Nevada’s public employee pension fund invests passively and beats peers (2016)

Short answer re: investing in active managers (based on my many years listening to rationalreminder.ca) is that, if you eliminate some of the worst active managers, the average returns net of fees are the same. However, eliminating the worst managers is challenging (but not impossible) to do ex-ante. Even then, you’re only getting the same average returns as indexing, not better. Plus, you will experience a higher dispersion with active managers (greater chance of extreme negative or positive outcome), which is not desirable. Because of these two issues, It’s definitely better to pick an index fund.

Re: picking stocks yourself, the answer is also pretty cut and dry. There’s strong evidence no individual trader can expect to beat the market. Active managers can only beat the market gross of fees because they employ large teams of people to do a lot of work to gain a small edge (stuff like predicting retail sales numbers from satellite images of store parking lots).

This is my attempt at summarizing a whole field of research in a few sentences. There are many more nuisances. I highly recommend listening to the Rational Reminder podcast if you’re curious about this sort of thing. They interview a lot of academics.

But why stress about beating the market? Just be the market with an ETF that tracks the S&P 500 index. Literally, setup auto invest from your paycheck. Go to sleep (Rip van Winkel style). Wake up 40 years later and retire comfortably.

Look at total returns over the last 40 years on the most popular indices in the world. S&P 500 crushes them all. I see a lot of "Internet advice" recommending various MSCI world indices. They are all much worse than the S&P 500.

The common refrain is that "time in the market always beats timing the market".

The implicit assumption in that refrain is that, despite periodic dips, the U.S. stock market always goes up over time. This has been true since the Great Depression (see graph of S&P 500 since 1929)

https://www.officialdata.org/us/stocks/s-p-500/1929

The implicit assumption behind that is that the American economy always invents a way to grow. Buffet famously said, "never bet against America".

For as long as these assumptions match reality, it's likely that passive management will continue to succeed.

It is the opposite. Market timing does not work reliably. Active management produces worse results on the long run. no individual trader or active manager can consistently beat the market. however active fonds may have periods (even several years) where they out perform.

for private investors buy-and-hold of highly distributed ETFs is the best way to do it. The easiest way to get started is a one ETF portfolio like e. g. Vanguard FTSE All World or SPDR MSCI ACWI IMI. They perform internal rebalancing automatically and you virtually have nothing to do. buy them and don't look at them for the next 20 years.

The catch 22 for active management is that if they are actually good then they would just use their strategies to manage their own money.

It's sort of self evident - if you are freakishly capable of spotting mispriced securities in a market full of smart hard working people who are paying attention, you can do better than average. If you aren't freakishly capable... you cant.

It's sort of like "does playing pro golf make sense?".

Active does better much better. If you know how the price moves you can easily beat the market.

The general wisdom is that it’s basically impossible for most people to tell the good fund managers from the bad/mediocre ones.

Except Warren buffet. A lot of people went with Berkshire Hathaway and did very well.

There's strong data supporting passive investment. I've found the stats in Andrew Hallam's book, "Balance: How to Invest and Spend for Happiness, Health, and Wealth" (https://www.amazon.ca/Balance-Invest-Happiness-Health-Wealth...) quite eye-opening.

Yes, read "The little book of common sense investing" by Bogle.

On average yes. An index tracker will get the average market return ignoring fees, so its returns will be those of an average active fund.

However, the active find will charge higher fees.

There’s the famous bet Warren Buffett won against an actively managed fund: https://www.investopedia.com/articles/investing/030916/buffe...

Take a look at the automated systems that have resided on Collective2 for more than 2 years.

https://collective2.com/grid

There are only a couple that has a large history of trades, fairly even equity curves, older than two years, and small(ish) drawdowns (< 30%).

In other words, it's difficult but possible.

The point of actively managed funds is not so much to "beat the market", it's to provide diversified returns via strategies that are uncorrelated with the market.

On average, the S&P500 has returned about 7% annually. If I had a strategy that returned 5% on average but was totally uncorrelated with the S&P, then you'd get the best overall long-term returns (maximize the geometric average of annual returns) by investing in a combination of my strategy and the S&P.

You’re probably aware that no fund manager would accept your offer. But it doesn’t prove that they don’t think they can beat the market (as misguided as that belief might be), it just means they’re not willing to take on an absurd amount of risk to prove it.

