately, taking costs into account AND/OR the mental anguish and effort required to track tens of stocks vs riding the wave of passive index investing, I am happy to be a boglehead :wink:

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