The problem that people don't understand is that active managers, almost by definition, have to be poorly diversified. Otherwise, they're not really active. They have to make bets. What that means is there's a huge dispersion of outcomes that are totally consistent with just chance. There's no skill involved it. It's just good luck or bad luck.
Interpretation
Active managers often take risks that lead to varying outcomes, which can be misinterpreted as skill.
Eugene Fama emphasizes that active managers in finance must concentrate their bets, leading to high variability in performance. This concentration is a defining characteristic of active management, and the wide range of outcomes can often be attributed to luck rather than skill, highlighting the inherent uncertainties in investment strategies.
In practice
A financial advisor might quote this when explaining the risks of active investment strategies at a seminar.
After costs, only the top 3% of managers produce a return that indicates they have sufficient skill to just cover their costs, which means that going forward, and despite extraordinary past returns, even the top performers are expected to be only as good as a low-cost passive index fund. The other 97% can be expected to do worse.
Market timing doesn't work. If all the bubbles and all this mispricing really exist, how come so few people see it before it turns out that way?
There's quite a bit of evidence that even professionals don't show any ability to pick stocks or to predict market rollbacks. Most of the people we identify as skilled based on returns have probably just been lucky.
I'll always understand the Schadenfreude aspect to short-selling. I get that no one will always like it. I'm also convinced to the deepest part of my bones that short-selling plays the role of real-time financial watchdog. It's one of the few checks and balances in the market.
We tend to focus on assets and forget about debts. Financial security requires facing up to the big picture: assets minus debts.
I cannot invest the way I want the world to be; I have to invest the way the world is.
There are no shortcuts when it comes to getting out of debt.
Ben's Mr. Market allegory may seem out-of-date in today's investment world, in which most professionals and academicians talk of efficient markets, dynamic hedging and betas. Their interest in such matters is understandable, since techniques shrouded in mystery clearly have value to the purveyor of investment advice. After all, what witch doctor has ever achieved fame and fortune by simply advising 'Take two aspirins'?
We've used derivatives for many, many years. I don't think derivatives are evil, per se, I think they are dangerous.
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