New York Discovers Wall Street Charges Fees
bloombergview.com
bloombergview.com
"If above-average performance is to be their yard stick, the vast majority of investment managers must fail. Will a few succeed — due to either to chance or skill? Of course. For some intermediate period of years a few are bound to look better than average due to chance — just as would be the case if 1,000 ‘coin managers’ engaged in a coin-flipping contest. There would be some ‘winners’ over a five or 10-flip measurement cycle. (After five flips, you would expect to have 31 with uniformly ‘successful’ records — who, with their oracular abilities confirmed in the crucible of the marketplace, would author pedantic essays on subjects such as pensions.)”
At the time of WaPo's sale to Jeff Bezos, the pension fund had a $1b surplus.
This article describes the memo, and includes a link to a PDF (thru Scribd):
http://fortune.com/2013/08/15/the-1975-buffett-memo-that-sav...
Seven years into the bet, he's way ahead:
http://fortune.com/2015/02/03/berkshires-buffett-adds-to-his...
For those interested in the coin-flipping analysis, I strongly recommend "Fooled by Randomness", which is a smart, passionate, and funny examination of how that problem plays out in the investment industry.
And it's great to see the $1M is actually up around $1.7M at this point. Hopefully it continues to grow before it gets donated to charity.
Its a really good read and can be applied to life outside of investment.
http://blogs.cfainstitute.org/investor/2015/02/12/betting-wi...
(Disclosure: I work at CFAI)
Edit: a better response - http://msantoli.tumblr.com/post/110804679383/cry-me-a-river-...
"None of this seems like a blanket reason to condemn "Wall Street," but, you know, politicians gotta politick. My takeaways are something like:
1. New York pension funds' performance is fine.
2. They pay fees that, over all, are quite low.
3. Their alternative investments seem to somewhat outperform public-market benchmarks, though maybe not as much as they'd like."
Actively managed money has a very nice angle going. They can charge money to actively manage your funds, while still getting to keep a share of any profits generated.
Insurance companies have to pay money to get access to the same funds, to do the same gambling.
It is somewhat insane that you can run a business where the choices are:
a) Do admin work to balance an indexed portfolio for price A b) Gamble with money for price (B + X% of profits)
And somehow people feel its ok that the price of B is higher than the price of A.
That's a $10 billion customer paying 5X in fees what a small investor like me pays. I think that's insane.
I would happily quintiple my risk of dying from a meteorite strike for $20,000.
At $57B and $27B invested respectively I imagine the city could negotiate an even better deal if it was going to put all the money in each category into a single fund.
That said, the author of the linked article does have a point. The expense numbers on the public market side don't look outlandish when expressed as an expense ratio rather than a ten year total number.
If you lose money on actively managed funds, you lose the money. If you win money on actively managed funds, you get a small part of the win, and give away a large part of the win to the guy who was gambling (how large is clearly a contract question). If the part you give away is too big, you are playing a fools game. The article isnt describing how much was fixed costs and how much were bonuses paid on outperforming funds, so it's hard to tell if they are indeed playing a fools game, but it seems at least possible.
Why pay someone to gamble for you if he will take 95% of the winnings but not eat any of the losses? If this is this because the managed accounts actually under-performed to expectation - ok. If it is because you're paying too big bonuses on exceeding some easy to reach baseline - not ok.
I think that is a reasonable argument. .
This is a common structure for "long only" management funds that limit their exposure to public equities and are under significant restraints in how "creative" they are allowed to be.
That is paying a fixed price for someone to gamble for you.
If you look at it objectively, a more sane pricing model would be that you get a discount on the flat fees compared to what you would pay for a non-managed fund, but with a bonus paid on earnings.
The value proposition from the fund managers is that they can significantly outperform a non-managed fund. If that is true, then what they lack is capital to actually play on a large enough scale (if they had the capital they would just play with their own money after all). Pension funds have a large amount of capital that they want to accrue interest on.
The win-win scenario is that the fund managers agree to handle the money at a lower cost than what having them in some form of indexed managed would be, but that in return they take a share of any profits that are generated.
