Fund Manager Ab Nicholas Has Been Beating S&P 500 for 40 Years | Hacker News Reader

Fund Manager Ab Nicholas Has Been Beating S&P 500 for 40 Years

bloomberg.com

34 pointslxm51 comments

> Nicholas’s focus on avoiding losses helped him in 2008, when he beat 93 percent of peers, and in 2011, when he beat 96 percent as the S&P 500 gained 2.1 percent.

So, survivor bias - this guy happens to be the current unicorn. To give a tech comparison, imagine it's 1980 and you're trying to pick who would be on top of the heap of the tech industry in 2015. There's not much more than a dartboard chance.

I wonder what the real ROI is compared to a simple S&P 500 tracking index fund with all additional fees taken into account for both cases.

I don't know whether you're right or not (that this particular fund is just a lucky survivor), but I don't like this argument.

The classification of anyone that beats the market as a lucky unicorn is logically impermeable. If you accept the argument, then no matter who says they're beating the market, you'll be able to dismiss them without further thought.

There needs to be a better argument, one that allows for the hypothetical fund that does manage to do something intelligent and beat the market.

I find that this style of logically impermeable arguments crop up quite often when dealing with peoples belief structures. Here yours is that the stock market cannot be beaten, which may or may not be true. A useful question to ask in these situations is; Suppose that your belief is wrong, what evidence do you imagine might prove that it is in fact wrong?

When you can answer that question, you'll have a more concrete argument for why this fund is indeed just a lucky survivor.

The obvious rebuttal is to argue that there is a pattern to picking unicorns, and then argue that a current investor will beat the market this year, and then use the same argument next year.

Note, being a unicorn isn't necessarily a sinker for an argument, it just can't be your only defence (i.e. gravity is the unicorn of theories about why things fall :) )

The argument isn't that anyone who beats the market is a lucky unicorn, it's that you can't tell if they're a lucky unicorn or not. Beliefs about beating the market aren't really relevant, the argument would be the same if we were evaluating a cancer treatment which only one person had taken.

You and splike both made good arguments.

I just want to point out that it's possible to pick out winners better than random quess if they have advantage over others.

Case in point: Warren Buffet. He is good investor who has beaten the S&P 500 decade after decade. But he is not beating the market because he makes series of good decisions. He beats the market because he has structured his business so that he has several advantages that others don't. The heart of his empire is his insurance companies. They create steady stream of cash even in the bad times when company valuations are low. Buffet don't have to loan money when he finds good investment or sell his other assets when he finds good investment. This already gives him severals percentage points advantage over others and that advantage compounds over decades. Also, he is in the position where he don't have to play martingale strategy [1] to please investors, because he and his friends own so many shares in the company (he is not in the payroll, he is in the charge).

[1] The real cause of the financial crisis - An MIT Blackjack Team perspective by Semyon Dukach http://semyondukach.blogspot.com/2009/01/real-cause-of-finan...

Maybe the question to ask is, how many similar "unicorns" were there last year? At any given time, what is the failure rate of people who look exactly like Ab Nicholas at that point in time?

I agree with the flaws in this argument.

Imagine Deep Blue beats Kasparov 40 games in a row. "Oh, this computer is getting lucky, it doesn't really have a strategy. This is the unicorn computer that is beating our best player."

If the manager picked a single stock 40 years ago and that outperformed the market, that would be a unicorn. If the manager actively managed the fund for 40 years, buying and selling several times a year based on market conditions, and beat the market (the "best we have"), I'd say the strategy was sound.

You can always cop out and claim talent is luck (Steve Jobs was "lucky" at picking products, etc.).

The problem with this argument, though, is that it's highly likely that if you have 10000 monkeys randomly picking stocks for 40 years, one or more of them will do really well. But it doesn't mean they'll do better than the average for the next 40 years.

So, yes it's possible that this guy is doing something clever or has some advantage that means he will continue to beat the market. It's also possible it's just that he got lucky, and the other 9,999 people who pursued strategies and didn't get lucky are forgotten about.