Fundsmith for example has beaten the market for a long time (not this year though). I can also mention another Spanish fund that I know: Tercio Capital.

https://markets.ft.com/data/funds/tearsheet/charts?s=GB00B4Q... https://www.finect.com/fondos-inversion/ES0174115057-Cinvest...

Why would anyone take the other side of this bet? It's an incredible financial instrument, that anyone on the buyside would buy in an instant (as formulated -- ignored fees/tcosts etc).

You are not an UHNW individual/institutional investor, so no "fund managers" of any note are going to waste their time on this wager.

"Beating an index" is really easy. Up to $10MM you can choose most any financial instrument class in the U.S markets and have a good probability of finding alpha for a long time (that would beat the S&P500 18.40% YTD). Many proprietary trading firms, or market makers, or quantitative trading shops do this regularly. Discretionary and systematic funds? Usually not. If their processes worked consistently, they would have no need to take outside capital and deal with relationship management. They could simply use more leverage (not exactly, but simplified for the general reader).

This is also ignoring the fact there are no details in TFA about actual portfolio compositions or returns -- i.e. this is a PR piece.

If your NW is under <$100MM, you should be focusing on hyper-growth strategies -- and not mentally limiting yourself on what is basically financial propaganda.

This sounds clever but many funds did exactly that. What’s your point?

S&P + nvidia was better than just S&P over the last 5 years.

Where will they find the money to pay you if they lose?

Sounds similar to recently launched buffer ETF products, specifically BlackRock and Innovator that hedge 100% of downside while capping your upside across different time horizons indexed to the S&P500.[1]

[1] https://www.bloomberg.com/news/articles/2024-07-01/blackrock...

Something I don’t see talked about enough is the extent to which the rise of passive investing increases the extent to which passive investing is the best strategy. Passive investing is predicated entirely on either freeloading off of the decisions of actively managed portfolios, who will adjust the market prices of securities efficiently, therefore resulting in passively managed funds automatically owning the “best” stocks because the bad ones will fall out of the indices; or it is predicated on what is effectively a Ponzi scheme wherein if everyone passively invests the same, then that form of passive investing will yield the best returns.

For analogy, consider school students trying to get all the questions right on the test. The first scenario is equivalent to one student studying hard to find the right answers. The rest of the class copies his answers and benefits from his efforts. The other scenario is no student trying hard, them all failing, but succeeding because the teacher curves the grades.

Note that both of these scenarios, especially the second scenario, results in stock prices which become increasingly detached from the economic reality of companies in proportion to the extent to which passive investing becomes prevalent.

For instance, assume stock XYZ is a bad investment but is in the S&P 500. If 90% of funds are actively managed, maybe they can sell a sufficiently large amount of it to push it out of the S&P 500 and save the passive investors from owning it. But if 90% of funds are passively managed, even if XYZ is hot garbage, the 10% of passively managed funds cannot possibly sell enough to make up for the fact that 90% of the market participants are indiscriminately buying a terrible stock.

Passive investing breaks the market to some extent. The free market system is predicated on having rational participants, not zombie participants.

There is a similar but different product (without the downside protection).

A fund manager can replicate the index with derivatives and overlay their alpha on top of it.

Google “alpha overlay” or “portable alpha” for more info.

These types of products were more popular about 10-15 years ago.

Firms typically charge just for the alpha for these strategies.

You are asking for the manager to sell you an option.

https://longbets.org/362/

“Over a ten-year period commencing on January 1, 2008, and ending on December 31, 2017, the S&P 500 will outperform a portfolio of funds of hedge funds, when performance is measured on a basis net of fees, costs and expenses.”

Predictor: Warren Buffett | Challenger: Protege Partners, LLC

https://longnow.org/ideas/warren-buffett-wins-million-dollar... (“Warren Buffett Wins Multi-Million Dollar Long Bet”)

I feel like some creative use of beta could make this a very lucrative deal for a patient, but unscrupulous fund manager.

An important component of a bet like this: you should base the win/lose calculation on returns after accounting for fees. The index fund likely has fees that are two orders of magnitude lower than the active fund. Otherwise, a random fund may beat a broad index just by chance.

Warren Buffett's very similar bet was done this way.

You won't have any guarantee that they will be able to make good on their promise and won't just go bankrupt.

Disclaimer, I work for a market-neutral fund, and have close friends high up in prop shops.