If you just add on a flat % fee that is higher than what the indexed fund would charge, then the fund manager isnt assuming any risk.
Followed to conclusion: a big enough loss = fees become negative and the hedge fund actually pays.
From the article:
> So for instance in U.S. equities the funds got annual returns of 8.24 percent for 10 years, versus annual fees for U.S. equities of about 0.08 percent. So the funds got 99 percent of the returns on their investment, and the managers got 1 percent of those returns.
I'm paying you to beat the average - I can achieve the average myself, at a lower risk by just investing evenly across the board.
If the funds delivered 8.24%, and matching S&P would have gotten me 7.5%, then you're in fact keeping 15% of what you gambled for. And if you had delivered 7.0% I would have eaten that loss compared to the average.
Where does it say that? I just did search on the web page and the string "25" doesn't appear anywhere.
Perhaps you're rounding up from this number: "total fees of about 0.24 percent a year on all assets, including private assets."
If you are, you're not comparing like with like. The closest equivalent in the article to your index funds is this: "The fees that NYCERS pays for U.S. domestic public equities are about 0.08 percent a year".
So we're now comparing 0.05% for an index fund vs 0.08% for "US domestic public equities", which almost certainly includes actively-managed funds, which incur higher fees than an index fund (e.g. Vanguard's average active fund expense ratio is 0.27%[1] vs 0.13% for index funds[2]), which would explain the 0.03% difference.
1: https://investor.vanguard.com/mutual-funds/actively-managed
Likely this is just the trial balloon, expect similar articles as the truth about government employee pensions funding comes to the forefront. Unlike private pensions the government at different levels can twist the rules quite a bit.
couple of scenarios come out of this 1) cuts to benefits, likely only through bankruptcy like Detroit. NYC should be able to avoid this result 2) tax increases to fund the pensions properly 3) finding new creative ways to fine financial companies for exploiting retirees and the like 4) bailouts, after all we have elections in a few years and what good polio wouldn't be for bailouts.. by the state or feds (again not necessarily for NYCERS, they are bad off but not the worst out there)
I
If you round up 0.08%, it should be 99.9% and 0.1% respectively.
A billion dollars buys a lot of developer and data scientist time.
1. Studies that say "XX% of active managers don't beat an index" include every tiny poorly managed fund. The best attractive lots of capital; Bridgewater has $169 billion under management and has a long track record of large outperformance.
2. A lot of investors aren't trying to beat the market per se -- that's in your own link. If you own safe investments during a bull market, you underperform... but if it (ideally) makes you less susceptible to both boom and bust, that could be a good trade depending on what you're doing. If you're an insurance company or pension fund, you probably want stability more than squeezing every last basis point out of your investments.
Anyway, I could give you many criticisms of many aspects of finance, but I think "index > active management" is a bit simple.
The second study linked found
Only 0.6% — you read that right, 0.6% — showed any true skill at beating the market consistently, “statistically indistinguishable from zero,” the three researchers concluded.
So your cavets, whilst valid, I don't think go anywhere near disputing the central point.
Also, "the market" is big.
First, the market in general works in the exact opposite way. You can invest a million dollars a lot of places; with enough luck and skill you'll earn a great return. Keep doing that and soon you'll have, say, 500 million.
But 500 million is harder to invest; you might say "stock X is really undervalued; I'm going to go long!", but if stock X has a market cap of 10 billion, you'll struggle to find 500 million in shares to purchase on a whim, and in so doing, you'll push the price up, and now it's no longer undervalued. Many investments that work for the guy with 1m don't work for the guy with 500m.
But if you keep going and keep being lucky (or skilled) you might end up with billions or hundreds of billions. Now you're basically fucked. Most possible investments don't have the liquidity or capacity to absorb the money you're trying to place. At this scale you aren't picking companies; you're picking industrial sectors or countries. You'll never make a great return like that. Plus you're being watched constantly; the merest rumour that you're about to invest will end prices soaring or crashing before you can move. You can "push the market around", but only in ways that benefit smaller, nimble players, not you. At that scale, your ability to be clever is basically nil.
