-------- Original Message --------
| Subject: | Re: Active "investing" is a negative sum gain . . . |
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| Date: | Tue, 2 Nov 2010 06:03:27 -0700 |
| From: | Jas Jain |
Nothing says more about America's System of the Crooks more than the fact that financial bloodsuckers, under the dictatorial rule of Greenspan-Bernanke Fed, have death grip on the US economy. Financial speculation is one of their channels for sucking blood. Pushing Debt is another. No one has done more to fan speculation and push debt than evildoers Greenspan and Bernanke. They were chosen for a reason. They have served their masters well. Agents of these bloodsuckers in academia, e.g., Blinder, Krugman, Shiller, Stiglitz, etc., all have solutions to Americas' economic problems that are based on more deficit spending than being currently done!
Jas
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To: Jas_Jain
Subject: Active "investing" is a negative sum gain . . .
Date: Mon, 1 Nov 2010 20:59:50 -0700And this phenomenon is particularly and demonstrably relevant during a secular bear market; however, most "investors" will not discover this unfortunate fact (for them, not necessarily the money "managers" scalping fees from other people's money) until it is much too late to do anything about it. And it is not an unreasonable assumption that many money "managers" are not aware of the reality of "managing" money; otherwise, they would quit and do something more useful with their time and intellect.
I would like to elaborate on an important consequence of this equilibrium accounting identity to understand the root cause of the crisis and how this bears on its resolution. There are so many discussions, works, brain-storming and efforts to find better ways to regulate, to manage, perhaps to diagnose and to control the financial system in order to get out of the problems, have the economy recover and prevent future crises.
I think that they are collectively and fundamentally misleading and misled. As a corollary of the analysis [1], it dawns on me that the core of the problem is us, in a collective sense. The core problem is our belief that active investments provided by pension funds, banks, mutual funds, hedge-funds and all the financial industry have the potential to out-perform naive static boring investments. But if GDP grows at, say, 2% per year after inflation, how can financial investments as a whole provide more return? Believing that financial investment can give more than the growth of the global portfolio is a gross illusion, which I believe is shared by most of us, either consciously or unconsciously. This is the illusion of over-optimism. This is the illusion of control. But it violates the fundamental equilibrium accounting identity and the fact that our collective wealth does not grow faster than (good measures of) GDP. As long as we, the people and the future retirees, hope for more return, we will provide the manure for the development of the species of parasites, called the banking and financial industry, that feed on our illusion and never ending hopes of easy gains.
I think that they are collectively and fundamentally misleading and misled. As a corollary of the analysis [1], it dawns on me that the core of the problem is us, in a collective sense. The core problem is our belief that active investments provided by pension funds, banks, mutual funds, hedge-funds and all the financial industry have the potential to out-perform naive static boring investments. But if GDP grows at, say, 2% per year after inflation, how can financial investments as a whole provide more return? Believing that financial investment can give more than the growth of the global portfolio is a gross illusion, which I believe is shared by most of us, either consciously or unconsciously. This is the illusion of over-optimism. This is the illusion of control. But it violates the fundamental equilibrium accounting identity and the fact that our collective wealth does not grow faster than (good measures of) GDP. As long as we, the people and the future retirees, hope for more return, we will provide the manure for the development of the species of parasites, called the banking and financial industry, that feed on our illusion and never ending hopes of easy gains.
In other words, do active investors in aggregate earn a higher expected return than passive investors? The arithmetic of equilibrium accounting says we do not need empirical tests to answer this question. Since we are assuming they all hold the market portfolio, passive investors earn the return on the market minus their fees and expenses. In aggregate, active investors also hold the market portfolio, so they also earn the market return minus their fees and expenses. If the fees and expenses of active investors are higher than those of passive investors, active investors must in aggregate lose to passive investors. This is the unavoidable arithmetic of equilibrium accounting. And notice that this is not a statement about expected returns or about long-term average returns. In aggregate active investors lose to passive investors every instant.
It is, of course, possible that individual active investors add value. But if they do, it's at the expense of other active investors. Again assume that passive investors always hold the cap-weight market portfolio. The arithmetic of equilibrium accounting then implies that the deviations from cap weights in one active investor's portfolio must be absorbed by other active investors who take offsetting positions. In aggregate active investors hold the market portfolio, so if some skilled active investors overweight an undervalued stock, other active investors must underweight it. This means that, before fees and expenses, trading is a zero sum game. Ignoring costs, the gains of the skilled investors are, dollar for dollar, at the expense of other investors. But real investors cannot ignore costs. If some active investors win, others must lose, and they all pay to place their bets. (French 2008 provides dollar estimates of the massive costs borne by active investors in U.S. public equity.)
Another common argument is that active investing is more likely to add value for small stocks than for the market portfolio in which big stocks dominate. Again, however, the arithmetic of equilibrium accounting plays a sobering role. Define a passive investor in small stocks as anyone who holds small stocks in cap-weight proportions, and define an active investor in small stocks as anyone who doesn't hold small stocks in cap-weight proportions. (Both groups can hold big stocks in whatever proportions they see fit.) Since passive investors in small stocks in aggregate hold the cap-weight market portfolio of small stocks, in aggregate active small stock investors must also hold the cap-weight market portfolio of small stocks. This again means that skilled active small stock investors must win at the expense of unskilled active small stock investors. If there are more opportunities for skilled investors to add value in choosing among small stocks, it is because unskilled active investors in small stocks are worse than unskilled active investors in big stocks.
. . . [A]ctive investing in any sector is always a zero sum game - before costs. After costs, active investing is a negative sum game.
Another common argument is that active investing is more likely to add value for small stocks than for the market portfolio in which big stocks dominate. Again, however, the arithmetic of equilibrium accounting plays a sobering role. Define a passive investor in small stocks as anyone who holds small stocks in cap-weight proportions, and define an active investor in small stocks as anyone who doesn't hold small stocks in cap-weight proportions. (Both groups can hold big stocks in whatever proportions they see fit.) Since passive investors in small stocks in aggregate hold the cap-weight market portfolio of small stocks, in aggregate active small stock investors must also hold the cap-weight market portfolio of small stocks. This again means that skilled active small stock investors must win at the expense of unskilled active small stock investors. If there are more opportunities for skilled investors to add value in choosing among small stocks, it is because unskilled active investors in small stocks are worse than unskilled active investors in big stocks.
. . . [A]ctive investing in any sector is always a zero sum game - before costs. After costs, active investing is a negative sum game.
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