Thursday, September 01, 2022

Beat the Market by Picking the Market

Stock funds have been pulling a switcheroo to make their returns look better: When they don’t measure up, they change how they measure 

See How to Beat the Stock Market Without Even Lying by Jason Zweig of The WSJ. Excerpts:

"You know all that stuff you’ve been hearing for so long about how fund managers can’t beat the market?

It isn’t true. Fund managers can easily beat the market. All they have to do is change which market they’re trying to beat.

Hundreds of them have been doing just that for years. Such maneuvers are perfectly legal—and investors need to fend for themselves, because regulators have so far been paying little attention.

A new study by finance professors Kevin Mullally of the University of Central Florida and Andrea Rossi of the University of Arizona finds that between 2006 and 2018, 37% of all U.S. stock mutual funds pulled this kind of switcheroo.

In as many as two-thirds of the cases, funds made past returns look better by changing the benchmarks they compared themselves to. More than half the time, funds chose a new index that wasn’t even a good match for their strategy.

Note carefully: Funds can’t retrospectively change their results, but they can switch what they compare those results to."

"Determining which index is appropriate is more or less up to the manager. Fund companies can change benchmarks without much explanation."

"On average, according to Profs. Mullally and Rossi, by switching indexes, fund managers make their past returns—relative to “the market”—look 0.8 percentage point better over one-year periods. Longer-term results get an even bigger boost, rising by an average of 2.4 and 4.8 percentage points, averaged annually, over five and 10 years, respectively."

"Prospectuses always warn that past performance is no guarantee of future results. Turns out it’s no guarantee of past results, either."

See also Efficient Market Hypothesis (EMH) by Lucas Downey of Investopedia. Excerpt:

"The efficient market hypothesis (EMH), alternatively known as the efficient market theory, is a hypothesis that states that share prices reflect all information and consistent alpha generation is impossible.1

According to the EMH, stocks always trade at their fair value on exchanges, making it impossible for investors to purchase undervalued stocks or sell stocks for inflated prices.1 Therefore, it should be impossible to outperform the overall market through expert stock selection or market timing, and the only way an investor can obtain higher returns is by purchasing riskier investments." 

The book The Armchair Economist by Steven Landsburg says, based on research by Lauren Feinstone done in 1987, that "all new information about an asset is fully incorporated into the price within 30 seconds of its arrival."

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