Which brings us to the second point: Vanguard is an index fund. They simply buy an even mix of the shares that make up an index. Their entire strategy/promise is that they won't "push the market around" (which is the reason they have $3t under management; people explicitly looking for people who won't try and be clever).
So your question is "couldn't Vanguard do the one thing they don't do, because it can't work"? And the answer is no, it can't work, which is why Vanguard exists and has those assets.
If you buy significant stakes in companies - which might be only a percentage point or two, but still putting you in the top individual shareholders, then you have the ability to change the strategy of the company.
The step up from that is into Berkshire Hathaway / private equity territory where you just buy companies, or very significant stakes and run them as you want to.
One guy bought 15% of the world's cocoa and now chocolate prices are high and manufacturers are trying to rip off consumers by filling thick plastic packages with more air and less chocolate bar.
If you had control of that sort of money it just seems you could be invisible. The cost of the entire coffee production of the world is only billions, buy any significant percentage and there's going to be companies who'll either pay or collapse?
Well yeah. Start to buy Apple shares, and the price rises, and you pay more than a smaller investor would. Try to sell them again, and the price crashes, and you receive less than a smaller investor would. As I already explained, you've got it backwards.
> One guy bought 15% of the world's cocoa
Yes, years ago. And it was 7%, not 15%. And like pretty much every cornering scheme, it didn't work. Armajaro ended up in trouble when cocoa prices dropped while they were still holding a large inventory, and they had to sell their commodities trading division off just to cover their losses, because of the same dynamics: The only way they could buy 7% of the worlds yearly cocoa production was by paying a premium—and the only way they could get rid of it was by offering it as a discount.
> If you had control of that sort of money it just seems you could be invisible.
The exact opposite of invisible, actually.
> The cost of the entire coffee production of the world is only billions, buy any significant percentage and there's going to be companies who'll either pay or collapse?
Not a good plan. :)
Armajaro did 2 major trades [I confused the two], the first in 2002 at 15% of the crop (http://www.theguardian.com/business/2013/dec/21/coffee-globa...) and the second in 2010 at when he took delivery of 7% (that you noted; IIRC he purchased more but took delivery of this portion??): http://www.tradingeconomics.com/embed/?s=cc1&d1=20000101&d2=... - notice in 2002 to 2007 the price ramps as it does 2010 to present.
Now the official story with Amajaro is that (eg http://www.ft.com/cms/s/0/8fb81fa0-5374-11e3-9250-00144feabd...) he lost "millions" but I've not been able to find specific details of this trade and the selling on of the cocoa. He purchased 7% of a crop that his CC+ fund bets on price changes of - the fund is making large gains (http://www.valuewalk.com/2014/06/anthony-ward-letters/), ~15% in 2010.
The above FT story reports that the problem with the trade was that customers expected extended credit and despite a $55M for 6% investment the company, doing many other deals, went under; reported as a credit issue. They sold for $1 to another commodities trade company [Ecom Agroindustrial Trading], FT reports Amajaro Trading was valued at $200M-$300M in 2012. I'm skeptical as to whether Amajaro made a personal loss in any of that, whether it's possible that the price was artificially lowered to sell on a lot of commodities for $1 and avoid tax? Does that seem at all possible?
As a complete novice to the field, could you explain why it's not a good plan in general to seize large proportions of a commodity, for example in these two positions with an increasing price and a stable retail demand for the end products?
Armajaro trading arm bought something like 240,100 tonnes of cocoa for around £650 million, or ~£2,700 per tonne, in July 2010. They then sold the cocoa beans "later that year".
Unfortunately, July 2010 was the peak of the market (it's almost as if trying to buy 7% of global production drives prices up), and they were paying above the odds even then. And prices immediately tumbled off a cliff, dropping to a low of ~£1,8200 in November 2010 (it's almost as if trying to sell 7% of global production drives prices down!), before rallying briefly in 2011, then proceeding to briskly tumble to a low of ~£1,330 per tonne in 2012. (They've since recovered, but they've yet to break £2,000.)
