October 13, 2006
From the desk of Jane Galt:Should you invest in the Blue Fund?
. . . asks a friend who wants to make money and support Democrats at the same time.
I took a look through their publicity materials, and according to them, if you throw out the companies with a 25 billion or greater market cap--Costco, Apple, Google, and so on--you get a 3% excess return over the S&P. Given that the time horizon is only 5 years, that's not a significant excess.
The real question is, how many of those big winners did they have? If there were five or six, then I would guess that most of the incredible excess returns are born of the fact that Google, an incredibly successful company, IPO'd after the stock market had begun to rebound. If those big companies are, say, half the sample, I'd be a lot more comfortable.
The other problem is that 5-year time horizon. I'm not accusing the guys of anything--5 years is a perfectly standard horizon to use. But it also leaves out the 2000 crash. If "Blue" companies are more volatile than average companies, then all the excess returns tell us is that volatile companies do better when the market is on the upswing. We already knew that. I'd like to see the ten year returns too.
That's not because Google or Apple aren't perfectly great companies; they are. But I wouldn't want to bet, based on a sample of two, that the next big success story is going to be "Blue" leaning.
Full disclosure: I went to the University of Chicago, which means I am legally barred from believing that mutual fund managers can beat the market over the long run. Lots of great market theories backtest well, and blow up in real time. And others are undone by the very fact of their discovery; if "Blue" companies really do outcompete "Red" or neutral ones, the returns will quickly be traded away as mutual fund managers become willing to pay a premium for "Blue" stocks.
At the very least, I don't think the average investor should be messing around in mutual funds; I think they should invest in very broad market index funds that track the S&P or the Russell. But if you are determined to waste your money on an actively managed fund, this one probably won't be all that much worse than any other fund--though I should also add that a long time ago, in a galaxy far, far away, the regressions I ran in statistics and finance classes indicated that SRI (Socially Responsible Investing) Funds underperformed their peers.
Posted by Jane Galt at October 13, 2006 5:53 PM | TrackBack | Technorati inbound links"); ?>SRI (Socially Responsible Investing) Funds underperformed their peers.
That's ok, then, because investing in Democrats isn't socially responsible investing.
Posted by: Anthony on October 13, 2006 6:17 PM"I went to the University of Chicago, which means I am legally barred from believing that mutual fund managers can beat the market over the long run"
I thought it was genetically, not legally.
Posted by: J on October 13, 2006 6:36 PMUm, if you're barred from believing that mutual funds can beat the market, aren't you also barred from believing that SRI funds can't "underperform their peers," for exactly the same reasons? (Unless it's just that SRI funds charge higher fees.)
ed johnson,
While I can't answer for the Chicago folk, I can easily see why you might have an imperfection preventing arbitrage. The offsetting asset would be a basket of sleaze stocks. There are probably strong legal as well as moral/social impediments to investing in this Vice Fund. Actually, my understanding is that the Vice Fund, historically has beaten the S&P.
Posted by: Bill Dalasio on October 13, 2006 7:15 PMYou can both index *and* satsify your socially-responsible desires by investing in -- tahdah! -- Vanguard's FTSE Social Index Fund. But don't expect it to beat a normal comparable index.
Posted by: Person on October 13, 2006 7:40 PMDuring the late 90's, weren't there conservative versions of SRI Funds? As I recall, they didn't do all that well either. (They were anti-Vice funds, I think.)
Posted by: Klug on October 13, 2006 7:44 PMVICEX is showing more than 20% greater appreciation than the S&P500 and the DJIA since VICEX's inception in late 2002, but it's only just caught up to the NASDAQ, and underperformed in the first part of 2003.
Posted by: Anthony on October 13, 2006 9:20 PMAnthony,
Thanks for the feedback on VICEX. Looking at the holdings, I kind of think its more comparable to S&P (larger, more established holdings predominate).
Posted by: Bill Dalasio on October 13, 2006 9:26 PMYou say that 3% outperformance is not that much, but it's actually huge. Most folks in finance would give their left eye to make 3% over the market.
