Howard Marks provides a great reminder in his 2001 shareholder letter that it takes a lot more than hard work for active managers to be successful in investing. He added that increasing the number of analysts to their firm does little to add value to their analysis saying:
“I was recently on a panel that was asked what gave our firms their edge. One panelist responded “we have 160 analysts around the world.” To me, that response demonstrated a total lack of insight. Unless those 160 analysts are more astute than the average investor, they’ll contribute nothing. Certainly another 160 wouldn’t double the manager’s ability to add value. (If they could, everyone would be an analyst.)”
Here’s an excerpt from that letter:
In order to get more out of the ups and try to lessen the pain of the downs, most people turn to active management via market timing, group rotation, industry emphasis and stock selection. But it’s just not that easy. The American Way – earnestly applying elbow grease – doesn’t often payoff.
As you know, I believe most markets are relatively efficient, and that certainly includes the mainstream stock market. Where lots of investors are aware of an asset’s existence, feel they understand it, are comfortable with it, have roughly equal access to information and are diligently working to evaluate it, the market operates to incorporate their collective interpretation of the information into a market price. While that price is often wrong, very few investors can consistently know when it is, and by how much, and in which direction.
The evidence is clear: most investors underperform the market. They (a) can’t see the future, (b) make mistakes that keep them at a disadvantage, (c) accept high risk in their effort to distinguish themselves, and (d) spend money trying (in the form of market impact and transaction costs).
Of course, there are individuals who beat the market by substantial margins, and they become famous. The mere fact that they attract so much attention proves how rare they are. (That’s the meaning of the adage “it’s the exception that proves the rule.”) Adding to return without adding commensurately to risk requires rare understanding – of how money is made and what constitutes value – and far more managers promise it than have it.
I was recently on a panel that was asked what gave our firms their edge. One panelist responded “we have 160 analysts around the world.” To me, that response demonstrated a total lack of insight. Unless those 160 analysts are more astute than the average investor, they’ll contribute nothing. Certainly another 160 wouldn’t double the manager’s ability to add value. (If they could, everyone would be an analyst.)
Most active managers go through times when their biases or their guesses lead them to do things that beat their assigned benchmark, which they attribute to their skill, and times which are the opposite, which they attribute to being blindsided by the unforeseeable (or to some defect in the benchmark). But these are two sides of the same coin, and in the long run the average manager adds little. Usually, active management will not allow you to beat the stock market, or to enjoy the fruits of the market without fully bearing its risk.
You can read the 2001 memo here.
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