So yeah, obviously Armajaro lost a bunch of money on that trade, precisely because of the volume they were working with. By actually taking delivery, they were relying on prices going up, but prices went down, right as they were needing to sell. Except that because they were buying and selling hundreds of millions of pounds of cocoa, they themselves were a leading cause of the markets moving against them. The same thing happened in other famous market corners, for example when the Hunt brothers tried corner the global silver market (and lost a staggering amount of money). It's no accident that there are no famous successful market corners.
Incidentally, I'm not sure what the graph you linked is meant to be, but here's a good graph of cocoa prices over the relevant period: http://www.indexmundi.com/commodities/?commodity=cocoa-beans...
> whether it's possible that the price was artificially lowered to sell on a lot of commodities for $1 and avoid tax? Does that seem at all possible?
Not following. If you're asking if it's possible if Anthony Ward sold a key part of his trading empire to a hated rival for $1 not because he'd lost a ton of money trading cocoa and the thing was basically worthless, but because he'd made a ton of money and it was actually hugely valuable? Then the answer is no, of course not.
> As a complete novice to the field, could you explain why it's not a good plan in general to seize large proportions of a commodity, for example in these two positions with an increasing price and a stable retail demand for the end products?
First, cocoa doesn't have a steadily increasing price, and while retail demand might be stable, the supply situation is very volatile due to political and economic instability in the growing regions. Cocoa prices were bouncing around like crazy, and while volatility is good for smart traders trying to make bets about price directions, it's bad for people trying to deal in the physical commodity, because what happens if you get stuck with 240 thousand tonnes of cocoa purchased when the price crashes?
Second, even if cocoa was a safe commodity with stable supply, demand, and price, you can't "seize large proportions of a commodity"; what you can do is start buying it. And the more you buy it, the less stable the price is going to be, because the demand is no longer stable due to some wannabe Bond villain is buying up huge amounts of it. The price will skyrocket. So when you ask:
> why it's not a good plan in general to seize large proportions of a commodity
Because you'll pay a large premium over the fundamental market price. Like, by definition. And buying anything for a large premium over the market price is never a good idea, unless you value it well over the market price. But Armajaro wasn't a producer; all they could do with the cocoa is sell it. Which, inevitably, they'll do at some discount to the market price. Nor would this trade have made sense if Armajaro had known that prices were going to spike due to an external shock; then they should have bought options, not actual physical cocoa.
Bottom line: Buying very large amounts of a physical commodity in order to profit from price movements is a terrible idea.
Edit: The largest purchase of cocoa ever was done in 1996 by...Anthony Ward, working for Phibro at the time. He bought 300,000 tonnes, but Phibro lost money on the deal when prices moved against him. Shocking! Although he is reported to have made money on his 2002 trade. Then again, the 2002 trade was only 5% of the market, or 200,000 tonnes, smaller than the other two. (The Guardian says 15%, but you can't trust the Guardian with numbers, and multiple other reports confirm the lower figure.) Or in other words, Ward has demonstrated the ability to make money on small trades, but lose them on bigger ones.
>"Armajaro trading arm bought something like 240,100 tonnes of cocoa for around £650 million, or ~£2,700 per tonne, in July 2010." (Lazare) //
>"Then the answer is no, of course not." (ibid) //
The ICCO [1] has an interesting section at paragraph 31 on page 10 where it discusses this tonnage [at arms length] and says a group of interested parties made appeals that unfair trading was attempting to manipulate the futures market. This suggests that those companies were thinking something along the lines of what I was suggesting: that this purchase was trying to manipulate prices, so the money made would not be from the trade directly.
