This is a guest article by Jim Stark. Jim Stark is a pseudonym for a practicing Canadian financial advisor. The article is written to financial advisors, but we both thought that readers of this blog would appreciate it.
Take it away Jim…
The thing about the ongoing ‘debate’ between active (markets are largely inefficient) and passive (markets are largely efficient) management is that no side has been able to score an incontrovertible ‘knock-out punch’. By the way, I use the term ‘debate’ loosely, as I’m unsure if you can call it that, given that few people in the active management camp seem willing to truly engage the logic and evidence that goes into a real debate. I digress…
The point that I make repeatedly is that the large majority of active managers lag their benchmarks and that the few that actually beat them are pretty much impossible to identify in advance (i.e. their performance does not ‘persist’). This is a compelling two-pronged argument, but many people have pointed out that one need only identify one (that’s right, one) person who can reliably be identified as a market-beater and victory for the active management side would be realized. Overwhelmingly, the one name that is thrust forward when it comes down to this is: Warren Buffett.
I have nothing but admiration for Mr. Buffett (who has encouraged most investors to use passive products more than once). By the way, “most” means at least 50% + 1. It means if 8,000 read this article, Buffet thinks at least 4,001 and one of them should use passive (assuming readers represent a representative sample of overall investors). With great respect, however, pointing to Buffett and saying “checkmate” rather misses the point.
What’s the use of going through the trouble of finding that one in a million person who can reliably beat the market if you don’t- you know- actually hire him to manage your money? It makes about as much sense as developing a foolproof way if picking winning lottery numbers- and then never buying a ticket! If a tree falls in the forest…
My impression is that MFDA registrants (Mutual Fund Dealers Association registrants – Financial advisors who can only sell mutual funds, GICs and Government savings bonds. They represent about 75% of all Canadian financial advisors- Preet) are somewhat more pro-Buffett than IIROC advisors (Investment Industry Regulatory Organization of Canada licensed advisors – they are allowed to also sell individual stocks and bonds and ETFs and other investments – Preet). It’s just my impression. The thing is this – MFDA registrants couldn’t hire Buffett to manage their clients’ assets if their lives depended on it. Berkshire Hathaway is a security and buying Berkshire Hathaway for clients requires a securities licence. Why people who are not licenced to sell securities extol the virtues of someone they cannot actually hire and an investment they are not licenced to sell makes no sense to me. If you’re an MFDA advisor who likes Buffett, please write to me to explain yourself. Don’t bother trying to convince me about how great the man is – I’ll only agree with you. What I want is for you to explain your behaviour to me.
(Technically, access to Berkshire Hathaway WAS available to MFDA advisors through single-security Principal Protected Notes – but the uptake was minimal and the PPN structure is all but dead for the time being anyway. Not taking away from Jim’s point, in fact it may even add to it. – Preet)
Let’s turn our attention to our Buffett-loving IIROC friends. What percentage of your client assets are managed by this icon of a man? My guess is that the number is an extremely small one. In fact, let’s open this up a little more. Who else is there with a great track record? My understanding is that it takes about a quarter century of data before performance histories can be considered statistically significant (i.e. to discern between luck and skill). How many managers (good, bad or otherwise) even have a 25-year track record? More to the point, what percentage of your asset base is managed by someone with a 25 year track record of clear market-beating performance? (Pauses for effect and to allow the reader to actually think about it). I see.
So let me get this straight: only a handful of managers outperform, but those outperformers remain largely unidentified in advance and the one person that has been reliably identified manages probably less than 1% of assets under management for the combined readership of this column? Again I ask you, if you could offer your clients a ‘bird in the hand’ instead of a ‘pig in a poke’, why wouldn’t you do it? And yet, most advisors don’t even tell their clients that passive options exist.
Thanks Jim! Look forward to your next guest article! :) – Preet