Meanwhile you are correct to ask how much of that 3% goes away if you take away the few huge hits, but they already did that for you. The excess return is *much higher* when you add Apple, Costco and Google back in.
The real gotcha is that, as they say, past performance is no guarantee of future results.
Posted by: Foolish Jordan on October 13, 2006 9:29 PM"if you throw out the companies with a 25 billion or greater market cap"
How is this different from the 'small firm effect' that has been examined for years? Except perhaps that they're including mid-caps?
"You say that 3% outperformance is not that much, but it's actually huge. Most folks in finance would give their left eye to make 3% over the market."
I think the question is whether the difference in the observations, using backtesting, is large enough to be statistically significant. If a method was sure to reliably earn 3% over the market (adjusted for risk), it would be impressive. But the fact that one particular (possibly small) sample happened to get 3% over the market may not be enough to be sure that it could outperform.
Posted by: Ann on October 13, 2006 9:38 PMAt the very least, I don't think the average investor should be messing around in mutual funds...The problem that average investors encounter with mutuals has more to do with how mutuals are ranked rather than how they perform. Both Lipper and Morningstar rate mutuals by how they have performed rather than how they are perfoming. There are several lesser known rating services that place more weight in their ratings on the immediate past rather that a "five star ten year rating." The one I use, NoLoad FundX, focuses on... no load mutuals. Their recommendations have outperformed the S&P 66.76% vs. 27.05% (july data - I cant find my most recent copy) since 11-01-01. I've only a quarter of my portfolio in mutuals, but as a non-average investor, I've a load of confidence in some mutuals - primarily due to inexpensive (read non-broker) and verifiable services. But, one has to to the research, regardless of the vehicle one choses to invest in. Posted by: bains on October 13, 2006 10:43 PM
Um, if you're barred from believing that mutual funds can beat the market, aren't you also barred from believing that SRI funds can't "underperform their peers," for exactly the same reasons?
You can't *beat* the market. Doing *worse* than the market, on the other hand, is easy, particularly if you are investing in companies based on criteria unrelated to how successful those companies are.
Posted by: Dan on October 13, 2006 10:49 PMYou can't *beat* the market. Doing *worse* than the market, on the other hand, is easy, particularly if you are investing in companies based on criteria unrelated to how successful those companies are.
Maybe you're being clever, but gross of fees, if you're investing in companies that have the same cost of equity as the market and still significantly underperforming, you're doing something remarkable.
Couple of observations.
1) 3% excess return is quite good when you are talking about the large cap space, it certainly puts you in the top quartile of managers
2) I believe they have fallen into the old canard of look-ahead bias. The statement is made..."Investors who put $100 into the market-cap weighted current blue portfolio...", but of course they could not have put money into a portfolio of current blue stocks 5 years ago. 5 years ago they have no idea what the blue stocks would be today. More importantly, 5 years ago they would have no idea which stocks are going to be alive in the future.
If you take any portfolio of stocks that are currently alive, and run the analysis where you held them over some prior period of time. Your return will always look outstanding, and significantly better than the Index.
Why because you are implicitly picking stocks that survived, and are taking away any chance of your investment going bankrupt. This mistake happens all the time when people test quant investment strategies.
When you run the analysis, you have to pick stocks in the past, using only knowledge you had in the past at that point in time. You do not have the extremely useful piece of information of which stocks will survive.
The entire methodology they use is not listed in the pdf, but the language strongly suggests they fell into this trap.
At the very least, I don't think the average investor should be messing around in mutual funds; I think they should invest in very broad market index funds that track the S&P or the Russell.
Oh sure they should -- after all, *somebody* has to pay for the research and do the active trading that gets the prices right for all of us free-riding index fund investors ...
The expectation of the equity is looking forward. The sustainability concept of "Blue" fund might support the positive attitude towards the forward looking prospectus. There is some behavioral anomalies ( Alias Paradox ? not quite sure =:p) the dicounting rate for the future return is decreasing respective to the long term.
