The catchy headline of the week had to go to the New York Post’s “Crypto-investing hamster beats performance of Warren Buffett”. The story describes how two German gentlemen have designed an enclosure for the rodent, named Mr. Goxx, that triggers buys and sells based on what tunnel he chooses to take to his hamster wheel.
Since June, Mr. Goxx has logged better returns trading cryptocurrencies than Warren Buffett at Berkshire Hathaway (or even the S&P 500 for that matter) has returned in the same timeframe. Surprising?
Not at all. But investors can learn something from this.
First, in a very short time frame such as June to September, random chance plays a huge role. Mr. Goxx could have just as easily been a clown flipping a quarter, pressing buy on heads and sell on tails. Or, as Princeton economics professor Burton Malkiel noted in his 1973 book, A Random Walk Down Wall Street, it could be a “blindfolded monkey throwing darts at a newspaper's financial pages…”, which he said, “…could select a portfolio that would do just as well as one carefully selected by experts."
While Malkiel’s observation may also support other academic findings (such as small stocks are more likely to perform better than larger ones), there is ample evidence to suggest that professionals often aren’t worth the fees they charge to manage assets. A few examples come from Dimensional Funds 2021 Mutual Fund Landscape, an annual report that analyzes returns from a large sample of US-based mutual funds.
Exhibit 1. Few equity funds beat benchmarks over time.
In Exhibit 1 above, you see the number of US domiciled equity mutual funds beginning 10, 15, and 20 years ago. As the time period lengthens, there are fewer and fewer funds that survived and even fewer that managed to win versus their benchmarks.
When you consider that random chance suggests that half should win and half should lose, it is truly remarkable how poor active managers have done. But you may be wondering, what about the 20-25% that won? They have to be worth considering, right?
Uhm, well, no.
Exhibit 2. Winners don’t continue winning.
As you can see in Exhibit 2, the top 25% in any five year period averaged only being in the top 21% of US domiciled funds in subsequent five year periods since 2006. The reasonable conclusion is that the top 25% were mostly just lucky to be there and didn’t outperform due to skill.
So, is there any way to predict top performers? Maybe not, but there is one way that seems to give investors a better chance and that is to focus on fees.
Exhibit 3. Lower fees correlate to higher performance.
As can be seen in Exhibit 3, there are more “winners” among funds with lower expense ratios than those with higher. An investor can conclude that focusing on funds with lower expense ratios, while not guaranteeing success, certainly seems to increase the likelihood of picking a winner.
But what other factors can an investor consider that may further increase their chances of winning?
Exhibit 4. Investing for size, relative price, and profitability has led to higher returns.
Most investors understand that investing in stocks has historically returned more than investing in bonds or cash. That difference is known as the Equity Premium. Similarly, premiums have also been observed in small stocks, value stocks, and profitable stocks. Thus, investors can reasonably assume that systematically investing more of their equity portfolio in those types of stocks may result in better long term results than a hamster.
While keeping cost down and emphasizing investments with higher expected returns doesn’t guarantee success, it certainly seems to increase the chances of doing so. If you don’t have a plan that incorporates these elements, get in touch to work on yours.