Presuming all strategies have a curve of diminishing marginal returns as assets under management increase, you would not expect any fund accepting outside money to have expected returns beating the market, but you would expect many of them to have a combination of correlation to the market and expected returns that would make them an attractive component in a basket of broad index ETFs and market-neutral funds. (Assuming risk-adjusted returns are the utility function being optimized. If variance is their preferred risk metric, this results in optimizing Sharpe ratio via mean-variance optimization, MVO.)

It's fair to assume that any fund manager is optimizing the sum of returns from their own personal investments in the fund plus fees from outside investors. They pick the place on the volume/risk-adjusted-returns curve that still keeps their fund attractive enough to outside investors, and maximizes their personal profits (personal returns plus fund fees).

If that optimal point on the volume/risk-adjusted returns curve for their particular strategy is at a point where risk-adjusted returns beat the market, then they maximize their returns by either never accepting outside funds (prop shops) or by not accepting additional funds and gradually buying out their investors (such as RenTech's famous Medallion fund).

So, (assuming diminishing marginal returns) it's not rational to simultaneously accept outside investment and beat the market on a risk-adjusted basis.

I suspect that many market-neutral funds could reliably beat the market on a risk-adjusted basis, but their volume/risk-adjusted-returns curve shape and their fee structures make it optimal for them to operate at a point on that curve where their expected returns are below the market.

Note that this rational self-interest optimization below market returns isn't bad for the investors. Under most fee structures, it ends up being close to maximizing total investor returns. Increasing percentage returns would mean kicking out some investors.

RenTech's Medallion Fund and many prop shops, and funds that are currently slowly buying out their investors seem to indicate there are at least some strategies where the optimal volume/returns trade-off is above market returns. You would expect all funds that are currently open to more outside investment to either be young and lacking capital or else have an optimal point on the volume/returns curve that is below market returns.

Note that as previously mentioned, a simple mean-variance optimization on a basket would allocate funds to both index ETFs and market-neutral funds returning a bit under the market on average. It's entirely possible that both fund investors and fund managers are being perfectly rational.

Of course, there are also plenty of people out there who fool themselves into thinking they know what they're doing. The world certainly isn't perfectly rational.

I'm just saying that in a perfectly rational world, assuming (1) utility function of risk-adjusted-returns (e.g. Sharpe ratio, resulting in mean-variance-optimization) (2) declining marginal returns on investment, you would expect all funds accepting outside investors (except for young funds desperate for money) to under-perform the market in expected returns.

Now, everyone talks about Sharpe ratio on the outside, but the particular risk models actually used internally by any fund are almost certainly not just variance of returns. I presume all funds simultaneously apply a mixture of commercially available risk models and internally developed risk models. Sharpe ratio is far from perfect, but it's a good least-common-denominator for discussion, and doesn't give away any secret sauce.

Side note: it would be rational for someone to take you up on your proposal and simply use index futures to take a highly leveraged position on your benchmark index. As long as they had enough money to make you whole in the case of bad tracking error and large downturns, their expected returns would be large. However, you wouldn't be very smart to take such an agreement instead of just getting leverage yourself. This demonstrates why risk-adjusted returns are usually more important than expected returns.

As a retail investor, it's good to remind myself that if I actually had the skills to invest professionally, someone would probably be paying me to do it for them.

Don't discount the knowledge you have from being deep into an industry. The higher quality of the CUDA toolkit compared to other SIMD languages, combined with it's increasing relevance in compute (gaming, followed by blockchain, followed by ML, followed by GPT) would have made this an NVDA an easy pick for anyone (of the increasing number of people) that worked in parallel computing from 2006-2023.

Sometimes you can see a company is positioning itself for a great long term position before the entire wallstreet herd takes notice. That's when you add a single stock as part of your diverse portfolio. I keep up to 5% of my stock portfolio as these single stock picks, judged entirely on the product the company sells.

Every share of an S&P 500 index fund you hold is already 6-7% NVDA, so a lot of investors already have substantial bets on some of these "race horses".

This is totally reasonable and I support it. When (usually young) people are bored with my advice about index funds, I tell them that it ok to "gamble" with a tiny fraction of their portfolio, but be prepared to lose what you bet!

I also think that if you look at the regulatory environment in the last 20 years and the lack of monopoly oversight from the SEC and FTC, you can just ride the regulatory capture. I can't see anything beating S&P500 + N100 over any 5 year period unless new laws are passed.

As a retail investor, it's good to remind myself that if I actually had the skills to invest professionally, someone would probably be paying me to do it for them.