Posted by: lucy on October 14, 2006 8:25 AMNot like value-based equities and small-cap equities , the SRIs cannot find their benchmark. The benchmark i mean is the industry stardards or norms the instituitional or investors based. Then facing the good news in the future, i just guess that the premium resulted should be higher than that with the benchmark. (For buyers, they would bid higher to insure the execution; and for sellers, they would ask a higher price to exert the highest surplus.)
Posted by: lucy on October 14, 2006 8:55 AMHow far can a public company legitimately go in supporting political causes and parties? If a company takes a position because it is in the interests of their business and hence their shareholders, then that's one thing. But if they support a particular position only because of the personal political beliefs of their officers, isn't there an issue with fiduciary responsibility?
Posted by: david foster on October 14, 2006 1:15 PMWhat makes us think that "Investing" for, solely, Financial Gain optimizes our portfolio of potential outcomes?
"Index Fund" and, more broadly, "MutFund" buyers have been sold a bill of goods, benefitting too few, themselves usually excluded--from everything but the cost, which they continually Pay.
The aforementioned group should ask themselves: How much say do I have in the MGMT of the companies I'm, putatively, "investing" in?
None, the Proxies, the right to vote those shares, are shorn from them, with no recompense. Who votes those proxies(?), how much do they receive for doing so? How much, if any, of those proceeds do the "Fund"/"Index" buyers, the ones at financial risk, receive?
Right.
There's a big difference between Finance and Economics--articles like this, the one the spawned this thread, do little to illuminate the true value, and power, of individual action and its, potentially, beautiful result.
Maybe that was part of its intent?
Posted by: Mark E Hoffer on October 14, 2006 4:38 PMIs there only one FTSE Social Index Fund for SRIs? What if we have more?
Posted by: lucy on October 14, 2006 4:58 PMFor the seventh-consecutive year, the average actively managed stock fund beat the Standard & Poor's 500 index in 2005.
Posted by: Messer Around on October 14, 2006 8:32 PMMesser:
The problem is not the average fund beating the S&P on an annual basis, but rather on longer term performance (the longer out you go, the more underperformance you see). The other problem is survivorship bias... only good funds last for x years, with fewer funds the larger x is.
It's easy to underperform the market, thanks to failings in human psychology, but very hard to beat the market, especially consistently. It's like playing "perfect" blackjack or poker... very hard to do, and even harder to beat, but very easy to do worse.
These funds will tend to do worse because they have a higher research overhead and a small base to pay for it. The other major problem is that they tend to be focusing on mass affluent services (Apple, Starbucks...) so it's a tech and service play, rather than a true D play. A minor problem is that the larger D donors will tend to be those who would benefit from a D admin, or that benefit from increased regulation, hence why they're donating to Ds... You're essentially taking out energy and pharma, two very major industries that should see significant growth longterm, unless Dems control government for a very long time...
Posted by: Hey on October 15, 2006 11:11 PMIt makes perfect sense that Blue stocks should outperform a broad range of non-blue stocks. The single biggest contributing factor in stock performance is management. If management is liberal they are less likely to engage in Enron type accounting, in granting illegal options, or the myriad other scams we see corporations trying to get away with. Liberals, after all, support the regulatory mechanisms that are put in place to prevent dishonest management stealing from shareholders. Over time, all else being equal, this should result in better stock performance.
The market might even reward a premium to Blue companies due to the superiority in the quality of earnings.
This really is not very controversial. Selecting Blue companies is just another way of sorting out the better manangement.
Posted by: ken on October 16, 2006 12:51 AMThe source for sponsorship could be the venture captial. Their ideology is to spread our capital over the sperms, which would generate the profits in the long run, and at the same time diversity the risk, and exerts the profits deserved for undertaking the above burdens that some irrational highly risk-averse invesotrs have no interest to take. No necessarily always to find a Donor for the investment ideas.
