annual returns from active investment?

[Deleted User]

As an economics student, I read a lot of literature saying that there's no point actively investing/trading in individual stocks/shares/areas/etc, as the market is efficiently priced and your returns wont be much higher than if you'd just bought, for example, the whole ftse.

How many of you make annual returns that justify the research/decisions/choosing individual stocks/areas to invest in?

Timingthemarket

Don´t believe everything you learn in school.

Look what the banks and firms are searching for. High frequency and milli seconds everywhere. People with phd´s in engineering, programming and statistics. 70-80% of the trades comes from software programmed to find out when the market is not perfect.

Linton

I think you are confusing two different concepts.

Active trading I would take to mean buying and selling on a frequent basis according to day-to-day movements in the price.

What you seem to be talking about is comparing investing in specific sectors with the FTSE.

Well first of all the FTSE is not a "vanilla" investment. It is heavily weighted towards large global companies in particular sectors. As such it is not strongly into growth shares. The FTSE is a portfolio just like any other and IMHO has no special status over any other portfolio.

If you put together a portfolio of funds that are growth oriented you can do very much better than the FTSE over the long term. For example a mixture of Emerging Markets, Small Companies, Technology and Resources has served me very well providing average returns of 10% annually for the past 10 years.

I guess the problem with the Efficient Market Hypothesis is that the influential price setters have a short term view - look at what happened to the global indexes with the credit crunch, and the Japanese Tsunami. It cant both be right for the short term and the long term, the "fair price" is very dependent on when you intend to sell.

Your second error I believe is implying that the only objective of a portfolio is maximum growth. There are many others - stable values and steady income for example for which people are quite happy to sacrifice potential growth. Chosing specifc funds and shares for your portfolio are essential if you have these sorts of objective. The FTSE doesnt provide either particularly well.

[Deleted User]

Timingthemarket wrote: »

Don´t believe everything you learn in school.

Look what the banks and firms are searching for. High frequency and milli seconds everywhere. People with phd´s in engineering, programming and statistics. 70-80% of the trades comes from software programmed to find out when the market is not perfect.

Linton is right, when I said 'active trading' I meant picking and choosing sectors/investments as opposed to frequent trading. But your post is interesting. I've read a bit about HFT but I didn't know 70-80% of trades were software programmed, do you have a source for this?

Linton wrote: »

I think you are confusing two different concepts.

Active trading I would take to mean buying and selling on a frequent basis according to day-to-day movements in the price.

What you seem to be talking about is comparing investing in specific sectors with the FTSE.

Well first of all the FTSE is not a "vanilla" investment. It is heavily weighted towards large global companies in particular sectors. As such it is not strongly into growth shares. The FTSE is a portfolio just like any other and IMHO has no special status over any other portfolio.

If you put together a portfolio of funds that are growth oriented you can do very much better than the FTSE over the long term. For example a mixture of Emerging Markets, Small Companies, Technology and Resources has served me very well providing average returns of 10% annually for the past 10 years.

I guess the problem with the Efficient Market Hypothesis is that the influential price setters have a short term view - look at what happened to the global indexes with the credit crunch, and the Japanese Tsunami. It cant both be right for the short term and the long term, the "fair price" is very dependent on when you intend to sell.

Your second error I believe is implying that the only objective of a portfolio is maximum growth. There are many others - stable values and steady income for example for which people are quite happy to sacrifice potential growth. Chosing specifc funds and shares for your portfolio are essential if you have these sorts of objective. The FTSE doesnt provide either particularly well.

I was being lazy when I said the FTSE; what I meant was just to choose a representative sample of worldwide companies/bonds, weighted by market cap and size/etc. Just a sort of theoretically vanilla index. (btw I'm sure there's a difference between the ftse100 and the ftse all-share when it comes to what you discussed?)

Also, in terms of different requirements, I'm not really concerned with that I'm assuming dividends to be reinvested anyways, so income would translate into growth. Let me explain it this way: say investing in the vanilla index I outlined above produced a growth of 10% annually with a given measure of stability. Could you achieve higher growth with the same/higher stability by picking investments as opposed to just sticking with the vanilla index?

Linton

nish81 wrote: »

......

I was being lazy when I said the FTSE; what I meant was just to choose a representative sample of worldwide companies/bonds, weighted by market cap and size/etc. Just a sort of theoretically vanilla index. (btw I'm sure there's a difference between the ftse100 and the ftse all-share when it comes to what you discussed?)

