Performance review 2016 – Comment “Active vs. Passive: The Story of Mr. Cool and Mr. Crap”
In 2016, the blog portfolio gained +12,42% (including dividends, no taxes) against 4,55% for the Benchmark (Eurostoxx50 (Perf.Ind) (25%), Eurostoxx small 200 (25%), DAX (30%), MDAX (20%)).
Some other funds that I follow have performed as follows in 2016:
Partners Fund TGV: +15,95%
Squad European Convictions +18,51%
Ennismore European Smaller Cos -1,49% (in EUR)
Frankfurter Aktienfonds für Stiftungen +6,2%%
Evermore Global Value +21,5%
Greiff Special Situation +5,88%
Since inception (01.01.2011), this translates into +135,6% or +16,9% p.a. vs. 69,5% or 10,1% p.a. for the benchmark. Graphically this looks like this:
The full details can be seen as always on the performance page.
This was now the 6th year in a row that the performance of the portfolio outperformed the benchmark. For the statistics fans, this was achieved with a Sharpe Ratio of around 1,51 based on monthly returns over 6 years.
The portfolio is a lot less volatile than the market because of many “idiosyncratic” risks in the portfolio. I would not call it less risky than the benchmark, but it has (on purpose) a different risk profile. The maximum drawdown 2016 was somewhere in the range of -7% to -8% in February compared to drawdowns of -15% to -20% of most benchmarks in the same period.
Again, as I mention every year: This outperformance is to a large extent coincidence. Normally I would expect to slightly underperform in a positive year.As every “hot streak” will come to an end at some point, I expect relative underperformance in the future especially if the markets keep going up like the do at the time of writing.
Current portfolio / Portfolio transaction
The current portfolio can be seen as always on the portfolio page. I have already mentioned the 2016 transactions in the “27 for 2017” post. As I forgot one stock (Delta Lloyd), here is the full list of transactions for 2016:
Compared to last year, Hornbach, Koc, the Depfy TRY bond, the HT1 Bond, NN Group, Citizen’s and Greenlight have been sold. New positions bought in 2016 are Dom Security, Majestic Wine, Handelsbanken, Coface, Silver Chef, Italgas and SAPEC, Kuka And Delta Llyod. 2 positions (Gaztransport and Kinder Morgan) went in and out in 2016.
Of the 2016 year-end positions, Kuka will already leave the portfolio in a few days as the deal is closing. The Delta Lloyd deal will also close in spring 2017.
The question remains if the current 28 positions are maybe too much in regard of diversification. I will need to come up with a better way to maneg this in 2017.
This year I decided to rank the top performers and the losers by absolute contribution to the performance, i.e. multiplying the performance with the beginning portfolio weight. This is the result:
Top 10 positive contributors
|Weight 12/2015||Perf 2016||Attribution abs.|
And the 10 most negative contributors:
|Weight 12/2015||Perf 2016||Attribution abs.|
|Depfa 0% 2022 TRY||2,25%||-6,10%||-0,14%|
A quick fun fact here: With a group of friends I have a small bet running. Every year we pick our 3 “top picks” for the year and at year-end we make a ranking. The losers have to pay the winners dinner (plus drinks….).
For 2016, my “top 3” had been Lloyd’s, Aggreko and Electrica. So none of my top 10 performers would have been in my top picks but 2 of the top losers. For me that is one clear indication that at least for me a highly concentrated portfolio might not work out all that well…..
One pretty obvious observation is that having UK exposure and financial exposure in 2016 was not helping much.
As a Group, my French stocks performed best, followed by everything (except Aggreko) that had oil/energy exposure. Looking back, I should have clearly done more in Energy as it was pretty clear that some rebound could be expected. I scored some gains with Gaztransport and KMI but I clearly could have done more.
Comment “The story of Mr. Cool and Mr. Crap”
2016 was the year when stock picking (and active investing) died, at least if you did read a lot of “mainstream” financial publications. “Actively managed” funds are losing money at an increasing pace, Index ETFs are booming. As a dedicated stock picker myself, I have to ask myself of course the question: Should I continue do what I am doing or just move into some index funds and use the saved time for doing something else ?