Think of it like a drug trial: the control is the stock market, the drug is your strategy.

If (somehow) beating the market was a 50-50 chance (which is like saying a randomly written chess algorithm has a 50-50 chance of beating Kasparov), the chance of 40 years of gains is 1/2^40, which is less than 1 in a trillion.

I'd say that's sufficient evidence to reject the null hypothesis, that the drug is no better than placebo. Just because we don't understand the mechanism doesn't make it chance.

I do no get this. How is the chance of gains less than 1 in a trillion? This is not an all-or-nothing bet: outperforming the market by a very tiny margin also qualifies him for the title. So you do not really need 1 trillion managers to get this 1 lucky manager. Much less will suffice - maybe even a couple thousands, which are easily active on the market all the time.

So, he very well could be the lucky monkey.

The typical claim is stock market returns are entirely random, not based on skill, so any returns that beat the perfectly efficient market are purely due to chance.

Beating the market (no matter the margin) is purported to be a 50-50 chance, and doing so 40 times in a row would happen by chance less than 1 in a trillion times.

(That is, if you accept the premise that stock market investing has no skill component.)

The actual argument that I know of rely on statistical test being the way to determine and not just a simple classification that anyone who beats the market is lucky.

Roughly speaking, if it's possible to beat the market, then when comparing between the result distribution we have of actual result, against a hypothetical distribution where investor was using coin toss to invest, those two have to be different. The conclusion comes from people saying that those two looks the same.

Now, actually make the test and choosing all the variable in question is NOT a simple task, and definitely is a hard problem.

The way to prove someone is not a lucky coin-flipper is to identify them before they flip the coins (or, at the very least, by some attribute that was observable before they flipped the coins). For example, "took a class from Ben Graham in 1951" [1] might be such an observable criteria.

[1] http://www8.gsb.columbia.edu/rtfiles/cbs/hermes/Buffett1984....

The 'top of the pops' funds are going to be at the top due to survivor bias. It means you can't rely on this fund performing well for the next 10 let alone 40 years, although the past performance does 'bode well' as it indicates some skill.

Having said that I'd say it is possible to formulate a strategy that will (on average) beat an index and be better than chance.

All that is needed is diligent research and a long term view.

With an index you are forced to invest in the good, bad and ugly. When you choose you can do better.

That's some bad reporting by Bloomberg. The advice against active manage fund isn't that they can't beat the market. It's that they can't beat the market better than random chance. In other words, the argument was that performance of stock picker is a completely random process that follow the standard normal distribution. Some one will beat the market, you can't tell who it is though

You most definitely can beat the market, and beat it by a lot. However, the bigger your holdings, the less likely it is to beat the market, since your trade execution suffers the more you're trying to trade at a time (try selling off 100K shares in something when the daily volume is less than a million, for instance).

Anyhow, half the point of a hedge fund isn't even to beat the market, but to hedge against market downturns. The ones beating the market are prop traders and the like...

funds 4, 5, and 6 on the bloomberg list (the primecap funds) are all closed to new investors. That is one way to try to avoid the problem.

yes, if you have a million money managers, 50K of them will beat the market, at a 5% confidence interval

another problem is, what is the proper benchmark? say he beat S&P 500. Ok, but we know that small stocks or value stocks outperform S&P 500. Did he beat a small stocks index? My guess is once you construct a proper benchmark, it becomes even less likely that he really did beat it.

Another way to look at what you're saying is to ask whether a small cap index beat the S&P 500 over the last 40 years. Of course it did (see the following link for the last 10 years, as Google doesn't have earlier data; https://www.google.com/finance?chdnp=1&chdd=1&chds=1&chdv=1&... ); as higher (diversified) risk begets higher return, but the returns were also far more volatile. So if he still achieved the return of a small cap index without as much volatility, that would have accomplished something.

I believe it's also that a lot of times even if the /fund/ consistently beats the market, once you include fees, it becomes much worse or riskier a deal.

I don't understand why people think everyone has access to the same amount of information and that the efficient market hypothesis holds outside an academic setting.

