ITA Wealth Management

Pepe Romero and the Academy of St Martin-in-the-Fields Chamber Ensemble are featured in this Philips recording of Boccherini Guitar Quintets.

The CD includes Quintet No. 2, No. 4 “Fandango,” No. 6, and No. 9 “La Ritirata di Madrid.” 

Here are the three Amazon reviews.

“Born after Haydn, but before Mozart, Boccherini’s music has much of the charm and style of the works of his celebrated contempories, if somewhat less depth. The matchless Pepe Romero, along with memebers of the Academy of St. Martin-in-the-Fileds, perform these four quintets with admirable and unpretentious Classical proportion; additionally, the sound is superb. This recording is highly recommended for guitarists, chamber music aficionados and devotees of the Classical esthetic.”

“It doesn’t seem to matter (to me) how many concert-quality guitarists there are at any one time, Pepe Romero, David Russell, and John WIlliams seem to stand tall whatever the genre happens to be. Boccherini on a guitar? Wait until you listen. It’s absolutely beautiful.”

“This is an excellent sample of Boccherini’s guitar quintets, including the beautiful, exciting, very famous, and incredibly modern “Fandango”. It even features castanets, rarely included in classical music, especially by an Italian composer! In his guitar quintets, Boccherini shows clearly how much he admired Spanish music. The performance by both soloist and orchestra is superb.”

Photograph:  Hotel fountain – Glendale, Arizona

Within the “Best Ideas” paper by Cohen et al, there are legitimate reasons as to why active money managers have such a difficult time beating their benchmarks.  Below is a long quote from their paper laying out several of the problems.

“There are several plausible reasons why examining total portfolio performance
may be misleading concerning stock-picking skills. First, manager compensation is often tied to the size of the fund’s holdings. As a consequence, managers may have incentives to continue investing fund capital after their supply of alpha-generating ideas
has run out. This tension has been the subject of recent analysis, highlighted by the work of Berk and Green (2004). Second, the very nature of fund evaluation may cause managers to hold some or even many stocks on which they have neutral views concerning future performance. In particular, since managers may be penalized for exposing investors to idiosyncratic risk, diversification may cause managers to hold some stocks not because they increase the mean return on the portfolio but simply because these stocks reduce overall portfolio volatility. Third, open-end mutual funds provide a liquidity service to investors. Edelen (1999) provides strong evidence that liquidity management is a major concern for fund managers and that performance evaluation methods should take it into account. Alexander et al. (2007) show explicitly that fund managers trade-off liquidity against valuation motives, when making investment decisions. Finally, even if managers were to only hold stocks that they expect to outperform, it is likely that they believe that some of these bets are better than others.”

Mutual fund size we know is a major problem for active managers.  The first reason given above is certainly legitimate and a cause for concern. Funds could close when they get to a certain size, but greed sets in and they continue to grow larger until performance declines.  Investors withdraw funds and the mutual fund self-corrects.

Risk management is also a reasonable issue.  I heard that Philip Fisher held six to eight stocks when he was managing money.  Most mutual fund manager cannot take this kind of risk to increase returns.

The third problem, one of liquidity, is something the managers do not control.  Fickle investors is a constant problem for mutual fund managers, but not such a big issue for endowment managers.

The above problems are ones not faced by the small individual investor.  Their relative poor performance has other reasons than those given above.

Photograph: City Center, Scottsdale, Arizona

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ITA Wealth Management readers will find James Montier’s paper, “Was It All Just A Bad Dream? Or, Ten Lessons Not Learnt” stimulating reading. At least parts of the paper are interesting.  A few of his “Ten Lessons” are less than compelling. You do need to register (free) to gain access to the full paper.  Or you can find it on my blog at this address.  This link will download the pdf file into your computer.  Be sure you know where downloaded files are stored.

On page two, under Lesson 2: Relative performance is a dangerous game, Montier references another paper by Cohen, Polk, and Silli.  The Cohen et al paper will provide additional background for Montier’s positions. “They [Cohen et al] examined the ‘best ideas’ of US fund managers over the period 1991 to 2005.  “Best Ideas” were measured as the biggest difference between the managers’ holdings and the weights of the index.  The performance of these best ideas is impressive.  Focusing on the top 25% of best ideas across the universe of active managers, Cohen, et al, find the average return is over 19% annually against a market return of 12% annually.  That is to say, the stocks in which the managers displayed the most confidence outperformed the market by a significant amount.” Quoting Cohen et al on “Best Ideas,” – “We identify the “Best Ideas” of a manager as the stock with the highest tilt in his portfolio.  Each of our four tilt measures proxies for the managerís relative conviction about his holdings. High tilt ranks indicate strong conviction.“  One does need to read the Cohen paper to gain a better understanding of their methods.

In the following paragraph, Montier writes, “The depressing corollary is that the other stocks they hold are dragging down their performance.  Hence it appears that the focus on relative performance – and hence the fear of underperformance against an arbitrary benchmark – is a key source of underperformance.“

Now prepare yourself to take this shot as to why the money managers fail.  According to Cohen et al, “The poor overall performance of mutual fund managers in the past is not due to a lack of stock-picking ability, but rather to institutional factors that encourage them to over-diversify.“ 

Montier continues to hammer the client with this quote – “Of course, this begs the question: why are fund managers so wedded to relative performance?  The simple, although unpopular, answer is that clients and consultants force them to be.” In other words, blame the client for poor management of funds.

Within the last few days I posted references to the fact that active managers, by a wide percentage, fail to beat their benchmarks.  Of course we know from William Sharpe’s papers, it is obvious why this is the case.  What is difficult to explain is why this occurs to such a large percentage as shown in this article.

If you are on the board of a pension or endowment fund, and it is not matching or performing better than its benchmark, take solace in that fact that it is your fault and not your money managers stock selection process.  Your expectations that they will beat their benchmark is holding them back as you are tying them to “relative performance.”  This logic is positively amazing.  Perhaps this is why the Cohen et al paper is still in draft form.

Photograph:  Mexican restaurant in Scottsdale, Arizona

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