INVESTING TO BEAT THE MARKET
Simon Benninga Faculty of Management Tel-Aviv University
דבר תורה—פרשת יתרו Dvar Tora
Jethro—the first management consultant Also an investment consultant? The Tora and speculation
Lending and Heter Iska
Shimon Benninga
2
May a Jew invest in stocks?
Shimon Benninga
3
10 LESSONS ABOUT INVESTMENTS
1. Risk and return are related. The larger the risks, the larger the (expected) returns.
Shimon Benninga
4
Shimon Benninga
5
Shimon Benninga
6
Shimon Benninga
7
Shimon Benninga
8
Shimon Benninga
9
Shimon Benninga
10
Shimon Benninga
11
Shimon Benninga
12
Risk and return—U.S. Stocks
Shimon Benninga
13
10 LESSONS ABOUT INVESTMENTS
2. Past performance is a poor indication of future performance
Shimon Benninga
14
Shimon Benninga
15
10 LESSONS ABOUT INVESTMENTS
3. Market timing is mostly futile (and costly ... see #8)
Shimon Benninga
16
Shimon Benninga
17
Shimon Benninga
18
10 LESSONS ABOUT INVESTMENTS
4. There is some persistence in stock market returns, but it may be difficult to exploit.
Shimon Benninga
19
Shimon Benninga
20
Shimon Benninga
21
Shimon Benninga
22
Shimon Benninga
23
10 LESSONS ABOUT INVESTMENTS
5. There are no magic formulas and it’s hard to predict
Shimon Benninga
24
10 LESSONS ABOUT INVESTMENTS
6. Don’t believe most of the investment nonsense you hear. Over any particular time period, half of all investments outperform the average. Typically, out-performers have wonderful after-the-fact explanations for why this happened. Over the same period of time, half of all investments underperform the average, and under-performers have good reasons why this happened.
Shimon Benninga 25
http://www.pa-investors.com/annual.html
Shimon Benninga 26
"Last year, it turned out good. We were down 2 percent, but the S&P was down nearly 12 percent, and Nasdaq finished down 20 (percent). So we outperformed the market," he said. Bateman said that a number of analysts contribute to the company's annual stock list, utilizing what he referred to as a top-down approach. Essentially, Bateman analyzes each sector's performance in various stages of a business cycle. Given the prevailing stage of the current cycle, the analysts look to which sector has a high-probability of outperforming the market. "Basically, our model does a number of regression studies looking at where we are in the current cycle and what industries have done the best." "We focus on those sectors that look the most attractive and identify the companies that are the most attractive in those sectors." As way of example, Bateman said that hotels historically have performed well during the existing phase of a business cycle. In fact, the probability of the hotel sector outperforming the S&P 500 exceeds 50 percent in each quarter this year. From there, it was a matter of selecting which hotel stock would be the best pick for the year, and Huntington analysts determined that to be Marriott International. Shimon Benninga
27
Shimon Benninga
28
10 LESSONS ABOUT INVESTMENTS
7. Most investment advice is worthless.
Shimon Benninga
29
Shimon Benninga
30
10 LESSONS ABOUT INVESTMENTS
8. Fees are important: 1% per year over 10 years = 13%
Shimon Benninga
31
Shimon Benninga
32
10 LESSONS ABOUT INVESTMENTS
9. Relate investment decisions to: a. Your investment horizon: The longer it is, the more risk you should be willing to take. b. Your risk-tolerance. c. The costs of managing your portfolio.
Shimon Benninga 33
10 LESSONS ABOUT INVESTMENTS
10. It’s very hard to beat the market. Investment in index funds (passive management) is preferable to managed funds
Shimon Benninga
34
Shimon Benninga
35
THE STREET.COM By Beverly Goodman Senior Writer 08/12/2002 Indexing has suffered quite a backlash of late. From pundits proclaiming that "we're in a stock picker's market now" to columnists decrying the active management of the S&P 500, hitching your portfolio to an index seems like folly. Actually, thinking you can consistently beat the market -- bear or bull -- is where the real folly lies. In the first five months of 2002, the average actively managed fund underperformed the relevant Standard & Poor's index in seven of the nine Morningstar categories -- and one of the remaining two essentially tied the index. That's from a just-released study by veteran Vanguard Index fund manager Gus Sauter. (See charts below.) The study also looked at five-year performance ending May 31, 2002. In that case, indexing roundly trounced eight of the nine categories.
Shimon Benninga
36
Study after study has shown that index funds outperform 75% of actively managed funds over virtually any time period. But half of the remaining funds (or 12.5%) that outperform their relevant benchmark do so just as a matter of chance, according to research done by finance professor and chair of the Richard H. Driehaus Center in Behavioral Finance at Chicago's DePaul University, Werner De Bondt. Those numbers are even more compelling since they don't include the thousands of failed funds that have either folded or merged over the years.
Shimon Benninga 37
Fees, Taxes and Spreads, Oh My! When active management does beat the benchmark, it usually does so only slightly. Equity index funds lost 21.94% in the past 12 months, while actively managed equity funds just barely edged that out, losing 21.74%. Index funds returned 0.66% in the past five years, and 9.8% in the past 10. Actively managed funds, meanwhile, returned 0.65% and 8.8% in the same period, respectively, according to Morningstar. For starters, the average equity index fund has an expense ratio of 0.79% -- and exchange traded funds, or ETFs, are roughly half that (although you will have to pay a trading fee on when purchasing). The average actively managed equity fund has an expense ratio of 1.49%, according to Morningstar.
Shimon Benninga 38
Expense ratios aren't the only aspect of active management that will eat into returns, though. The average turnover of actively managed equity funds is 118%. All that buying and selling means more internal transaction costs, greater bid/ask spreads and more capital gains generated (which, of course, means more taxes that you get slammed with -- whether or not the fund even makes money). By contrast, index funds generally have a turnover of next to nil; buying and selling occurs only when the index changes. Small wonder the average actively managed fund lags the market by 2%.
Shimon Benninga 39
CAN YOU BEAT THE MARKET?
NO
(well, probably not … )
Shimon Benninga 40
Dvar Torah דבר תורה
The lot is cast into the lap, but the decision is the Lord’s alone.
Better a dry morsel in peace than a house full of feasting with strife.
Proverbs 16:33, 17:1
Shimon Benninga 41
Thank you!
For a copy, write me: benninga@post.tau.ac.il
Shimon Benninga
42