In the real world insider trading is everywhere, and people pay big bucks to get data faster and trade faster than everyone else.

The main reason most people lose money on the stock market is because it is a zero sum game baring inflation, not because of EMH.

A significant amount is returned to the market through buybacks and dividends...

That money comes out of the company which came out of other people. It doesn't come from thin air.

I know you can create "value" when currency changes hands, but we're talking about beating the average returns. And for someone to do better than the market, someone else will obviously do worse.

And it returns to the economy when those investors buy basically anything. Money will always return to the economy, except when people hoard cash (which is why inflation is key to our society - it reduces the value of cash and increases the money supply so that hoarding is a bad investment).

> And for someone to do better than the market, someone else will obviously do worse.

While it's true someone will do worse (especially when 'trading'), that 'worse' could just be a lower profit. After all, the stock markets do generally go up over time. Inflation helps, and of course economic growth too.

One post isn't enough to explain the entire monetary system, however investing isn't a 'zero-sum' game...

If the title of the article were accurate (which it's not, since the text of the article confirms the fund did not outperform in each of those 40 years), then that performance would be hard to explain by random chance. Assuming naively a 50% chance of beating the market each year, doing it consecutively for 40 years straight is 10^12 against, which is far larger than the number of people in the world, never mind number of funds.

Now, the naive assumption of 50% odds of beating the market is a little dangerous, since there are plenty of investments that are highly likely to beat the market but suffer occasional catastrophic losses -- i.e. without being particularly clever one can trade probabilities for magnitudes.

So at the end of the day, there's no substitute for understanding how a fund manager actually thinks and operates. It is possible to beat the market, and to do it consistently and for reasons other than luck. And it's possible, with diligence, to pick a fund manager to do it for you. But merely looking at the history of returns is not diligence, it's laziness, unless the fund has a truly astounding statistical record, which very, very few funds do, even the good ones.

I can't recall the statistical test being done in those papers that conclude how the funds don't do better than random chance right now, but I don't think random chance imply 50% chance to beat the market each year - so your maths following that won't hold. Why? I don't know the reason, but have a note: one year is a completely artificial cut off range. There is no reason to naively assume that it would be 50% chance of beating the market every year rather than 50% chance every 10 years, or 50% every other full moon. I think the maths will have to be done on something else and not a range period.

You're right that it's an arbitrary interval, but the math is still valid if you assume (as I cautioned against) that each investment is a coin flip relative to the market. In that case, over any time period your relative performance is the sum of a series of coin flips, i.e. a binomial distribution with mean 0. This has a 50% chance of outperformance regardless of the interval -- what changes as a function of interval is the total variance, not the median result.

One consequence of this is that the probability of outperforming each day over 40 days is the same as outperforming each year over 40 years. The latter sounds more impressive, but it actually isn't. The former would be impressive too if the null hypothesis really is a series of coin flips (but again, it's not).

From the (terrible) article: "The Nicholas Fund, which he has run since 1969, has topped the Standard & Poor’s 500 Index by an average of 2 percentage points a year for the past 40 years and has beaten it every year since 2008. If you think that doesn’t make a big difference, consider this: A $10,000 investment in the Nicholas Fund in September 1974 was worth about $2 million in September 2014, roughly twice the value of the same investment in the index."

Sounds impressive, but from http://en.wikipedia.org/wiki/Berkshire_Hathaway : "Berkshire Hathaway averaged an annual growth in book value of 19.7% to its shareholders for the last 49 years (compared to 9.8% from the S&P 500 with dividends included for the same period)"

Weird, because y_to_the(1/41) of 200* is about 1.1379 for an annual gain rate of 13.79 - which does not match 9.8 plus 2.

*the 41st root of 200... n such than exp(n,41) == 200...

> This Fund Manager Has Consistently Beaten the S&P 500 for 40 Years

...

> The Nicholas Fund, which he has run since 1969, has topped the Standard & Poor’s 500 Index by an average of 2 percentage points a year for the past 40 years and has beaten it every year since 2008.

Was 2008 already 40 years ago, or is the title using "consistently" in a figurative sense?

