Financial planners must outsource their investment decisions instead of trying to achieve the 'mission improbable' of beating the market, according to legendary investment consultant Charles Ellis.
Pointing to US returns data suggesting that, over a 20 year period, 80% of investment managers fail to predict the movement of stock prices, Ellis said the chances of outsmarting thousands of economic analysts and computer models are "surely negative".
Ellis, who founded Connecticut-based Greenwich Associates almost 40 years ago, was speaking this week at the 2010 IFP Conference at the Celtic Manor resort in Wales.
He laid into past performance data, outlined the dangers of misunderstanding clients' attitudes to risk and spoke of his enduring admiration for Warren Buffett, a man he describes as "extraordinarily smart, unbelievably focused".
Charles Ellis on...risk
"It's a little like being a marriage counsellor. A couple say they are so in love, but there are always negative things they will not know about at the beginning. It would be a great thing if investors knew more about the possible negative side and therefore might be a bit more prepared to live with it.
"Returns are residual. Risk is fundamental. Everybody's judgement about how they should invest should start with how much risk they can comfortably live with. Let the returns come as they will."
"I love the accuracy of it, but let me draw my own chart. Results often look compelling, until you discover the data only covers 90 days!
"Performance data really ought to be 10 or 20 years long. Nobody ever shows 10, 20 years of performance. Do you know why? Because it's not very impressive. Except that it tells you a fabulous, powerful message: the market is pretty damn hard to beat."
Beating the market
"Mission improbable. There will always be some investment managers, over any time period, who can beat the market, but that's not the important data. The important data is you will never be able to figure out in advance who they are. Try it. Nobody can figure this stuff out in advance.
"There are people who just knew Warren Buffett was brilliant, but they were neighbours, or people who spent a fair amount of time with him, and they figured it out. How many people have that kind of special access? And why hasn't everybody put all their money with Buffett?
"Some look at Buffett and say he can't be right forever, others think they can do even better with someone else. They may be right."
"He's extraordinarily smart, unbelievably focused. This is a man who every day of every year, for a very long time, focused on mastering knowledge of investing. That self discipline and intensity of concentration, nobody has ever done so much.
"He is also not an investment manager full stop, but also a business manager. If you look at his great triumphs, he has made an investment and then deeply influenced the way that company is run. By working both disciplines, he has created something truly quite remarkable. Who has ever done that before?
"There has never been anybody like him. Remarkable consistency."
Planners outsourcing investment decisions
"The hard work in financial planning is not investment related, but investor related. It is hard enough to determine who clients are, what their resources are, what problems they have. This is demanding work. Planners can make a spectacular, sustained difference in that kind of work. It makes a great deal of sense to me that would be a concentration of effort.
"Planners could also spend time doing significant work on investment management, but that just doesn't make any sense to me. The nature of the world is that there are so many people, with such extraordinary talent and with so much resource in the way of knowledge and information and computer models, who are working to figure out what the prices of every security really ought to be.
"The chances you are going to outsmart them are not just small, but they are below zero. They are surely negative, so why spend a lot of time banging away at that? It will simply be an expense to your clients and yourself and it gets you off the focus that you really ought to be on, which is to find out what the individual investor is trying to achieve?
"Trying to beat the market is a bit like saying: 'I'm going to go out and play tennis today by hitting the ball against the wall. And sooner or later I'm going to beat it."
Charles Ellis is a graduate of Yale and earned his MBA from Harvard and his Ph.D. from New York University. He is the author of many books on investing, including the widely-acclaimed Winning the Loser's Game. He advises institutions and governments around the world on investing.
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