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Comment by dsacco | Hacker News Reader

>> Fama and his co-author French found that there is no evidence of active fund managers who perform better than average...

The paper you linked by Fama and French doesn't support this assertion. In fact, it's incorrect, and the paper admits that there are outliers (however few) with consistent superior performance.

From 1994 to 2014, Renaissance Technologies averaged a 71% return. From 1982 to 2012, Baupost averaged a 19% return. In the same time period the S&P 500 returned 7-8%. Even after fees, these managers easily beat the average for their clients.

It's tempting to claim that there is no such thing as beating the market, especially if that belief aligns well with a corresponding set of political beliefs about Wall St. But it is inarguable that funds and managers like these exist, it's just a matter of admitting that it's extraordinarily difficult instead of impossible.

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No, it's not "inarguable". What the paper says is that some funds in the extreme right tail are able to demonstrate a modicum of skill, meaning they do better than pure randomness would suggest. However, they do not do sufficiently better to consistently generate four-factor alpha net of fees. In other words, they do not do sufficiently better that you could invest in one and have a higher expected return than you would get investing in a passive fund with similar factor exposure.

The bare fact that certain funds or managers have averaged 20%+ over whatever time period is irrelevant, as that is absolutely expected due to randomness alone. It has no predictive power over the ability of those funds to generate future alpha, regardless of what intuition suggests. Again, in other words, investing in a fund that has consistently outperformed in the past does not increase your expectation of outperforming in the future. In fact, it is more likely than not that you will still underperform a low-cost passive fund with the same factor exposure.

> Again, in other words, investing in a fund that has consistently outperformed in the past does not increase your expectation of outperforming in the future.

So…you're saying that Bayesian updating in this case does not apply? No amount of positive results should alter the probabilities…ever?

(I'm not challenging your assertion by the way, just trying to confirm for myself.)

Sorry, no, I'm saying that historical returns have not demonstrated an ability by anyone to consistently generate alpha net of fees. Even the longest running market-beaters thus far do not fall far outside the expected range. Some have demonstrated statistically significant alpha, just not enough to account for their fees. In one sense it is certainly possible to imagine a string of returns that would do so, but it hasn't happened yet. (Also if you believe in (relatively) efficient markets, it seems unlikely to happen in the future either, at least in a fashion that could be identified ex ante, and thus profited from. But that's tangential to the point I was making above.)

The paper demonstrates this by comparing the actual distribution of returns to many sets of simulated returns over the same period. When the simulations are built assuming that fund managers have just enough skill to generate zero net alpha, the actual distribution has consistently lower returns across the board than the majority of the simulated distributions. It gets closer in the very extreme right tail (the 98th to 100th percentiles), but still not enough to generate positive four-factor alpha net of fees.

Thanks, that makes sense.

By the way, I recommend reading that Fama/French paper linked above. It's not that difficult to follow even without a finance background, and it covers all this far better than I could. (Although if you're not familiar with the Fama/French three factor model it would be good to start with that; otherwise this paper will lose you on the third or fourth page.)

Arguing is about making solid arguments. It's not about cherry picking and twisting facts because of your political leanings.

You misquoted the grandparent to argue against a position he did not take.

Who said it was impossible?

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