>"[...] This price development on the London market led 16 cocoa companies and trade associations to send a letter to NYSE Liffe to complain that “a manipulation of the contract” was “bringing the London market into disrepute”. Many market commentators argued that this backwardation was fuelled by a squeeze, which is a trader or a group of traders deliberately disrupting the supply of physical cocoa to artificially increase the price of cocoa futures contracts which are about to expire, and hence to profit from it while other traders find themselves struggling to fulfil their obligations. In response to this allegation, NYSE Liffe advised that it did not find any evidence of abusive trading behaviour on the cocoa market." (ICCO report [1]) //
You said the price "tumbled off a cliff, dropping to a low of ~£1,8200 in November 2010". According to the chart you linked a tonne of cocoa averaged [?] £2.11k [in London?] in July 2010 when Amajaro made the trade. So why would companies be complaining about backwardation then? [2] Says the price was pushed up and rose by 0.7% after the purchase.
Presumably then those with warehoused stock that's accessible can undercut Amajaro in order to bring down the price? But if there are sufficient goods for this then the "other traders find themselves struggling to fulfil their obligations" from [1] makes no sense.
Also seemingly there was a major issue with Ivory Coast [aka Cote d'Ivoire] being under a flood warning, that previous years had returned deficits in terms of the global demand vs. the global harvest. Was this the issue that broke Ward: There were various embargoes and shenanigans around the Ivory Coast's presidential elections and when they eventually shipped the harvest proved excellent and there were massive excesses [1].
>So yeah, obviously Armajaro lost a bunch of money on that trade, precisely because of the volume they were working with. //
Looks like a top estimate for that is -£72M based on the July to November price change for 240k tonnes.
>* Nor would this trade have made sense if Armajaro had known that prices were going to spike due to an external shock; then they should have bought options, not actual physical cocoa.* //
Correct me if I'm wrong but you can't corner the market that way because the seller can default; moreover a future glut can come in and wipe out your position and/or movement of goods can alleviate the local shortfall [it's something like 3-4 weeks to ship cocoa from US warehouses to European buyers]. Thus it wouldn't create a clamour in the market to ensure that delivery of the commodity can continue, as was apparently the case here?
- - -
Couple of figures that are pertinent:
* Re your edit [3] puts a figure of £40M on the 2002 trade, Wikipedia reports a £58M gain.
* Ward's CC+ fund made 15% in 2010, not exactly sure how much that is but it seems to have been £25M based on some other figures (all Amajaro funds passing £1B, CC+ being 20%, working backwards from [4]).
[1] http://www.icco.org/about-us/international-cocoa-agreements/...
[2] http://www.telegraph.co.uk/finance/markets/7895242/Mystery-t...
[3] http://www.telegraph.co.uk/foodanddrink/foodanddrinknews/789...
The article is based entirely on an assumption 10x higher than Vanguard's institutional fees. He declares it cheap relative to mutual funds, which is an absurd comparison.
The lower bound of his fee comparison is 8 basis points, which is 4x higher.
Not to mention the condescension dripping from every word. This piece is a good example of how not to write an 'informative' rebuttal.
In what way is the market not free and competitive?
The possibility for kickbacks (or just complacency) when the ones selecting the fund managers do not necessarily have significant funds under management is evident.
One side effect has been the inclusion of a greater buffet of options for retirement funds offerings from employers.
This news story seems to be another side-effect, in which people start to realize how large these fees had been in some cases.
Active managers compete for business, and retaining clients even when performance is good is not easy. One of the key differentiators isn't just performance but client service - if you're investing $40bn of other people's pensions then you want to get good answers from your active investors about their thinking, where they see things going, risks, performance etc.
Oh and the best active managers charge relatively low fees, it is very much not a case of "you get what you pay for" - low fees and high assets under management is a much better money making model for everyone.
This is an increasing and pernicious trend in political discourse.
NYC (pop. 8.4M): 78B
Los Angeles (pop. 3.8M): 8.1B USD
Toronto (pop. 2.8M): 10B CDN
Chicago (pop. 2.7M): 9B USD
I wonder if it's something in how the headline numbers are calculated. Toronto splits out its operating and capital budgets, and there are some services like social housing that are (used to be?) cost-shared between the provincial and municipal government.
That said, most people just don't realize (or take for granted!) all the services that cities provide: police, fire, paramedics, garbage/sewer, water, roads and public transit - many of which are highly labour intensive.