The majority of supposed "experts" are not beating the market. Its probable that the only difference between them and you is the belief/confidence in their skillset.

I like this approach too. My primary investments in index funds continue to grow and I get just enough of a dopamine hit from smaller bets on Nvidia and Crypto that I don't get crushed by fomo and end up betting my mortgage on some far otm call options or some shitcoin.

NVDA cracked 300% cost basis when I finally sold, which is wild.

It's not if you consider the volatility of the stock. It appreciated x10 in less than 2 years and 20-30 times since the pandemic. Volatile stocks have high returns because they have high risks for losses.

It’s not just a matter of skill but of time. Value investing a la Warren Buffet works extremely well, but choosing a single stock with the deep research required for that method is so much work it is a full time job. It’s not worth it unless it is in fact your full time job.

This is great advice. You follow the best rule of thumb for individuals, ETF w/ dca and set it and forget it, but allow a bit of fun to scratch the itch.

I do something similar but honestly allow too much to go towards the latter. I need to pair back. I am thankful and lucky that my returns have been similar to index funds and not far below (thanks NVDA and NET)

I haven't touched my 401(K) in over 30 years. It's done 9-20% per year. It's not super aggressive, but will take a hit, on really bad markets (the only year it actually lost money, was 2020 -and it has completely made up for that. It even made some money in 2008).

I ignore the Fidelity calls. Every time a new broker rotates in, they try to get me to move my money around.

I've done well (39% annual returns) investing in 2-3 individual stocks in addition to index funds for the rest of my investments. More than that would be IMO too much to pay attention to.

Admittedly my choices for stocks are a bit on the high-risk side, but it's worked out well so far. Picking up lots of AMD in 2017, and Rivian 6 weeks ago, seems to have been decent calls.

It depends. I had a pension plan that grew x2 in 17 years (don't know what they invested into). My own investments grew much faster than S&P though.

Great read. I actually recommend it over Nudge. I had him as a professor at Cornell for a couple courses before "behavioral economics" was a term.

What about the book made the difference? I'm 100% convinced that it's better to do as you say, and forget about the accounts, and also unable to resist the temptation to check them every day. I'm constantly tempted to make changes.

One of my big brain investing ideas is to pick the stocks at the top of the index instead of buying the whole index. If index funds continue to rise in popularity, the stocks that are at the top will benefit most from passive investment volume.

Plus, index funds follow a kind of Pareto principle where the top stocks contribute disproportionately to the total return anyway.

As I’ve gotten older though, one of my realizations is that the tax-free rebalancing of index ETFs is their most valuable property, rather than their actual choice of equities.

Index funds are not some clever hack, they are just tracking the combined productivity of the publicly traded companies that make them up. Whole market, or the top 500 as a representative slice, whatever. When you buy the whole US market for example you are saying, "I strongly believe that the overwhelming majority of companies in the US want to make shitloads of money and pass it down to themselves and their shareholders."

Index funds will never bring down the market as long as individuals and companies are allowed to trade individual stocks at prices of their choosing. There will _always_ be someone who thinks a particular stock is overvalued or undervalued. Those people set the prices.

There are a lot of unknown for the markets in the future. Also the 0 or negative interest rate environments we will probably enter (again).

IMHO we need to rethink or tweak the financial system sooner rather than later.

On the contrary, that article makes it seem perfectly fine to invest in index funds.

In crypto, successful investors get their funds stolen and then later recovered (MtGox, Gemini Earn)

I've been harboring a suspicion for several years that I've forgotten an account or two. Maybe I'm one of the fidelity investors.

Your link has John O'Shaughnessy being interviewed by Barry Ritholtz (two respected folks in finance), and O'Shaughnessy later corrected himself:

* https://twitter.com/jposhaughnessy/status/115517108366392524...

While I do believe set-and-forget passive investing is best for the vast majority of people, last time I checked that Fidelity study does not actually exist, and the story is apocryphal (no one seems to be able to actually link to it).

If you ask Fidelity about it, they'll tell you it does not exist:

* https://www.morningstar.com/columns/rekenthaler-report/archi...

Until it gets liquidated and the cash put into state lost money accounts because of escheatment rules. You should still login once a quarter or so.

https://www.investopedia.com/ask/answers/110415/what-are-dor...

That's pretty much how I did it.

I didn't actually forget, of course, but I didn't get around to looking at the numbers every year. And when I did, I hardly ever changed anything.

