Wednesday, October 23, 2013

Mutual Fund trading costs.

An interesting post from Josh Brown.  What really caught my eye was this:

Trading costs are too high, too. What comes along with lots of trading is lots of trading costs. Scherrer puts the annual cost at around 1.4% (average) to 2.59% for small cap managers, which really takes a chunk out returns.
Remember that when you buy an actively managed fund you are already paying the fund expense ratio which can run 0.5% - 2% depending on the fund.  Add to that 2% trading costs and it is amazing that any of these funds ever beat the market.

Monday, October 14, 2013

Nobel Prize for Economics - Fama, Shiller and Hansen

The Nobel prize in Economics was announced today and it goes to Gene Fama, Lars Hansen and Robert Shiller. From a finance perspective this is very big news.  But personally - both Fama and Shiller have had a profound impact on my academic career.
Let me talk about Gene Fama (of U. Chicago) first.
Fama is sometimes called the "father of market efficiency".   The efficient market theory is one of the most important concepts in finance.   Simply stated, it says that all public information is instantly incorporated into stock (or asset) prices.  This means that you can't use public information (balance sheets, sales forecasts etc) to forecast stock prices.  In essence, if you believe markets are efficient, then you believe that anyone who beats the market is just lucky.   Not surprisingly, money managers don't like this.
So, are markets efficient (I am referring to major financial markets)?  The answer is a resounding YES.   That is why most finance professors are indexers - we don't try to beat the market.  We know that chasing abnormal performance is a fool's errand.
I have never met Fama, although I've seen him talk.  But in the seven degrees of separation in finance, I know quite a few academics who had Fama as their dissertation chair.  Fama's book "Foundation of Finance" is still required reading in many top PhD programs.  I still have my copy on my shelf.
Robert Shiller is being pegged as the opposite to Fama by much of the media.  This isn't true.   What Shiller shows in his research is that markets can deviate from fundamentals - for example - the housing bubble of 2000-2007 and the tech boom of the 1990s.   His arguments are brilliantly laid out in the book "Irrational Exuberance".   Shiller's work is sometimes called "behavioral finance".
My PhD dissertation at the University of Florida looked at how investors fail to take account of inflation when they value stocks.  I showed (with Jay Ritter) that a decline in inflation can lead to a bull market.  In 1997 we showed that the market was horribly overvalued (it crashed in 2000).   Shiller cited my work in his book "Irrational Exuberance" - I made it into a footnote!  I've met Shiller and had dinner with him on a couple of occasions - he's a quiet, mild mannered guy.  I am sure that he doesn't disagree with the bulk of Fama's work - but his work shows that while Fama is correct in the short run, in the long run things can get out of line.

Sunday, October 13, 2013

NC Pension Fund bets on Private Equity

An article on  (also reprinted in the News and Observer) that talks about NC's move into more PE.

I'm quoted in the article stating that I don't think returns for PE will be that great going forward, simply because "everyone and their grandmother" is in the asset class.

Saturday, October 12, 2013

Market manipulation in GTA V

Apparently, some gamers have taken it upon themselves to try to manipulate stock prices in the latest version of "Grand Theft Auto".

While the article is quite interesting, one of the comments is great:

This is solid proof that Grand Theft Auto is harmful and a menace to our society! It doesn't teach people to be murderers, it teaches people to be something far worse: bankers.

HT: Mark (one of my past students).

State Pension Fund Performance Rankings

My State (NC) is 43rd.

Saturday, October 5, 2013

Thursday, October 3, 2013

2/3 of hedge funds are dead.

From the FT via Finance at Tepper  - two thirds of hedge funds that are reported in major data sets are dead - they are no longer in existence.  

How can this be?

Simple - hedge funds are started all the time.  If they get off to a good start and make money they are kept open.  But if they don't do well, they are closed down and a new fund is started.   Basically, in the hedge fund industry you get unlimited do-overs as long as you can find money to start funds.

Finance researchers know of this issue which is why they take special care to control for this "selection bias" when they compute returns.   Just looking at the returns of hedge funds in a given year is horribly misleading as these returns are just those of the funds that survived.

A similar thing happens in the mutual fund industry -  mutual fund companies start many funds - and hope that some fraction of the funds will do well.   The badly performing funds get dumped in target date funds which are then sold to unsophisticated individuals.  That's why target date funds are like hotdogs - they are full of the nasty stuff that can't be sold on its own.