The title appears to be inaccurate. The fund has, on average, outperformed the market by 2%/year over 40 years, which works out to 120% outperformance with compounding. That is far less impressive than beating the market consistently (i.e. every year) for 40 years. He's only done that for the last 7.

Hindsight is 20/20. An index fund is still better than choosing whatever fund someone tells you to. If you can travel in time 40 years ahead and know that your non-index fund is going to be THE one that outperforms, then sure, go for it. But if you don't have that time machine, index fund is the wiser bet.

Correct me if I'm reading this incorrectly, but this is what the article says:

"The Nicholas Fund, which he has run since 1969, has topped the Standard & Poor’s 500 Index by an average of 2 percentage points a year for the past 40 years and has beaten it every year since 2008."

Does this not mean that it has not, in fact, "been beating S&P 500 for 40 years"? Very misleading title if this is the case.

And a lot of the comments I'm reading here seem to have indeed been mislead into thinking that it has beaten S&P consecutively for 40 years.

That said, index funds' popularity is part performance, part cost. Were costs factored into these performance metric? If not, I wonder how much of the 2% gains would have been passed on to the individual investor, if any at all.

If you had the same number of monkeys as you had fund managers, I'm sure at least one would also do well for 40 years. Statistically, one of them is bound to be lucky.

(Nothing against this guy - probably a combination of skill and luck, which I doubt he'd deny.)

But what are the fees he charges? I bet that 2 million figure doesn't incorporate fees.

Also, how are they accounting for survivor bias in the "best of" lists?

I often hear the outliers make claims like "the models predict that we shouldn't exist -- if the analysts are right, there shouldn't be any outliers as good as we are." The implicit argument is that the people claiming "on average, stock pickers don't beat the index" don't know what tehy're talking about. But it's widely acknowledged that the tails are exactly where modeling of this kind tend to fail, so I'm not convinced. A model that gets the tails wrong might still be much better at figuring out expected value, which is what investors should actually care about. How do I make sure that they're not just trying to sell a product with sub-par expected return by chopping off yesterday's heavy tail and waving it around?

Survivor bias doesn't really matter here, because we're looking at only the best.

In order to properly correct for survivor bias, you'd have to count the # of funds that were created in the past 40 years, and then figure out (assuming a normal distribution of performance), what you expect the best fund performance to be. He has to beat that number to be considered genuinely better (rather than being the luckiest).

For example suppose that the volatility of the S&P 500 is 10% per year. In a 40 year period, the volatility is thus 0.10 times sqrt(40), the central limit theorem, or 63%. So, a 1 standard deviation move in the S&P 500 over 40 years is 63%.

To outperform by 2% per year, is 1.02^40 = 2.28 = 128% gain.

63% * 2 = 126%

So, this guy performed two standard deviations above the mean over 40 years. That certainly is within the realm of random chance, considering he was the best/luckiest.

Therefore, I conclude he did not outperform the market by a statistically significant margin. Actually, I'd expect the best fund to be 3 or 4 standard deviations above the mean (given the # of funds), so this result is an argument AGAINST active managers.

Actually, the volatility of the S&P 500 is more than 10%, so I overestimated his performance. It's closer to 15% long-term, but it's varied a lot over 40 years.

> assuming a normal distribution of performance

If someone assumes that performance is normally distributed (e.g. by dividing by standard deviation and using the gaussian CDF to reject null hypotheses), couldn't you arbitrage against them by creating a bunch of "heavy tail" funds, waiting for a few of them to beat the market in a more extreme fashion than the normal distribution would predict is possible, and then using the normal distribution to "prove" that it couldn't have happened by chance?

No, because

1. You can't normally short sell mutual funds. As a retail investor, short selling is hard. Plus, short selling has fees, even for institutional investors.

2. Even if a fund gets lucky (or unlucky), its future returns are also normally distributed. I.e, if a fund beats the market 20% one year, its next year is just as likely to be lucky again as unlucky.

Funds that underperform the market severely are closed or merged into other funds.