This is correct. NYC is basically sui generis for American cities. As examples, there's essentially no county government and the school system is part of the city government. The school system alone accounts for $20B of the $78B and over 100,000 of the 360,000 city employees...AND those school numbers don't include the $900M for the city-funded-and-operated 4-year university system.
http://web.mta.info/mta/budget/pdf/MTA%202015%20Adopted%20Bu...
Vanguard's fees are 0.17. The pension fund paid ~0.25. That's a small difference because the numbers are small!
Actually, that's nearly a 50% upcharge for the fund relative to vanguard.
Saying "50% more" is completely the wrong way to look at it.
Then what's the value in a fund manager instead of a simple algorithm that follows the market? Would you hire an employee and pay them the entirety of the value they generate for your business?
What a preposterous argument.
Indeed.
The market generally has been growing for a long time, with 2008 being a notable exception. If you've been growing money at market pace, then historically you've been doing pretty well.
How much more than that does one deserve for mirroring the market returns?
By Matt Levine
Here is a simple model for hedge fund fees:
1. There are some people who can reliably generate alpha -- returns in excess of the market return -- but those people are rare.
2. It is somewhat difficult to tell who those people are; in particular, at any given time, there are more people who look like they can generate alpha than who actually can.
3. If you are one of the people who can generate alpha, you should charge a fee for your services that is equal to the alpha that you generate.
4. If you are not one of those people, you should charge a fee equal to the alpha that those people generate, because then investors might think that you're one of them. "
So, best case scenario I get market returns? Then why not just invest in an index fund?
B) Change the point of view from the retail investor to the pension fund, funds have a very narrow and constrained mandate, they need to hedge risks and deal with the increasing negative cash-flows. They can't merely park their money somewhere and hope for the best.
Yes. Note: This is a surprisingly accurate description of reality. Aggregate hedge fund returns are goddamn terrible.
> Then why not just invest in an index fund?
Well, you should, if you're trying to maximise your expected outcome. Of course, not everyone is trying to do that.
In particular, what if you run a pension fund which is currently underfunded, but for political reasons is claiming to be adequately funded through the expedient of assuming that future returns will exceed any reasonable expectation of market returns?
If you invest in an index fund you'll get market returns; since that's not enough this means you will miss your targets, and be unable to pay promised pensions, at which point you'll be fired. But if you give all the funds cash to a hedge fund, or engage in some crazy snowball derivative[1], then you'll probably do even worse than an index fund, be able to pay an even lower percentage of the promised pensions, and you'll be fired. Which is actually no worse for you. But you MIGHT do really well, and actually be able to pay the promised pensions. Not likely, but if it works you avoid you getting fired, and if it doesn't you were going to be fired anyhow, so why not give it a shot?
All of why is completely hypothetical. The fact that many US pensions funds are horribly underfunded using any plausible actuarial projects and are simultaneously investing heavily in exotic asset classes is just a funny coincidence.
[1]: http://www.bloombergview.com/articles/2014-05-02/portuguese-...
If the ability exists at all, it's certainly very rare. And if you are one of the people who has it, why would you hire that ability out to other people? The guy who owns the golden goose is going to sell the eggs, not rent the goose out. Or if he did rent the goose, it would be for an amount no lower than the expected value of the eggs because otherwise he's losing money.
But given these dynamics, that means that there's no reason to think that if you see some guy offering to rent a golden goose it would be a great deal for you. I mean, he's actively trying to price it so it's not, and it's his goose, so he's probably right.
This is what most level headed people who study the stock market suggest you do!
If you are a customer for hedge funds, you should be willing to pay anything up to the expected future alpha based on past correlations between previous and future alpha.
That correlation is always affected by regression to the mean. Therefore someone with a good track record will not be able to charge on the expectation of future performance matching past performance. But only on the expectation of future performance being somewhat better than the market mean.
The ideal if everyone does everything perfectly is that, on average, fund managers that can generate excess alpha will, again on average, capture their entire outperformance as fees.