Posted by: lucy on October 16, 2006 2:01 AMIf management is liberal they are less likely to engage in Enron type accounting, in granting illegal options, or the myriad other scams we see corporations trying to get away with. Liberals, after all, support the regulatory mechanisms that are put in place to prevent dishonest management stealing from shareholders.
Yep, that would certainly explain why Apple's 10-Q is over two months late because of "illegal options," or why Google illegally issued stock to its employees and had to offer rescission before its IPO.
Posted by: AT on October 16, 2006 2:12 AMSEC rules regarding to the option grant has just changed, and the option has been categorized as the expense.
Posted by: lucy on October 16, 2006 3:31 AMIf we have SRI funds sponsored by ventual capital and get the benchmark (the industry norms) for the SRIs, will the premium disappear? Actually, if Apple and Google could boosting its options, why cannot they control their expense?
Posted by: lucy on October 16, 2006 4:50 AMIf there are more SRI funds sponsored by venture capital, and then we can find the benchmark ( the industry norms) i mentioned, will the premium related disappear?
The same intuition applies to Apple and Google. As they can boost their option value, why can not they control their expenses?
Posted by: lucy on October 16, 2006 4:53 AMKen,
So Global Crossing (and its CEO Gary Winnick a major democratic fund-raiser) was not guilty of any "Enron-Type" accounting games?
Posted by: lannychiu on October 16, 2006 9:50 AMAs mentioned in lannychiu's comment, survivorship bias is a very important thing to consider in any long-term appraisal of mutual funds or stock indices. This can completely swamp most other differences that you might be looking for.
As for actively-managed mutual funds, I completely agree with David Swensen, who manages Yale's money (spectacularly well). The fees charged by most mutual funds make long-term success quite difficult.
As for Ken's comment above, I think it would be useful for him to actually get out and meet some corporate executives. They are not as motivated by ideology as he thinks. Actually, most people aren't.
Posted by: Derek Lowe on October 16, 2006 10:04 AMken,
I have read some real horses*%t in my time, but yours is one of the most hilarious examples.
Posted by: Yancey Ward on October 16, 2006 10:24 AMOver time a wide swath of companies managed by progressives, liberals, or democrats (it probably doesn't matter which of these screeners you use) should, all else being equal, outperform their peers. It is just common sense (which I have found often leads to superior investment results) that people who support the regulatory schemes that keep business honest will be more honest than people who want to destroy those schemes.
Posted by: ken on October 16, 2006 11:26 AMKen,
A couple of questions;
1) Have you tested this hypothesis out using a real-backtested system that does not have a significant survivorship or look-ahead bias?
2) What is your investing experience? Professional or personal?
3) What criteria do you use to evaluate potential investments?
Lanny
Posted by: lannychiu on October 16, 2006 12:05 PMKen -
Did you invest in Air America? Now there was a well-managed, true-blue company!
Posted by: Anthony on October 16, 2006 12:13 PMken,
As someone who works in government, I can assure you that a person's or political party's support for a particular regulation or law has absolutely NO bearing on their propensity to obey that same regulation or law.
To believe otherwise is to live in Fantasyland.
Posted by: geeber on October 16, 2006 12:39 PMLanny, I have over thirty years as an investment professional. Mostly as a fixed income trader but recently I began managing equities for a fee.
I have not back tested it. But like I said it makes sense. I am not going to do the work required to back test this myself as I do not see any easy way for me to get a large enough group of companies to test. But as a way to protect myself and my customers from moral hazard I have always avoided companies that are closely connected with Republican politics. I found that, as a general rule, their management could not be trusted. It is just a general rule and I am sure there are exceptions but if you want to avoid the risk of tying money up with dishonest management it works just fine.
And as for my investment criteria I have always placed a significant weight on management. Success or failure is generally not a mistake it happens because people make it happen.
Posted by: ken on October 16, 2006 1:00 PMKen: Your "general rule" sounds for all the world like personal political bias plastered over the data.
If one already believes that the mean ol' Republicans lie and cheat and steal, of course one will believe that Democrats are better managers. But until you can show us the data, we're going to assume the source is your pre-existing belief, rather than fact.