Also, in terms of different requirements, I'm not really concerned with that I'm assuming dividends to be reinvested anyways, so income would translate into growth. Let me explain it this way: say investing in the vanilla index I outlined above produced a growth of 10% annually with a given measure of stability. Could you achieve higher growth with the same/higher stability by picking investments as opposed to just sticking with the vanilla index?

As I see it the FTSE has major two problems as a vanilla index:
1) Each individual constituent is weighted by its market capitalisaion ie the total value of its shares. The effect of this that the 20% largest companies determine 80% of the index so the FTSE 100 and FTSE AllShare are pretty similar.

2) The FTSE indexes are built out of companies that happen to to be registered on the London Stock Exchange. The effect of this is that some major industries are barely represented - eg electronics, car manufacturing. Others are over-represented - eg mining, oil and pharmaceuticals. The indexes also are naturally constructed from UK companies with oddly a random selection of large resource based foreign companies. So no input from say China.

So I suggest there is no such thing as a vanillla index. In constructing an index one has to defined the weighting by size and by country and possibly by sector. There are many ways to do this.

Growth and income are not interchangeable. Someone wanting income may much prefer a steady flow with say 8% annual return to an investment that might produce an average annual 15% return over 20 years but with wild fluctuations in the meantime.

On your final question - over a given time period and given economic conditions I would say its pretty obvious one could construct an index that does particularly well. I see no reason why that contest should always be (or even mainly be) won by the same index.

The FTSE is not particularly stable! Look at the past 10 years- do you really believe the intrinsic value of the worlds industries has halved and doubled twice? This is evidence for my contention that the indexes are heavily weighted to short term returns which makes them unhelpful for a long term investor.

GrowingMyOwn_2

I agree with everything that Linton says.

If the market was efficient, then it should be impossible to 'beat the market'. The fact that even one fund manager can be shown to 'beat the index' over any given length of time disproves efficient market theory.

That said, judging by the fact that comparatively few fund managers do manage to beat the index, I think it can be said the market is fairly efficient.

gozomark

GrowingMyOwn wrote: »

If the market was efficient, then it should be impossible to 'beat the market'. The fact that even one fund manager can be shown to 'beat the index' over any given length of time disproves efficient market theory..

You misunderstand the concept -
"If the market was efficient, then it should be impossible to 'beat the market'. " - what you mean is "If the market was efficient, then it should be impossible to 'beat the market' consistently and with predictability" Purely by chance some would beat the market

"The fact that even one fund manager can be shown to 'beat the index' over any given length of time disproves efficient market theory." - incorrect - take 1000 managers, and say there is a 50% chance of beating the index every year - so after one year 500 beat the index, and only those continue - after 2 years 250 have beaten the index etc etc - just by chance some of those 1000 would beat the index for 10 years in a row. Now if all those who ever underperform are sacked, all the fund managers remaining after 10 years would have outperformed the market for 10 straight years, so it would appear that the efficient market hypothesis is disproved - all its done is show the problem of survivability bias

Linton

Yes, but conversely I could assert that the XYZ fund is The Index, the proof being that some other fund, the FTSE100, could not consistently and predictably beat it.

So is the FTSE logically different to any other portfolio of shares?

IronWolf

The efficient market theory is nonsense in the real world. People like Warren Buffet are its biggest critics and they have the 40 year investing records to prove theyre right.

gozomark

Linton wrote: »

Yes, but conversely I could assert that the XYZ fund is The Index, the proof being that some other fund, the FTSE100, could not consistently and predictably beat it.

which also supports the efficient market hypothesis

Linton wrote: »

So is the FTSE logically different to any other portfolio of shares?

its logically the same as some other portfolio of shares, and different to others - it depends on the stock selection procedure

gozomark

Its good to understand what the EM hypothesis actually says, and which form of the hypothesis you are trying to disprove.

The hypothesis states "You cannot consistently achieve returns in excess of average market returns on a risk adjusted basis, given the information publicly available at the time the investment is made."

There are three versions

weak - prices reflect all publicly available info
semi-strong - weak plus prices instantly react
strong - semi strong plus insider info is reflected as well

Although strong form has been shown to be generally invalid, semi-strong and weak versions of the hypothesis do have statistical support, atleast some of the time, and to be a useful starting point