atans1

Benchmark performance against peanut eaters?

In Financial competency on 16/06/2014 at 5:45 am

Gd performance in managing money is a matter of luck. So whether Ho Ching is qualified to run Temasek or not is irrelevant: is she lucky? And paying peanuts or millions of $ is irrelevant, at least in managing wealth.

[C]omputer programs run by Cass Business School that have randomly picked stocks using data from the past 43 years. Their performance was then compared to stock market index trackers, and in every decade bar the 1990s the “monkeys” won out.

Cass professor Andrew Clare – co-chief executive of “Simian Asset Management” alongside the monkeys – says: “We programmed a computer to randomly pick and weight each of the 1,000 stocks in the sample; we effectively simulated the stock-picking abilities of a monkey. We found that nearly every one of the 10m monkey fund managers beat the performance of the market-cap-weighted indices. One of the implications of our work is that we should perhaps be benchmarking our fund managers against monkeys rather than against a cap-weighted index.” (From Observer)

This too …

“A BLINDFOLDED monkey throwing darts at a newspaper’s financial pages,” wrote Burton Malkiel in “A Random Walk Down Wall Street”, his 1973 bestseller, “could select a portfolio that would do just as well as one carefully selected by experts”. Many investors took issue with Mr Malkiel, an economics professor at Princeton University. Some researchers have also contested his prediction, but not because they think that he exaggerated the power of randomly picking stocks; rather that he was too modest. Simulating a dart-throwing monkey has resulted in portfolios that would not just beat many investors, but also outperform the market.

In a study Robert Arnott and his co-authors picked 100 portfolios, each with 30 equally-weighted stocks from the 1,000 largest American stocks by market capitalisation. 94 of the 100 “dartboard portfolios” did better than a market cap-weighted portfolio of all the 1,000 stocks. Similarly, in another study Andrew Clare, Nick Motson and Steve Thomas randomly picked American stocks to construct ten million indices. An additional twist to their experiment was that the stocks were also randomly weighted. Nearly all of the ten million “monkey indices” delivered “vastly superior returns” compared to a cap-weighted index.

But

“financial knowledge does appear to help people invest more profitably” and that this may be a reason to “enhance financial knowledge in the population at large”.

This study, while compelling, does not necessarily contradict the superior performance of dartboard-equipped monkeys. The most knowledgeable respondents in the survey were found to hold 11.5% more stock in their portfolios than their least knowledgeable peers. It could thus simply be the case that more financially literate individuals hold more stocks rather than being better at picking them. While the authors speculate that the estimated positive effect of financial knowledge on returns could be even stronger if investors face a more complex set of choices (the particular institution in this study offered a menu of mostly index funds), the opposite is also plausible if financially illiterate individuals were to be found to make more random stock selections.

http://www.economist.com/blogs/freeexchange/2014/06/financial-knowledge-and-investment-performance

 

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  1. Interesting observation except that I do not think paying peanuts or millions to fund managers is irrelevant. Why pay them millions when peanut fed monkeys outperform them? They should rewarded with less peanuts than what the monkeys get.

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