Here’s an interesting conundrum. As every TEBI reader knows, beating the market over the long term on a cost- and risk-adjusted basis is extremely hard to do. On average, actively managed funds underperform the index by about as much as the fees and charges they extract. David Blake at the Pensions Institute in London has spent much of his career analysing fund performance and calculates that only around 1% of them genuinely beat the market. And yet so many people in the investing industry are keen to tell you how they’ve outperformed by x or y per cent.
So, what’s going on here? Are those people lying? Or are they self-delusional? Well, either of those is possible. A third explanation, I point out in my latest piece for the Betafolio blog, is that they’re being very crafty and choosing a benchmark that makes them look far more successful than they actually are. After all, we can’t all be above average — and we certainly can’t all be in the top 1%.
“Welcome to Lake Wobegon, where all the women are strong, all the men are good-looking, and all the children are above average.”
Garrison Keillor, A Prairie Home Companion
We all like to think of ourselves as being better than average. Let’s face it, whether it’s driving, cooking or deciding who should take the penalties when the scores are level after extra-time, most of us think we’re pretty good.
The truth, of course, is that, regardless of the activity, half of us have to be below average. But good luck telling your spouse that they’re sub-par in the parallel parking or, heaven forbid, the bedroom department.
This phenomenon is sometimes known as the Lake Wobegon Effect, after the author and broadcaster Garrison Keillor, who famously poked fun at people’s reluctance to see things as they really are. And it’s certainly alive and well in the investing industry.
All the time we hear pension funds, asset managers, investment consultants and financial advisers say, “We’ve beaten the market by x per cent.” Most people simply take their word for it, and I used to be one of them.
But anyone with a passing knowledge of academic finance, the SPIVA scorecard from S&P Dow Jones Indices or Morningstar’s Active/Passive Barometer knows to take these sorts of claims with at least a pinch of salt.
Robin is a regular columnist for the Betafolio website. Here are some of his other recent posts:
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