This is silly. The author points out the problem of making short-term evaluations of a long-term strategy and yet he never actually says that. Also, his hypothetical omniscient "god" can see 10 years into the future but doesn't allow himself to rebalance the portfolio more often than 5 year intervals. I'm not sure what point he's trying to make or why.
This is the basic risk vs. return tradoff in investing lesson. Risk in stock market can be reduced with diversification and longer time-span.<p>Don't listen active investors unless they have most of their own money in the scheme and manage your money on the side (like Warren Buffet does). Figuring out winning market strategy and selling it as a service to others and living off management fees indicates that the winning strategy involves separating fools from their money.
Probably not a surprise, but this also applies to value investing.<p>If you construct a perfect portfolio using god-like knowledge of a company's performance as measured by <i>future free cashflow</i> then you will also have drawdowns and down years.<p>Makes you think about how the market has mutated from its original purpose over time.
The thing I don't get here is, if I'm God, then aren't I going to sell off right before the drawdowns and then buy back in at the local minimum?
This is the money quote (no pun intended): <i>"These results highlight the fickle nature of assessing relative performance over short horizons."</i><p>How many times have you told a fund manager, "Gee your fund lost 10% last year when the S&P500 was up 8%, how did you manage that?"[1] Only to move all your money into some other fund and have it get worse returns than the one you moved your funds out of? The point the article tries to illustrate is that evaluating a fund's strategy should be separate from evaluating a fund's returns. And if its strategy is sound, then even if it under performs other metrics over a shorter term, it out performs over a longer term.<p>And yet there aren't really any investors who are willing to 'take it on faith' and stick around for 10 years to see if their strategy is sound.<p>[1] Ok probably not a lot but I did get to ask one this question. They did not respond effectively.
TL;DR: If you look at the best stocks, measured by 5-year performance, they sometimes go way down within those 5 years (mainly because of recessions). Not very surprising.
This is actually a well-known issue though probably never presented to a non-trader audience like this before. As you raise your holding period, max attainable returns and max attainable risk-adjusted returns decline very sharply. This is why good quantitative hedge funds insist on short-term forecasts and active strategies that trade frequently though not necessarily HFT.<p>There are a number of other issues here. Even obvious things that a junior analyst on a good desk would do in about 2 minutes haven't been done in order to make God's returns look worse. For example, (I haven't tested this myself) I suspect God would do MUCH better if God rebalanced 1/1260th of his portfolio every day based on the 5-year forecast that day. (1260 trading days in 5 years), and God would likely have lower transaction costs as well.<p>There are also many issues with how they are constructing these God portfolios. Portfolio construction and risk management frequently have a bigger impact on investor returns than the quality of the forecasts.
Has anyone ever quantified the "self-fulfilling" component of index fund returns? ie all the money automatically going into them and that everyone knows that?
So if I get it, the God foresight would enable you to own the planet, at a CAGR of 49% but the regular losses would scare the living crap out of you.<p>Aan interesting exercise in learning various financial libraries this seems - and I would love to see what the end of year amounts would be for 100 dollars invested in 1927.<p>I guess it’s just human nature - “yes God, you may have been right about every 5 year period for the past century, but this time it’s dofferent”<p>The Anti-VC statement
On these constraints, what if you bought a basket of stocks with the highest 5 year performance, conditional on never losing more than 5%? How much of your return would be given up by needing to avoid those "risks"?<p>If you're going to evaluate god on something, seems only fair to allow them to optimize for it.
This is related to why I firmly believe any amateur outside of Wall Street can beat the crap out of this deplorable industry:<p>- by focusing on great value, the proverbial dollar for 50 cents. This is kind of hard work, you have to put in the time, which means you have to be genuinely interested in "business" or you won't keep it up.<p>- by not doing anything <i>unless</i> you find a dollar for 50 cents. Wall Street has to play all the time, you don't.<p>- by holding a sufficiently long time. Of course you can't wait indefinitely; sometimes just taking a loss e.g. if you find something else which is great value.<p>- by stomaching volatility<p>- by <i>embracing</i> volatility and, when you can, making sweet love to it<p>- by keeping it simple. Your only "hedge" can be just trying to pay 50 cents for a dollar. Having some crude heuristics for timing and taking profits.<p>- by assuming every management team and big shareholder is constantly trying to screw you over. Tolerating no bullshit. Trying to avoid being around morally handicapped people (this applies to any part of life imho).<p>- most relevant to the original article: by not tolerating anybody else's opinion (which implies investing your own money and only your own money, meaning you can. not. get. fired. Ever. And if you screw up, you'll learn.)<p>- by avoiding tip givers and tip takers. Group think is a killer. But of course, enjoying talking about general conditions. (My honest, very personal take on current group think: "you can't go wrong with low cost index investing". Which is not a bad idea in itself, until everyone starts doing it and they flood the market with indices and dubiously structured trackers.)<p>- once again, by not feeling you have to be part of everything which goes up.<p>- by having a lack of stress (you will doubt a lot, get screwed by management and big shareholders and have plenty of losers and lumpy payoffs)<p>- by doing this for a very long time (as in: the 80s were <i>much</i> easier than the 201xs, maybe just because fewer people were watching. And back then they were sometimes hiding profits instead of faking them. Today is the hardest time ever, if I find something superficially good, probably something is wrong with it. Personally I have very little self confidence today.)<p>- being small, which means you can look in places the big guys who have to move around billions can't look<p>- staying on the "easy side" of the basic math of loss vs profit. I personally would never short or sell optionality or stuff like that. Willing to take a gentle thrashing but never ruin.<p>And necessarily:<p>- by avoiding the show stoppers (start playing bridge, take a journey around the world, get divorced, disease, death)<p>Everything else is bullshit. Or at least part of more complex or shorter term or "trading" strategies with which amateurs can of course never do great. Volatility is not risk. Concentration is not necessarily risky.<p>Edit: poured out some random thoughts and tried to clean it up later. Sorry for the mess.