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“Winning the Loser’s Game” by Charles Ellis takes a balanced, realistic view of the risks and rewards of investing. It is useful for individual investors who get swayed by short-term market moves and allow emotions to overrule rationality while taking Investment decisions. Charles advised investors to focus on long-term investment objectives and appropriate asset allocation (plays far bigger role than stock selection). He advocates passive investing given limited room left for active managers to make alpha in today’s times.
Active money management has turned from winner’s game to loser’s game:
In a winner’s game, the outcome is determined by the correct actions of the winner. In a loser’s game, the outcome is determined by mistakes made by the loser. Active investing is at the margin always a negative-sum game. To achieve superior or better than average results through active management, you depend directly on exploiting the mistakes or blunders of others.
As the share of professional money manager’s investment to market capitalization increases, the ability of professionals to generate Alpha diminishes as these smart investors compete against each other to beat the market. Alpha generation was easier in the past as the amateur individual investors tend to underperform market given trait of being influenced by emotions over fundamentals. Alpha generation is a zero-sum game; with brokerages/taxes/management fees, disproportionate funds end up with negative alpha. For example, if a layman allocates an equivalent amount of money across all the actively managed funds, he is expected to generate market returns but with a higher expense ratio, his net returns tend to be lower than the market returns.
The investment objective is paramount:
The book cautions investors from deviating from their long-term investment objective in times of emotional swings caused by market volatility. For most investors, the market is a casino, they love the fun of betting on speculation but forget their long-term objective of making consistent returns. Like in a casino, when the players end up being losers and the casino owner makes the most of money (Mr. Market).
Learnings from the book:
Whilst in the US, active money managers are losing shares due to consistent underperformance. However, In India, active investing may still have some way to go. This is because the share of active management to market capitalization in India is far lower than in developed markets.
For an investor, the portfolio objective should weigh higher than an alpha generation. Sub-optimal allocation of funds in various asset classes with timing mismatch to investor’s needs may hurt investors more than underperformance. Individual investors are not absolved from their responsibility of acting rationally when they allocate their wealth with professional money managers. Individual Investors tend to redeem in bear markets and increase allocation in bull markets. This emotional trait eats into an individual investor’s total return.
– Repost from UTI Mutual Fund
