Can You Beat The Market?
With the new semester under way, my students at Texas Lutheran University gave a presentation on the process and performance of the Bulldog Investment Company internship. In doing so, they documented how they evaluate business models with competitive advantages and then deeply analyze and interpret financial statements. Once they find a worthy candidate, they are incredibly patient waiting for the right valuation.
Although few of the students will go into the investment industry, this discipline will benefit them no matter where they go.
In concluding their presentation, they stated that over the last 12 years this discipline led to their $1.5 million portfolio outperforming the S&P 500 Index over the last one year, three years, five years, ten years and since inception. It has been quite impressive.
As they finished, they asked if there were any questions.
A hand shot up in the back. It was a new professor. He asked, “Why are we told you can’t beat the market, when different groups of students in your program have repeatedly done so over the last dozen years?”
It is a great question and one that causes confusion.
The professor added that the patron-saint of “value” investing, Warren Buffett, often recommends that most people should buy an index fund.
A student presenter, Luis, responded that Buffett has said, “If you like spending six to eight hours per week working on investments, do it. If you don’t, then dollar-cost average into index funds.”
As Luis grinned, he said the student group spends more time studying and evaluating investment options than they do on most other things. They are obviously passionate.
Another professor asked the students, “Why do you think you have been so successful?”
Ellie answered that when the market gives them great opportunities, they are willing to load up. As such, they have had as much as 15% of their portfolio in just one company.
Brandon chimed in that there is discipline in not only how they research, but in what they are ultimately looking for. They don’t want to own 500 average companies. Rather, Brandon referenced Hendrik Bessembinder’s research at Arizona State University which concluded that over the last 30 years the positive returns came from only 1.5% of the companies.
Brandon said this helped the students to focus on a very rare and select group of highly profitable businesses. In the process, the students were able to succinctly know what shouldn’t go in their portfolio and why. This knowledge has prevented them from chasing the hot deal of the day, businesses mired in too much debt or other fatal flaws.
Esam, who is finishing his Master’s degree in Data Analytics, has been in the program for five years. He offered that many people who hold index funds still have sub-par performance.
Esam commented that the average investor allows emotions to get the best of them. Index fund disciples often forget that when the stock market drops by 60%, that fund will follow the index down lock-step. As such, they often irrationally jump in and out of the market at the worst times. In doing so, even by investing in index funds, investors significantly lag the performance of the index.
This is well documented by the DALBAR studies showing the average investor underperforms the stock indexes by more than 70% over long periods of time. Some of this is due to fees and manager performance. However, investors are harming themselves if constantly jumping in and out. If you want the true long-term performance of the market, you must stay consistently invested.
This brings up another good point about investing in general. A fundamental understanding of how to value assets and markets is quite helpful. This is true whether buying a new car, a house or an index fund. You are paying out money to get something in return. Is it a good deal or not? How do you know?
Can an investor beat the indexes? Yes. Clearly it has been done. However, it takes a lot of time, effort and discipline. It also takes a lot of reading, knowledge and judgment. And finally, any investor who wants to be successful must be emotionally stable and disciplined to hang in there when things get rough.