Funds that get lucky and trounce the market tend to stay open. If your 5 year track record is +20%/year, and you have a "bad" year, your 6 year track record is still +15%/year.

Based upon the Prospectus Summary (http://www.nicholasfunds.com/NF/Summary.html) the total annual fund operating expenses are 0.73%.

Contrast that with Vanguards S&P 500 fund (http://www.vanguard.com/pub/Pdf/p040.pdf) at 0.17% for Investor Shares and 0.05% for Admiral Shares

Millions of people make money trading. Yes, it's hard for hedge funds to generate returns on billions of dollars. Luckily (?) for me, I don't have the problem of investing billions. Instead, I can seek-out high probability trades (pairs trades, spreads, futures and other derivatives, anything really, i'm agnostic to specific product). I'm not saying everybody should do what I do, just offering my own experience.

Not sure why you're being downvoted. HN seems to have an aversion to the idea that some people can beat the market. Yes, it's hard, but there are certainly strategies that have performed well historically (value, momentum, selling volatility, as well as the more specialized ones you mentioned), and look like they'll do so going forward.

It's odd how very few on HN doubt the ability of HFTs to make money, but when it comes to active management the assumption is that no one can really add value.

Because his comment has zero value.

I'm being downvoted because people on HN are smart but have been sold a bill of goods that people don't make money trading, and that creates an emotional reaction. As if wall street firms can all make billions but literally nobody else can make a dollar trading. Maybe they lost money and convinced themselves that the game is rigged. Who knows.

People like btian below feel they have a moral obligation to protect the innocent from the charlatans, and hey at least that's noble, even if it is misplaced.

I don't think the way I trade is right for most people. Primarily because it takes time and many people don't care to invest time in managing their money. Also because it takes a lump sum of capital that many people do not have. But the idea of making very high probability trades using leverage is not even provocative, it's boring and the antithesis of "get rich quick". It's about grinding it out, carefully balancing your delta risk to guard against "black swan" events, managing trade timeline to reduce gamma risk. Anybody can get an education in this stuff, it's not black magic.

I avoid talking about this stuff on HN because the downvotes come in swarms, which is something i SMH at -- ideas getting censored here of all places -- but I don't like the "nobody can make any money trading" folks to have the airwaves solely to themselves.

I think there are two fundamental reasons why even intelligent, technical people look down on making money through finance. One is lack of financial literacy and deep understanding understanding of how it works. Second is that with finance, one can make money without creating a tangible product or service- anathema to the engineer mindset.

While I do not do finance for a living, I have scratched the surface and recognize that there are infinite interesting problems out there in finance waiting to be solved.

Do you have any resources I can use to get a deeper understanding about your strategy? I consider myself a moderate level investor, but when I look for real information about what you are talking about I feel like I'm finding late night informercials versus actual valid information. I also think the number of snake oil salesman is why HN frowns upon beating the market talk.

I currently do research based stock trading and momentum based e-mini futures to give you an idea of my level of knowledge and risk tolerance. I've done okay with both, but I would like to continue to improve.

Check out TastyTrade.com -- their archives, their daily shows Market Measures, Closing the Gap, and others.

Without giving away any secrets, can you expound on the current state of pairs trading? I was under the impression that the easy ones (GM vs Ford) had been arbitraged away long ago. I'm sure there are small-cap opportunities but I haven't been able to identify them in my research.

http://en.wikipedia.org/wiki/The_Superinvestors_of_Graham-an...

The report I'd love to see is one that determines whether there are any unusual characteristics among outperforming fund managers that cannot be explained by chance.

For example, I'd love to see: the percent of fund managers who quote Warren Buffett that outperform over five- and 10-year periods; the percent of fund managers who are significant investors in their own funds that outperform the indices over five- and 10-year periods; and so on.

From a quick look it seems like he is more of a value investor than a rapid trader.

Just to make sure for the people who are claiming he's a unicorn/the top end outlier of a normal distribution...do you claim the same about Buffett? Or is it different because Nicholas basically charges for the stock picking and with Buffett you invest in "his" company?

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