One aspect which in my opinion has not been covered well is the following: How do you actually determine if someone is a good active portfolio manager ?
One of the more popular measure (also used by Damodaran) is that you look how a manager who outperforms in a given year performs the next 3 years or some other measure of years of annual outperformance over a fixed time period. This is the chart he is showing
This implies that a good active investor should outperform EVERY year or every period x of rolling years. In my opinion this is a pretty idiotic point of view, especially if you think about the importance of compounding.
Mr. Cool and Mr. Crap
As a matter of fact, there are really many crappy active investors out there. Many fund managers, especially in larger organisations are either glorified but crappy traders or “professional investors” who are actually not very interested in what they were doing, but do the job because it paid exceptionally well.
In many large organizations, people who move to the top are not those who are the best at doing the actual task but those who have the ability to manage the “system” of the organization to their advantage. Especially larger investment management organizations prioritize Assets under Managment (AuM) growth before anything else. As many strategies don’t scale well, larger AuM often negatively impact performance.
The big question is: Why has crappy active investing so successful for such a long time ? My guess is that it is a combination of intransparency, aggressive selling, overall positive markets and short termism.
Let’s look at two different strategies (which I made up but are not totally unrealistic) of 2 portfolio managers, one that I call Mr. Cool, the other is Mr. Crap. Both run a German Large Cap portfolio with the DAX as a benchmark.
Here are the returns of those strategies for the last 20 years:
|Date||DAX||DAX Return||Mr. Cool Return||Mr. Crap Return||Mr. Cool Outperf.||Mr. Crap Outperf.|
|31.12.1997||4249,69||47,1 %||49,5 %||44,8 %||2,4 %||(2,4 %)|
|31.12.1998||5002,39||17,7 %||18,6 %||16,8 %||0,9 %||(0,9 %)|
|31.12.1999||6958,14||39,1 %||41,1 %||37,1 %||2,0 %||(2,0 %)|
|29.12.2000||6433,61||(7,5 %)||(11,3 %)||(3,8 %)||(3,8 %)||3,8 %|
|31.12.2001||5160,1||(19,8 %)||(29,7 %)||(9,9 %)||(9,9 %)||9,9 %|
|31.12.2002||2892,63||(43,9 %)||(65,9 %)||(22,0 %)||(22,0 %)||22,0 %|
|31.12.2003||3965,16||37,1 %||38,9 %||35,2 %||1,9 %||(1,9 %)|
|31.12.2004||4256,08||7,3 %||7,7 %||7,0 %||0,4 %||(0,4 %)|
|30.12.2005||5408,26||27,1 %||28,4 %||25,7 %||1,4 %||(1,4 %)|
|29.12.2006||6596,92||22,0 %||23,1 %||20,9 %||1,1 %||(1,1 %)|
|31.12.2007||8067,32||22,3 %||23,4 %||21,2 %||1,1 %||(1,1 %)|
|31.12.2008||4810,2||(40,4 %)||(60,6 %)||(20,2 %)||(20,2 %)||20,2 %|
|31.12.2009||5957,43||23,8 %||25,0 %||22,7 %||1,2 %||(1,2 %)|
|31.12.2010||6914,19||16,1 %||16,9 %||15,3 %||0,8 %||(0,8 %)|
|30.12.2011||5898,35||(14,7 %)||(22,0 %)||(7,3 %)||(7,3 %)||7,3 %|
|31.12.2012||7612,39||29,1 %||30,5 %||27,6 %||1,5 %||(1,5 %)|
|31.12.2013||9552,16||25,5 %||26,8 %||24,2 %||1,3 %||(1,3 %)|
|31.12.2014||9805,55||2,7 %||2,8 %||2,5 %||0,1 %||(0,1 %)|
|31.12.2015||10743,01||9,6 %||10,0 %||9,1 %||0,5 %||(0,5 %)|
|30.12.2016||11481,06||6,9 %||7,2 %||6,5 %||0,3 %||(0,3 %)|
|Period with outperformance||15||5|
|Period with underperformance||5||15|
If we look at periods of under/outperformance, Mr. Cool has periods of long outperformance: one 3 year “streak” in the beginning and even two 5 year streaks with positive outperformance. Overall he outperforms in 75% of the 20 years. His funds would be easy to sell after those streaks and the mentioned metrics above would identify him as a outperformer most of the time. Investors (especially via consultants or fund of funds) would flood him with money after outperforming several years in a row. His bosses in the large asset management company would pay him nice bonuses in the years where he outperformed which would be 15 out of 20 years. After a bad year he will maybe switch employers however with a much higher salary. He will have a nice house , drive at least 2 or 3 different sports cars or old timers and spends his holidays either helicopter skiing or on his boat in St. Tropez.