(Or, perhaps, it's just sample bias; perhaps more managers tend to be Republican than Democrat, perhaps due to Republican-leaning people of college age choosing Business and Law more than Democrats - pure speculation, but plausible.
If that's so, it seems likely that more Republicans would be high-level managers than Democrats, and given even an equal rate of corruption between the two, the greater number would be Republicans ... but not because the latter are more corrupt themselves.
But we don't have to worry about explaining why it might be, since we have no reason to believe it's even so.
Certainly my "general rule" from watching cases of political corruption is that sleaze and corruption know no party bounds, and that Democrats and Republicans are about as likely to be crooked - the probabilities seem more bound to local political culture than party.)
Posted by: Sigivald on October 16, 2006 1:45 PMSigivald, mostly I do not know the politics of most company's management. For the most part, it doesn't matter. But when I see a company closely tied to Republican politics it does send up a red flag.
You do see bias on my part, towards honesty. You also see a healthy skepticism that whatever the reasons are that a company becomes publicly connected with Republican politics so that it becomes visable to me, that company's management is suspect.
This has worked over the years enough to keep me out of some trouble.
I am not sure the opposite is true but it makes sense and I am glad someone is taking the trouble to build a portfolio around the idea.
We will see.
Posted by: ken on October 16, 2006 2:06 PMRemember that the Index 500 is not "The" market. A better standard might be Vanguard Total Stock Market Index. Since small caps have mostly done better than large caps over the last few years, it is not a surprise that active managers -- mixing small and large caps -- have outperformed the S&P 500 over a given short-run period. In the short-run, someone often will.
Posted by: ghost on October 16, 2006 2:45 PMThere's not enough Kens in the world. I've been hoping to buy Halliburton low the last few years, but for all the bad press, it just keeps tracking its sector.
Posted by: Henry on October 16, 2006 2:48 PMMs. Galt, people can go to University of Chicago without becoming indoctrinated into Efficient Capital Markets. Sandy Grossman went to Chicago, eventually wrote this-- http://papers.ssrn.com/sol3/papers.cfm?abstract_id=228054, won a John Bates Clark medal and now runs a multi-billion dollar hedge fund.
Posted by: John on October 16, 2006 2:56 PMKen:
Yes, we all know that lefties [trial lawyers, for example] never push ethical edges.
http://www.npr.org/templates/story/story.php?storyId=5244935
-dk
A key difference that hasn't been talked about is what these companies "blue." Typically it's a some sort of "progressive" company policy. I am using quotation marks because the simple fact is that companies care about one thing - the bottom line. If they have adapted a policy, it is going to improve the bottom line. For example Google's famous gourmet cafeteria probably saves the company a great deal of money in terms of salaries of employees by offering high quality food on the premises. No one goes out for lunch - lunches tend to be a bit short as a result and more brainstorming occurs as a result. When I was running a small software company, I did the same thing except I had gourmet lunches delivered everyday. When you crunch the numbers it makes complete sense - you have a software engineer earning $95,000 and you multiply it by 10 - the savings is quite substantial. Not surprisingly this tends actually improve the employee loyalty as well. So when a company has a "blue" policy it usually does so for some economic benefit.
Posted by: Brian Despain on October 17, 2006 11:51 AMI just realized something, that should have been more obvious: It doesn't matter if "blue" companies are better run or not. They could be the best-run companies ever. All that matters is whether this value is currently reflected appropriately in their stock prices. So the historical data just proves that over the past 5 years (very, very short sample), blue companies were undervalued. The real question to ask is whether there is a reason for their persistent undervaluation. A better theory would be that since their methods are scoffed at by more traditional businesses, traders undervalue them for the dividends they will pay.
Of course, that would still run into the same problem Jane mentioned above, which is that realizing this advantage (of blue companies) could completely eliminate their superiority as the market learns to correctly value them.
