The definition of insanity is doing the same thing over and over and expecting different results.
— Benjamin Franklin
According to Greek mythology, Sisyphus was the son of Aeolus (the king of Thessaly). Sisyphus was a clever and evil man, who would waylay travellers and murder them. He also betrayed the secrets of the gods and bound Thanatos, the god of death, so the deceased could not reach the underworld.
Hades eventually intervened, severely punishing Sisyphus. He was forced to remain in the realm of the dead and complete the same task for eternity — pushing a boulder up a steep hill only to watch it roll back down just before it reached the top. Then he had to begin the whole process again. Are investors who search for outperformance via active management condemned to a similar fate?
The majority of financial advisers, investment policy committees, and trustees of pension and retirement plans select investment managers based on historical performance. The selection process includes thorough due diligence, often with the assistance of a “gatekeeper” — a consulting firm such as Frank Russell Co. or SEI. These firms have tremendous resources.
Unfortunately, on average, the active managers chosen based on outstanding track records have failed to live up to expectations. The underperformance relative to passive benchmarks invariably leads decision-makers to fire the active managers. And the process begins anew. A new round of due diligence is performed, and a new manager is selected to replace the poorly performing one. And almost invariably, the process is repeated a few years later.
Among the studies finding that the fired managers go on to outperform the new hires that replace them are The Trust Mandate by Herman Brodie and Klaus Harnack, Institutional Investor Expectations, Manager Performance, and Fund Flows by Howard Jones and Jose Vicente Martinez, and The Selection and Termination of Investment Management Firms by Plan Sponsors by Amit Goyal and Sunil Wahal. And Tim Jenkinson, Howard Jones and Jose Vicente Martinez, authors of the Picking Winners? Investment Consultants’ Recommendations of Fund Managers, found no evidence that consultant recommendations add value to plan sponsors.
Sadly, many individual investors go through the same motions and end up with the same result — a high likelihood of poor performance.
The conventional wisdom that past performance is a strong predictor of future performance is so strongly ingrained in our culture that it seems almost no one stops to ask if the conventional wisdom is correct, even in the face of persistent failure.
Investors should be asking themselves: “If the process I used to choose a manager who would deliver outperformance failed, and I use the exact same process the next time, why should I expect anything but failure again?” The answer is painfully obvious. If you don’t do anything different, you should expect the same result. Yet, so many have not thought to ask this simple question.
It is important to understand that neither the purveyors of active management nor the gatekeepers want you to ask that question. If you did, they would go out of business. But you should ask that question. Your obligation is to provide the best returns, either to yourself or to members of the plan for which you are a trustee — not to provide the fund managers or the consultants with a living.
As chief research officer at Buckingham Wealth Partners, I have asked hundreds of people that simple question. Not once have I received an answer that explained either why they should expect a different outcome or what they would do differently the next time. It is as if those who select active managers believe they will be able to push Sisyphus’ rock over the mountain.
The moral of the tale
Like Sisyphus, both individual and institutional investors seem condemned to a life of repeating an action that has been proven highly likely to fail — though the odds are not quite as bad as they are for Sisyphus.
As the story goes, Sisyphus is doomed to a failure rate of 100 percent. The odds against selecting active managers that will outperform on a risk-adjusted basis over the long term are not quite that bad. However, they are so poor that Charles Ellis, the author of Winning the Loser’s Game, called it is a loser’s game. He meant that, just like at the roulette wheel, the slot machines and the craps tables at casinos, while it is possible to win the game, the odds of doing so are so poor that it is not prudent to try.
Of course, it doesn’t have to be that way. Investors would benefit from taking philosopher George Santayana’s advice: “Those who cannot remember the past are condemned to repeat it.”
Important Disclosure: The analysis in this article is for informational and educational purposes only and should not be construed as specific investment, legal, accounting, or tax advice. This analysis contained herein is based upon third party data and information may become outdated or superseded at any time without notice. Certain information is based upon third party data and is deemed to be reliable, but its accuracy and completeness cannot be guaranteed. By clicking on any of the links above, you acknowledge that they are solely for your convenience, and do not necessarily imply any affiliations, sponsorships, endorsements or representations whatsoever by us regarding third-party websites. We are not responsible for the content, availability or privacy policies of these sites, and shall not be responsible or liable for any information, opinions, advice, products or services available on or through them. Mentions of SEI or Frank Russell, Co., were for example purposes only and do not imply any affiliations, sponsorships, representations, or endorsement of the services they provide. The opinions expressed by featured authors are their own and may not accurately reflect those of the Buckingham Strategic Wealth®. R-20-978
LARRY SWEDROE is Chief Research Officer at Buckingham Strategic Wealth and the author of numerous books on investing. Want to read more of Larry’s insights? Here are his most recent articles published on TEBI:
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