INVESTING TO BEAT THE

MARKET

Simon Benninga
Faculty of Management
Tel-Aviv University
 ‫דבר תורה—פרשת יתרו‬
Dvar Tora
Jethro—the first management
consultant

Also an investment consultant?

The Tora and speculation

Lending and Heter Iska

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May a Jew invest in stocks?

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10 LESSONS ABOUT
INVESTMENTS
„ 1. Risk and return are related. The
larger the risks, the larger the
(expected) returns.

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Risk and return—U.S. Stocks

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10 LESSONS ABOUT
INVESTMENTS
„ 2. Past performance is a poor
indication of future performance

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10 LESSONS ABOUT
INVESTMENTS
„ 3. Market timing is mostly futile
(and costly ... see #8)

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10 LESSONS ABOUT
INVESTMENTS
„ 4. There is some persistence in stock
market returns, but it may be difficult to
exploit.

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 10 LESSONS ABOUT
INVESTMENTS
„ 5. There are no magic formulas and it’s hard to
predict

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10 LESSONS ABOUT
INVESTMENTS
„ 6. Don’t believe most of the investment
nonsense you hear.
„ Over any particular time period, half of all
investments outperform the average.
Typically, out-performers have wonderful
after-the-fact explanations for why this
happened. Over the same period of time,
half of all investments underperform the
average, and under-performers have good
reasons why this happened.
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http://www.pa-investors.com/annual.html
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"Last year, it turned out good. We were down 2 percent, but the S&P was
down nearly 12 percent, and Nasdaq finished down 20 (percent). So we
outperformed the market," he said. Bateman said that a number of analysts
contribute to the company's annual stock list, utilizing what he referred to as
a top-down approach.

Essentially, Bateman analyzes each sector's performance in various stages of

a business cycle. Given the prevailing stage of the current cycle, the analysts
look to which sector has a high-probability of outperforming the market.

"Basically, our model does a number of regression studies looking at where

we are in the current cycle and what industries have done the best."

"We focus on those sectors that look the most attractive and identify the
companies that are the most attractive in those sectors."

As way of example, Bateman said that hotels historically have performed

well during the existing phase of a business cycle. In fact, the probability of
the hotel sector outperforming the S&P 500 exceeds 50 percent in each
quarter this year.
From there, it was a matter of selecting which hotel stock would be the best
pick for the year, and Huntington analysts determined that to be Marriott
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10 LESSONS ABOUT
INVESTMENTS
„ 7. Most investment advice is worthless.

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10 LESSONS ABOUT
INVESTMENTS
„ 8. Fees are important: 1% per year
over 10 years = 13%

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10 LESSONS ABOUT
INVESTMENTS
„ 9. Relate investment decisions to:
„ a. Your investment horizon: The
longer it is, the more risk you should be
willing to take.
„ b. Your risk-tolerance.
„ c. The costs of managing your
portfolio.

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10 LESSONS ABOUT
INVESTMENTS
„ 10. It’s very hard to beat the market.
Investment in index funds (passive
management) is preferable to managed
funds

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THE STREET.COM
By Beverly Goodman
Senior Writer
08/12/2002
Indexing has suffered quite a backlash of late. From pundits proclaiming that
"we're in a stock picker's market now" to columnists decrying the active
management of the S&P 500, hitching your portfolio to an index seems like
folly.
Actually, thinking you can consistently beat the market -- bear or bull -- is
where the real folly lies.
In the first five months of 2002, the average actively managed fund
underperformed the relevant Standard & Poor's index in seven of the nine
Morningstar categories -- and one of the remaining two essentially tied the
index. That's from a just-released study by veteran Vanguard Index fund
manager Gus Sauter. (See charts below.)

The study also looked at five-year performance ending May 31, 2002. In that
case, indexing roundly trounced eight of the nine categories.

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Study after study has shown that index
funds outperform 75% of actively
managed funds over virtually any time
period.
But half of the remaining funds (or 12.5%) that
outperform their relevant benchmark do so
just as a matter of chance, according to
research done by finance professor and chair
of the Richard H. Driehaus Center in
Behavioral Finance at Chicago's DePaul
University, Werner De Bondt.
Those numbers are even more compelling since
they don't include the thousands of failed
funds that have either folded or merged over
the years.

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Fees, Taxes and Spreads, Oh My!
When active management does beat the benchmark, it usually
does so only slightly.

Equity index funds lost 21.94% in the past 12 months, while

actively managed equity funds just barely edged that out, losing
21.74%. Index funds returned 0.66% in the past five years, and
9.8% in the past 10.

Actively managed funds, meanwhile, returned 0.65% and 8.8%

in the same period, respectively, according to Morningstar.

For starters, the average equity index fund has an expense ratio
of 0.79% -- and exchange traded funds, or ETFs, are roughly
half that (although you will have to pay a trading fee on when
purchasing).

The average actively managed equity fund has an expense ratio

of 1.49%, according to Morningstar.
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Expense ratios aren't the only aspect of active
management that will eat into returns,
though. The average turnover of actively
managed equity funds is 118%.
All that buying and selling means more internal
transaction costs, greater bid/ask spreads and
more capital gains generated (which, of
course, means more taxes that you get
slammed with -- whether or not the fund even
makes money).
By contrast, index funds generally have a
turnover of next to nil; buying and selling
occurs only when the index changes.
Small wonder the average actively managed
fund lags the market by 2%.

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CAN YOU BEAT THE MARKET?

NO
(well, probably not … )

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 Dvar Torah
‫דבר תורה‬

The lot is cast into the lap, but the

decision is the Lord’s alone.

Better a dry morsel in peace than a

house full of feasting with strife.
Proverbs 16:33, 17:1
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Thank you!
For a copy, write me:

benninga@post.tau.ac.il

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