Posted by: Person on October 17, 2006 12:26 PMken: I reiterate, that when you simply assert that Republicans are less honest ("bias ... towards honesty"), that itself is no evidence for such an actual state of facts, and no evidence against the (unconscious) biases I suggested can colour such a belief in the first place.
Unless you can provide some reason to believe that Democrats are, in fact, more "honest" in their business dealings on average than Republicans (to avoid the possible problem, again, of "more Republicans in business means more Republicans in scandals even if the rate is identical between parties"), your - undoubtedly true - assertion that you believe it to be so carries no extra weight.
"My side is better than theirs!" is an assertion that everyone should be - ahem - skeptical of, in the absence of a non-anecdotal argument and any hard data.
Posted by: Sigivald on October 17, 2006 1:14 PMBrian,
With this: "So when a company has a "blue" policy it usually does so for some economic benefit."
I get your point. Though, the "policy"(-ies), like all others, are Economic ones, they are, to whatever efficacy, engaged for Financial benefit.
I point this out because I think you'll get the distinction.
Hey, Henry, Halliburton failed to purify GIs’ water:
Halliburton Co. failed to protect the water supply it is paid to purify for U.S. soldiers throughout Iraq, in one instance missing contamination that could have caused “mass sickness or death,” an internal company report concluded.The report, obtained by The Associated Press, said the company failed to assemble and use its own water purification equipment, allowing contaminated water directly from the Euphrates River to be used for washing and laundry at Camp Ar Ramadi in Ramadi, Iraq.
The problems discovered last year at that site — poor training, miscommunication and lax record keeping — occurred at Halliburton’s other operations throughout Iraq, the report said.
Keep supporting the troops, Henry!
Posted by: purple on October 17, 2006 3:52 PMpurple,
you (already) know, by his previous post, that he wouldn't care, even if HAL was actively killing US Troops, just so long as his "positions" were quoted: "up an 1/8".
Posted by: Mark E Hoffer on October 17, 2006 4:40 PMPURPLE:
The water was for washing and laundry?
Not drinking water.
At least according to what you cited. But it CERTAINLY IMPLIES IT IS FOR DRINKING.
I walk through rivers all the time that haven't been purified. I swim in them, fish in them, boat in lakes, even hiked and camped DIRECTLY IN THEM.
I was never once worried that my skin or my clothes or heaven forbid my fork could briefly come in contact with "unpurified" water that might potentially be "contaminated" and therfore cause "mass death" as the report puts it. That the reporter who wrote this story was so biased against HAL that it suggested solidiers who are being shot at, bombed, etc, should be worried about "mass death" because their clothing and their plate came in contact with river water is almost hilarious. It would be funny if only it wasn't yet another attempt by the press to demonize someone or something.
Posted by: red on October 17, 2006 6:20 PMI walk through rivers all the time that haven't been purified.
In Iraq?
Posted by: purple on October 17, 2006 8:10 PMClearly not. The point is the article conveys the intial impression that perhaps its drinking water that was not purified. Then later on mentions it's for laundry.
I've been through plenty of rivers where thousands of cattle, ranchers, sheep, etc. are just up stream and in the run off area. I'm guessing that's the main concern, bacteria.
Whatever the case, take a poll of the military and ask if they are more concerned about the water used to wash their clothes or the bullets being fired at them. That story is just trying to pile crap on. Soliders have a tough life. They live in holes. They get shot at. If that's happening to them its also happening to or near the people purifying the water. My priority would be the drinking water. Course, maybe you like to complain about everything and think soliders should have a happy life and wash their socks with Avian.
Posted by: red on October 17, 2006 8:17 PMThis reminds me the story about The Money Magazine asking presidential candidates in the early 2000 about their personal portfolios. I forgot the details, but Patrick Buchanan had most of his assets in gold and T-Bonds. No doubt that his portfolio would have beaten the rest of the pack in the years to follow if The Money Magazine followed it. Portfolio management skills? Sorry, Pat, you simply were lucky.
In other words, wishful thinking married survivorship bias, and they had lots of children, the Blue Fund among many others.
Posted by: PK on October 18, 2006 3:10 AM