Winning the Loser’s Game: Timeless Strategies for Successful Investing by Charles D. Ellis

CHAPTER 1

 THE LOSER’S GAME
 DISAGREEABLE DATA ARE STREAMING STEADILY OUT OF THE computers of
 performance measurement firms. Over and over again, these facts and
 figures inform us that most mutual funds are failing to “perform” or beat the
 market. The same grim reality confronts institutional investors such as
 pension and endowment funds. Occasional periods of above-average results
 raise expectations that are soon dashed as false hopes. Contrary to their
 often-articulated goal of outperforming the market averages, investment
 managers are not beating the market; the market is beating them.
 Faced with information that contradicts what they believe, people tend to
 respond in one of two ways. Some ignore the new knowledge and hold
 firmly to their beliefs. Others accept the validity of the new information,
 factor it into their perception of reality, and put it to use. Most investment
 managers and most individual investors, being in a sustained state of denial,
 are holding on to a set of romantic beliefs developed in a long-gone era of
 different markets. Their romantic views of “investment opportunity” are
 repeatedly—and increasingly—proving to be false.
 Investment management, as traditionally practiced, is based on a single
 core belief: investors can beat the market, and superior managers will beat
 the market. That optimistic expectation was reasonable 50 years ago, but
 not today. Times have changed the markets so much in so many major ways
 that the premise has proven unrealistic: in round numbers, over one year, 70
 percent of mutual funds underperform their chosen benchmarks; over 10
 years, it gets worse: over 80 percent underperform.

Yes, several funds beat the market in any particular year and some in any
 decade, but scrutiny of the long-term record reveals that very few funds
 beat the market averages over the long haul—and nobody has yet figured
 out how to tell in advance which funds will do it.
 If the premise that it is feasible to outperform the market were true, then
 deciding how to go about achieving success would be a matter of
 straightforward logic.
 First, because the overall market can be represented by a public listing
 such as the S&P 500 or the Wilshire 5000 Total Market Index, a successful
 active manager would only need to rearrange his or her portfolios more
 productively than the “mindless” index. The active manager could choose
 to differ from the chosen benchmark in stock selection, strategic emphasis
 on particular groups of stocks, market timing, or various combinations of
 these decisions.
 Second, because an active manager would want to make as many “right”
 decisions as possible, he or she would assemble a group of bright, highly
 motivated professionals whose collective purpose would be to identify
 underpriced securities to buy and overpriced securities to sell—and, by
 shrewdly betting against the crowd, to beat the market. With so many
 opportunities and so much effort devoted to doing better, it must seem
 reasonable to casual observers that experienced experts working with
 superb information, powerful computer models, and great skill would
 outperform the market—as they so often did decades ago.
 Unhappily, the basic assumption that many institutional investors can
 outperform today’s market is false. Today, the institutions are the market.
 They do more than 98 percent of all exchange trades and an even higher
 percentage of off-board and derivatives trades. It is precisely because
 investing institutions are so numerous and capable, and so determined to do
 well for their clients, that investment management has become a loser’s
 game. Talented and hardworking as they are, professional investors cannot
 as a group outperform themselves. In fact, given the operating costs of
 active management—fees, commissions, market impact, and taxes—most
 active managers will continue to underperform the overall market every
 year, and over the long term, a large majority will underperform.
 Individuals investing on their own do even worse—on average, much
 worse. Day trading is the worst of all: a sucker’s game. Don’t do it, ever

Winning the Loser’s Game: Timeless Strategies for Successful Investing by Charles D. Ellis