Of course, buying Apple in 1997 was also an important factor.

Funny. Just today I receive main from Fidelity to review my account. The only thing I wish to but can't afford to change is retirement age to an earlier date.

Because on HN we like titles to have information and not be click-bait. The WSJ title is prime click-bait.

There most definitely is a reason to edit titles: to reduce clickbait or shorten titles.

The system even automatically removes certain clickbait elements, for instance "How" is stripped out of submitted titles.

He doesn't literally do nothing, does he? So I don't think it was exactly correct. And it was vague because it didn't explain what the article was actually about.

Yeah. Some are saying passive investment is the biggest bubble of all times. The P/E of so many companies, not just tech ones, makes zero sense.

Mandatory pension funds are a ponzi. And btw the EU is hard at work working on one atm: they re currently thinking hard as to how to capture the wealth of EU citizens and the latest iteration would be a mandatory fund to invest in... State sponsored companies. They ll oc course not be presenting it that way but that s what it is. Then they ll kick the can down the road for years or decades by forcing mandatory contribution from new taxpayers.

Ponzi / pyramidal / state-mandated shenanigans never end well.

FWIW that mandatory fund in the EU shall be used to finance the army, digital transition (supposedly to counter the US but actually to siphon taxpayers money into friends of politicians creating companies that ll never compete with SV) and... Ecology.

I'm not thrilled that in a few months I ll be forced to invest in that.

Can you explain how it's fundamentally any different from retail investors just buying and holding the SP500 Index Companies' stocks individually?

The market seems to hate dividends and buybacks, preferring expansion or acquisition, but then what gives it value?

I've always thought of a stock as a claim on future dividends, but for most of a company's lifecycle they should have a better idea how to invest funds than returning them to shareholders. So ideally only mature large cap companies should pay dividends.

As far as valuations go, international stocks are far more attractive than US stocks right now.

Total US stock fund (VTI): 1.33% dividend yield, 25.1 P/E

Total international stock (VXUS): 2.94% dividend yield, 15.4 P/E

It's been my experience discussing with many US investors that they are loathe to hold any international stocks for a variety of reasons. Personally I think they will have their decade soon. The US market cannot continue eating the world market capitalization without commensurate outsized earnings growth to back it.

Reminds me of that scene in The Long Short where Michael Burry is hemorrhaging money on the bet against CDSes and basically everyone has completely turned on him.

This is true. Of course, when you have many indices, with random returns, some of them will perform well, but past performance doesn't guarantee future results.

Oh, that's funny... apparently to reduce the risk of there just being one person.

Can you elaborate on the regulations preventing corp implementation here please?

I don't think most of us think the hedge fund industry is full of idiots. Speaking only for myself, I think it's mostly full of grifters.

1. The benchmark for hedge funds is not the sp500, it’s the bond market

There is not _a_ benchmark for "hedge funds" as they are not really _a_ thing.

In some cases S&P 500 may be an appropriate benchmark. Unless Bill Ackman is not a true hedge fund manager, I guess. "In 2023, Pershing Square’s 20th year, Pershing Square Holdings generated strong NAV performance of 26.7% versus 26.3% for our principal benchmark, the S&P 500 index."

Normally non finance people in the organisation get hoodwinked by investment sales people.

Some benefits salesman came to my blue collar office and tried to hoodwink [great wordchoice] our boss into buying employee insurance policies (health, whole life)... but would not allow employees to read the contractual terms until after bossman signed-up.

It was left to employee vote, and I was grateful when my peers listened to my concerns [slick sales guy was out-voted, left frustrated with me about his lack of commission]. Why not just let us see the terms & conditions.?. are you really offering that shitty of a product?! †

†: insurance company's mascot was some waterfowl with a loud two-syllable mouth...

Unfortunately Firefox is often treated as a forgotten child.

I say this as a mostly Firefox user on every platform. When the Firefox experience sucks too much, I switch to Chrome or Samsung Internet.

(Well, Firefox itself has a number of open bugs that haven't been fixed for a long time)

Updated title.

Private equity has not, as an asset class, had excess returns since around 2006. Prior to that, private market companies were systematically undervalued relative to public. Post-2008, an accommodative equity market has supportive private equity as a volatility dampener for portfolios. Volatility is often used as a proxy for “risk”. There are still many private market firms generating excess returns. It’s a competitive market now and many players are getting eliminated.

Same reason we pay the TSA.