So from this perspective, it'd make sense to go with the human fund manager who was beating the market and charging exactly his outperformance.
I wonder if index funds ever get widespread enough adoption that they start to drive prices of the major indexes up and underperform... maybe it sounds crazy right now since institutional investors don't really go for index funds heavily, but if there's a shift on those parameters I could see it happening.
Also, I've started to get more down on index funds as I look into them more. An index that has a weighted average of the stock market is always paying for past performance -- you're going heaviest on the largest market cap stocks always. In an era with both stability and upside for large market capitalization stocks it'll do well... in an era where the best private companies don't IPO until they've ran out most of their growth trajectory and then IPO once they've relatively stabilized, you're going to get hammered, no?
If active managers are under-performing, then at some point as passive funds grow we will reach an equilibrium point where they are causing such price distortion that they will produce opportunities for active managers to profit from mispricings, correcting the situation.
Most middle- to upper-middle class individuals with a 2+ decade investment time horizon (which should describe the majority of HN readership) are better served with starting on a relatively vanilla FIRE/Boglehead approach, and fine-tuning with allocations to broad bond/EM/International indexes as they go along and get a feel for their personal risk appetite.
The plentiful exceptions are people for whom investing is a hobby, they are good at tracking their own performance, and they have domain knowledge about a specific industry. Small-scale active investment can work, but for the vast majority of people who just want to set aside a comfortable retirement without having to spend a lot of time tinkering with it, I have yet to find a better generic approach than passive index tracking on very broad market indexes, though I'm certainly very open to suggestions.
I somewhat doubt passive indexing will ever catch on to the levels you mention due to human nature. Indexing only really works over extremely long time spans, and the data has so far consistently shown most people do not plan that far out for their personal finances. As long as most people are personally responsible for the majority of their retirement finances, I don't expect the consistently-applied delayed gratification a successful indexing strategy requires to cause "too many" people to sit in indexes. I classify that as a "would be a nice problem to have", so I'm not worried even if it somehow comes to pass.
[1] http://www.crsp.com/files/Equity-Indexes-Methodology-Guide_0...
So my question to HN is - what is so hard (or not) about making market returns for a fund of this size?
I mean the obvious approach seems to buy 100m worth of shares in the top 1000 companies and just hold?
Perhaps it is worth not being fully invested all the time? Perhaps just making market is not worth it - but if it is, is the saving in fees compensating?
Boggleheads have been asking that question for like 40 years. Vanguard funds (which simply pick the top 500 shares, or all the shares... depending on the fund...) outperform something like 85% of actively managed funds.
One theory is that modern markets are extremely efficient, which means that actively managed funds do not provide a benefit over just "trusting the market price" of various things.
I mean - if I was a trustee of a million fund let alone billion I would expect to know the baseline level of dumbest simplest possible investing process. That approach seem the simplest.
Because Vanguard's prices are the lowest. Where else are you going to go?
The typical fund charges between 1% to 2%. Vanguard charges 0.05% if you qualify for Admiral Shares ($10,000 minimum). Various ETFs can drop down to that amount, but you still have to deal with tracking error and commissions. $7 per trade typically... while Vanguard doesn't charge commissions if you own a Vanguard account and buy Vanguard Funds (or ETFs).
So ... What am I missing. Exchanges all use electronic trading now, Charles Schwann would give me 5 bucks per transaction.
Why does anyone pay percentages?
My favorite is the Goldman Sachs aluminum "scandal" from last year: http://www.bloombergview.com/articles/2014-09-03/the-goldman...
There's a lot of bad stuff that happens in finance, but we shouldn't be whipping out the pitch forks every time someone makes an accusation.
edit: typo
Because in a competitive market, the price of a good is equal to its marginal cost? "Difficult" here is being used synonymously with "expensive".
You cannot really say its twice as difficult but you can easily say that its more difficult because when you are working with a small amount of money you invest in plenty of small promising companies. When you are working in big money a small profit is not going to affect your results much so you need to find a big fish, its very difficult to find such big fish all the time.