Mr. Crap in comparison will be identified by the “years of outperformance” metric as a constant loser. His fund is almost impossible to market. Some will tolerate 1 or 2 years of underperformance but finally they will pull their money out because “he has lost it” and allocate the money happily into Mr. Cool’s fund. Mr. Crap will have lost his job at least twice during these 20 years, maybe three times. He will not get big bonuses and maybe he is not even managing a portfolio anymore but has been degraded to simple analyst as his fund did not attract money in the beginning. He will most likely drive an old car, live in a rented apartment and goes hiking for vacations.
So this is how the returns actually work:
Strategy 1): Mr. Cool runs a strategy which gives him 1.05 times Dax Perfomance in any year with a positive return but he will suffer 1,5 times the loss in a negative year
Strategy 2): Mr. Crap runs a portfolio where he underperforms by -5% in every positive year (Dax performance times 0,95) but only takes 50% of the loss in a loss year for the DAX
But now let’s have a look how the investors of Mr. Cool and Mr. Crap would have done if they would have stayed in the portfolios for the full period and what kind of 20 year compound return they will have achieved:
|DAX||Mr. Cool||Mr. Crap|
For anyone knowing remotely how compound interest works, this is not a surprise. Mr. Crap’s (most likely non-existent) investors would be very happy whereas at some point in time Mr. Cool’s investors have become angry and are shifting into Index ETFs and call active investment a game for idiots.
Just to be clear: Do not forget that most large institutional active funds are actually crap, but there are active investors who outperform significantly, however not in the metric that is often used.
One could argue that the strategies are unrealistic, but effectively those are relatively simple strategies: Mr. Cool is selling constantly puts which look great if stock go up, but really bad if stocks go down. Mr. Crap sacrifices performance by buying puts but then earns it back in bad times.
In my opinion bashing active portfolio managers for (temporary) under performance is quite popular, especially after the recent bull market, but part of the problem are fund investors themselves.Many professional advisors are often not more than performance chasers. When those performance chasers meet “Asset gatherers” then you can be sure that the actual investor will pay the bill.
Not many investors actually try to really understand what the asset manager is doing. On the other hand, especially the crappy asset managers try to make their strategy a “secret” as otherwise it would become quite apparent that their strategy is mostly crap. Take it a a warning sign when portfolio managers make a big secret out of what they are holding.
I don’t know if one could analyse the data but I would bet that among those active asset managers whose primary target is performance and not Assets under Management, there is as surprisingly high percentage of investors who will show superior long-term compounded returns although they will outperform the benchmark only during a few years. Maybe there is a way to distinguish between funds that are closed to new money (permanently) against all the others. I would bet that those funds as agroup perform quite well.
So as a quick summary of this comment/rant:
- Good active management doesn’t manifest itself in beating the benchmark every year
- Good active management will show in superior compound returns after a sufficient long period of time (10 years or more)
- Good active management will focus on performance and not on Assets under Management
- Good active management will be transparent at what they do and how they do it.
Good active management is actually not that difficult to achieve with a consistent strategy and focus on performance, however it is relatively rare as the allure of AuM growth is always there and investors are often not able to identify superior long-term active mangement or don’t have the patience to stick with it through rough times.