Wednesday, October 29, 2014 |
Joe Alfonso, GoLocalPDX Contributor
It’s been interesting to follow the recent handwringing in the financial press about Bill Gross, the bond fund manager, and his abrupt departure from the investment firm, PIMCO.
For those of you blessedly unaware of who Mr. Gross is, until very recently, he was the co-chief investment manager of PIMCO and directed its flagship bond mutual fund, PIMCO Total Return. Mr. Gross had a good run of performance for quite a while that made him famous and his fund a staple in many 401k plans. Investment dollars flooded in and by April 2013, assets in the fund had peaked to almost $293 billion.
But Mr. Gross hit a speed bump in 2011 when he bet against US Treasuries, a blunder that dropped his fund’s performance into the bottom 13 percent of intermediate bond funds that year. This year, through September, PIMCO Total Return ranked in the bottom third of funds in its category.
Mr. Gross abruptly left PIMCO in September after a falling out with management to join a competitor, Janus Capital Group. Much ink was spilled about the events leading up to Mr. Gross’s resignation which I will not rehash here. In the month of his departure, investors pulled out almost $18 billion dollars from Total Return, much of it in the days following his resignation. Total Return ended September with approximately $202 billion in assets, a steep fall from its peak just a little over a year earlier. Speculation is that investors and institutions will follow Mr. Gross to Janus and invest with him again in his new fund, Janus Global Unconstrained Bond.
The story of Mr. Gross and PIMCO has been good fodder for the financial press but what lessons can we draw from it?
The status accorded Mr. Gross as a result of his previous investment success reflects the belief many investors have that investment gurus exist and can be expected to continue to outperform in the future. Clearly the many investors who flocked to Total Return in its heyday believed so, as do current investors following Mr. Gross to Janus.
Underlying this belief is the assumption that investment skill exists and can be employed to find overlooked opportunities or to predict future market movements before these become evident to other market participants. Clearly Mr. Gross was seen as having such skill and investors expressed their faith in him by flocking to his fund. But was this belief warranted?
Professor Eugene Fama of the University of Chicago was awarded the 2013 Nobel Prize in economics for his theory of efficient markets. The core hypothesis of Professor Fama’s theory is that security prices are determined by the collective assessment of market participants based on their interpretation of all publicly available information. Given the availability of information and the speed at which it is disseminated and digested, market prices quickly reflect the consensus value for securities, making current prices the best estimate of market value. New information, in turn, affects the price of securities, but since this information is, by definition, not currently knowable, future prices are also unknowable and impossible to correctly predict with any consistency.
Empirical market data extending back to 1926 supports Professor Fama’s theory, showing how the ebb and flow of information causes stock prices to move randomly. This same market data shows that, after costs, most investors who try to time their market investments or identify mispriced securities in an effort to outperform in fact underperform the market. These “active” investors on average are market losers and would have been better off seeking average market returns using a less costly “passive” buy and hold approach that avoids market timing and individual stock bets.
The above does not mean that outperforming investment managers do not exist. They obviously do and Mr. Gross is evidence of that. The data, however, shows that the incidence of outperformance is no more than would be expected by chance. The take away from all this is that it is not clear if the Bill Gross’s of the world are truly skillful or just lucky. Given the efficiency of the market, however, it really does not matter because you cannot identity outperforming managers in advance. Knowing after the fact that Mr. Gross did very well until 2010 did nothing to help the investor who bought into Total Return in 2011 based on the earlier record.
The key lesson from the news about Mr. Gross should be that investors are better off placing their faith in markets and not investment managers. Achieving market-beating returns consistently is hard and investment manager outperformance is only evident after it is too late to profit from it. Investors are better off putting their money in low cost funds that pursue a passive, market return approach, such as index funds, and hold these for the long term.
So tune out the news about PIMCO and listen to the advice of another star investment manager, Warren Buffet, himself an advocate of index funds: “I’d rather be certain of a good return than hopeful of a great one.”
A version of this article originally appeared in the
Business Section of GoLocalPDX