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On Benchmarks and the “Hardest Profession in the World”

Josh Brown points us to an interesting post discussing the difficulty of the investment profession and the fierce competition with benchmarks.  The author states:

“Benchmarks are the most ferocious of competitors.  They show up for work everyday. They never get sick.  They don’t take vacation.  They are always 100% invested so their results are continuously compounding.  Most importantly, they’re not aware of their own performance.  The S&P 500 will never enter the 4th quarter feeling it needs to really press to have good numbers for the year.  Nor will it take December off to “lock in” a good year.”

It’s even more difficult than that.  What is the S&P 500?  The S&P 500 is essentially the biggest, baddest corporations that exist in the USA (and maybe the world).  We’re talking about the 500 best companies out of millions.  And that’s not even counting the ones that haven’t survived.  Throw in the survivorship bias of the companies that have all failed over the years and the S&P 500 is the very best of the best.  Better than the top 1 tenth of 1% of all companies alive.  And every single day millions of investors step into the arena against this index, beat their chest and get crushed.  That’s the beauty (and ugliness) of the market.  Anyone is free to play the game, but be careful differentiating skill from luck.    In this world there are a lot of lucky managers pawning their brief luck off as skill.

This doesn’t mean that fund managers can’t add value or that trying to manage money is a pointless endeavour (differentiation is a powerful allocation tool here).  Far from it, but if you give me 500 plain vanilla “large cap blend” funds and compare them to the S&P 500 over a 30 year period the odds are overwhelmingly against them outperforming after taxes and fees.   Competing with the S&P 500 on an even playing field is like stepping onto the golf course with Tiger Woods with no handicap.  It’s almost always a bad idea.   So beware those correlated benchmarks.  They’ll kick your ass if you don’t know what you’re doing.  Perhaps more importantly, beware the fund manager pawning off outperformance as skill.  It’s not always the case.

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