I'm currently running an algo that is giving me returns of about 25-30%/year. I do this as a hobby - I don't generally devote more than 10 hours/week to this. Why doesn't NY just give me their money? Why aren't I the greatest investor ever?
The answer is that my algo consists of watching the market and picking off liquidity from the top of the book (typically < 500 shares) when things get unbalanced. Then I passively (for the most part) close my positions a couple of weeks later, very rarely taking liquidity.
I made $2k last year on approx $10k in the market. If I put $20k into the strategy I'd be losing money by taking liquidity from deeper in the book. I.e., buying 500 shares might cost me $10/share but buying 1000 shares might cost me $10.10/share. I'd lose another $0.10 closing my positions, and shaving off $0.20 in profit per trade would kill my profits.
If I were investing 5-10x as much, phrases like "very rarely taking liquidity" would not even be possible - I'd have to take liquidity and I'd then lose the spread as well. And if I were investing 100x as much, I'd be moving the market and losing even more.
I also earn a bit more than $2k on other strategies. I was just describing my highest return strategy and explaining why it can't scale for the sake of discussion.
The real benefit of trading, and why I encourage most quant devs to do it even if they lose money is that it is great mental exercise. When you make mathematical or rationality errors, the market punishes you by taking your money. That's my real reason for actively trading.
It is very common for management fees to follow an 2 and 20 Fee Structure.
Meaning they charge a flat 2% to keeps the lights on and pay outrageous salaries. Then above a certain threshold an additional 20% of any profits earned.
Why does this matter?
IHMO this motivates funds managers to accumulate large AUM (Assets Under Management) to make that 2% larger. The fund manager is less motivated to make good returns since he knows he will still collect that 2%. So it might be better to remove the 2% flat fee and simple charge a percentage on the profits earned. This motivates the fund manager to actually generate returns before he makes a buck. Even if the market is going down he will still be motivated to outperform.
And see which pays better?
So they added value above and beyond the benchmark and you're complaining that they expected compensation for this service?
Why should I hire a manager that beats the market, he he charges the amount he beats the market with? Wouldn't that leave me of the same as simply averaging the market?
In your example, you suggest that you could get $100 by using an index, but instead, you hire a guy who gets you $200 for not using an index, and then charges you the $100, and you're no better off.
In the article, you could get $100 by using an index, but instead, you hired a guy who gets you $200, and then charges you a percentage of that, keeping $4 for them to your $196.
Do you begrudge them their $4, knowing that you "profited" $96 on the deal?
Yeah, the math gets uglier when you realize you're talking about much larger numbers, but the clients, e.g., the pension funds, still came out ahead against the index, even after the managers took their fees.
To keep (dumbly) using my simple numbers, while still using their percentages, it would be more like this:
You could get $100 by using an index, but instead, you hire a guy who gets you $103 for not using an index, then charge you a $2 fee, leaving you with a "profit" of $1.
At the end of the day, the fund recipients still come out ahead, just not as much ahead as if the managers charged no fees. If you can figure out a way to get people to work for free, and do a good job on top of it, then you'll have surely cracked the code (or reinvented slavery). Until then, it's hard for me to demonize a money manager who charged two percent over ten years, even if it was two percent of a very large number.
The way this reads to me is that his idea of an actively managed fund should either match index performance after fees (in the case of a good manager) or perform worse after fees (in the case of a bad manager). In which case, you'd be better off sticking with index funds instead of betting on whether or not you have a good manager.
To put it into your example: The S&P 500 has returns of 5% for the year of 2020. Guy_A has his investments managed by Investor_Good who gets gross returns of 7%, but charges fees that leave Guy_A with 5% net returns (~1.87% management fee). Guy_B has his cousin Investor_Bad manage his scratch-off earnings who ends up matching the index with gross returns of 5%, but charges the same fee as Investor_Good leaving Guy_B with net returns of 3.04%.
Edit: I just wanted to add that this is how the how situation (not the NYC Pension, but the quoted section) sounds to me. Finance is not my area of expertise, so I could be misinterpreting something.