When you first start out, trade with the best. This is the only way to learn and improve. When you are an experienced trader and your only goal is to make money, trade with the worst. Isn't there an old poker saying that if you can't figure out who's the sucker at the table, you are it.
what is the definition of "beating the market", after all? making money and beating markets could be mutually exclusive exercises how you define the score of such a "competition"? who actually won, you or market? importantly, who even cares? it could be ok when market is up, and even better when it is down. why not? why compete, fight or even pretend we can successfully hold sticks with this beast in the long run? i'm not even particularly interested to be right at any cost in any moment and end up to be very poor in the process of being right . the thing is you can be totally right and still lose your money...
I haven't read this entire threat but obviously you are referring to the EMH which has been refuted multiple times. You are trying to make an argument analogous to that of a gambler saying that poker is a zero-sum game utilizing random chance and therefore you cannot make money at it in the long run. What you fail to recognize is that in both poker and trading there is a psychological aspect that gives some people edge over others. Additionally, not all market participants (or poker player) 'play' with the same timeframe in mind.
You are right - the idea of beating the market doesn't make much sense. What is actually implied in the active vs passive investing argument, is that you can earn about 4-6% annually after inflation if you simply hold a well diversified portfolio of productive assets such as stocks (which are claims on companies' earnings). So this is your alternative cost of doing business (which is trading). You don't have to put any effort into this passive strategy. The only catch is that to minimize risk you must have a really long holding period. So if you can't earn more than 4-6% real return on your capital by trading (assuming similar risks measured as volatility or drawdowns), then it is better to stick to a passive strategy. The problem currently with this long-term diversified portfolio of stocks, bonds, real estate and even some commodities, is as always the competition. As more and more people resort to such portfolios, they tend to make the assets more and more correlated and this increases the overall risk for the portfolio. The other weak point of this strategy is that it is simply looking in the rear view mirror. We just got 200 years of positive stock returns and academics are quick to conclude that we can expect another 200 years of such stellar performance. First of all, I don't think people knew much about common stocks a century ago, so it was smart to own some, especially in the US. Second, assuming that the future of our globalized, complexly intertwined economy in an overpopulated Earth, will resemble the recent economic history, is a very bold bet. So many things may happen that have never happened in the past, that choosing not to use your common sense when making investment decisions, and blindly following the popular academic wisdom, can leave you with nothing but your shirt on your back. So there is an implied risk in any kind of decision, including a passive investing strategy.
The fact that you cannot beat the S&P 500 without taking on additional risk has, as of yet, not been refuted.
I believe the reason most lose in the stock market is my idea of the inverse pyramid or upside down pyramid. Long ago when I first started trading Soybeans, I knew little about trading and the broker I used knew even less than me other than he would get $40 bucks with every trade I'd do. I started with 5k, every time grains went up enough, broker called and said I covered the margin for another contract, he say "how bout adding another contract", Grains kept going up up up, well my acount was sitting at 105k in short time, the most money I had ever seen in my life. Next three days I was in a suicidal state of limit down move, could not get out of my position till I had lost 115k. What I should have done was as market rose, reduction of contracts especially at new contract highs and buying some cheap puts as a hedge would have offered consistent return. But that was not offered by a supposedly professional. I think most folks have the most amount of shares at the all time highs of the stock market, fear of losing out and greed keeps them adding more. And cause of this, most people will never build wealth. In USA, more is better but not in all aspects of investing.
