Tuesday, December 15, 2009

Finally - what those mutual funds titles really mean

Ever wondered what the difference was between "Aggressive Growth" and "Ultra" funds? Well click here for the full explanation.

Excellent stuff - and quite funny unless you actually own one these things.

HT: Felix Salmon

Monday, December 14, 2009

Are stocks more risky in the long term

Are stocks more risky in the long term?

I'd guess that most investors think that stocks are actually safer in the long run than in the short run. This idea is supported by the well known book by Jeremy Siegel.

The intuition is based on a of time-based diversification - in the long run the ups and downs cancel themselves out.

But as Fama and French note, this logic suffers a fatal flaw. This time diversification effect only really works if you know what the true expected return is, and for stocks this is unknown. So, as the time horizon gets longer, you face risk from the volatility of the expected return, and also risk from not knowing what the expected return is.

Is Siegel's book wrong? The answer depends on how you view it. If you read it as a description of how well stocks did over the past 100 years, then it is a great read. If you think it tells us something concrete about the future, then I'd exercise more caution.

Sunday, December 13, 2009

RIP Paul Samuelson

The Economist, Paul Samuelson has died. My MBA students will recall his appearance in the "trillion dollar bet" in which he utters the wonderful line that he got Louis Bachelier's Thesis translated from French to English in order to "preserve every precious pearl".

Tuesday, December 1, 2009

Can you have positive alpha in an efficient market?

Is a positive alpha in an efficient market evidence of illegal activity?

I don't think so. There is nothing in the efficient market theory that says that an investor cannot earn positive alpha. In fact it is entirely possible for an investor to beat the market for many years in a row. Market efficiency just says that the reason for the investor's success was luck, not skill.

Luck vs Skill in mutual fund management

Gene Fama and Ken French show that after you take account of fees, actively managed mutual funds underperform index funds. This is not new news really, but Fama and French present the evidence in an exhaustively robust way. The evidence against active management is very strong.

Felix Salmon summarizes the article nicely here.

Still, most investors will ignore the results of this and other similar studies and chase returns by trying to pick actively managed funds. In the long run they will fail.