Thanks, TRS. Adopting the view that markets are impossible to beat due to perfect competition has direct implications to my managing of outside money. I want to serve my clients in the best possible way. If I don't think I can add return after trading costs and compensation, I should simply advise my clients to buy a couple of ETFs depending on their investment horizon and risk tolerance, and then forget about me altogether. And for this advice I think it is fair that I receive a modest advisory fee like a $100 or whatever. But if I have doubts that I can beat the market and I still set up the standard compensation agreement of 2% of assets and 20% of profits, I will be putting my interests before my clients. Specifically taking 20% of profits (even after a hurdle rate) is a nice call option - I will make money even if my clients lose all of their money, all I need is a little volatility, in fact the more volatility - the more profits for me on the way down. It's a sweet deal and that is why you have 10,000+ hedge funds, but it has nothing to do with taking good care of your clientsâ money. It's just a shrewd scheme to rob your clients. Simply put, if I don't believe I can add any value with my trading, I should forget about setting up a hedge fund, raising money, attracting investors etc. I came in this game to take other traders money in a fair market, not stealing from people who entrust me their money. Fortunately, as it became clear in this thread, I found some good reasons to continue competing in the market, despite the discouraging odds of success. So I feel better about going the active management route. The more immediate reason for this thread was a lecture I was asked to present on my trading methods. This got me thinking, well, what right I have to teach others how I make money if my success is mostly due to luck. Why not just tell them that it's better to play the passive investing game. The presentation is due in February, so I still have time to figure out which one of my opposing opinions should I defend
Good luck with your capital raising. It's a long and hard process. It took me more than 6m to find a FOF investor. In general they are more concern about your risk profile and how you handle risk than what your absolute return is. Few other thing to consider: 1) Do you really want to trade other people's money? It's a lot of work handling the business aspect of running a HF. You need to hire a professional to manage all the client inquiries and reporting. Are you going to have the scale to have that dedicated person. My experience is that 50% of your time will be spent on the legal/capital raising/office management side of the business. A good trader does not necessarily make a good business manager. 2) You need to find an investor that understands your strategy and lets you do your trading without any interference. Institutional investors tend to be trend followers. They allocate to the hottest strategies and redeem from the not so hot regardless of your performance. I was running a long vol fund for a major FOF during 2005-2007. Even thou my returns were consistantly positive, long vol strategy was getting hurt globally and they ended up pulling their money out. What a great decision! If they stayed for 1 more year, the return would have been phenomenal! 3) The HF business is getting a lot more institutionalized. Meaning investors are less willing to take on small startups. You need to have the infrastructure in place before capital raising. Large office, multiple traders, back up systems, reputable prime brokers etc etc. My seed investor send their own DD team with a complete check list. All of this cost money. Are you willing to make this large initial investment?
I am aware of the difficulties related to managing outside money. Financially, it's a great opportunity, because you are not only risking your own money in the markets, but you are also selling your skills and time. If my total capital is 5% of the fund I will manage, and I make 20% a year on average and take 10% of profits, that will give me a 60% return on my money instead of just 20% without the downside (I will lose only on my own money). Compounding capital at 60% instead of 20% is a huge difference and I can reach my financial objectives much faster. The problem as I see it is really attracting the right clients. So this is where I will put a great deal of my energy. Taking clients who do not understand what I do and what is my decision making process, who call me every week and put unnecessary pressure on me, is a sure way to disaster. It's just not going to work. I am not alone in this process, I work for a financial institution in a sort of principal trading desk (I trade company capital), but they expect me to leverage my skills to a product where we can attract clients money. Of course the major burden of setting up of such fund with all the details and choices that have to be made will fall on me. But we have a good sales force in place as well as lawyers who will help me in the process. I haven't made up my mind if I want to go this way or just manage the company capital. I know that this is the big game, and if I want to make some serious progress I might have to put myself to that stress, instead of playing it safe and small. It's really a matter of personal preference and financial goals. I value my independence and comfort a lot, but that certainly means a lot of money left on the table (that is if I am successful for at least a couple of years). I am doing well so far, so I am not pressed to take a decision. I don't mind making little money as long as I have people and family to support me and if I feel happy with my life. But one thing is sure - if I can't set up the fund the way I want with the clients I like, I am not going to start it no matter what the financial benefits.
I assume you will leave the above out of your prospectus. I will assume that you are sincere in your purpose but it does not warm my cockles to see you post the above sentiment.