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07/17/2016

Warren Buffett has said you should buy the stock of a company when you like it and sell it when you don’t like it.  His point was to ignore the stock market as a whole.

Some investment managers like to invest on the basis of “drivers” or things that will drive the value of a stock upwards.  Examples are stock buybacks, takeover rumors, or activist interference.  (This is sometimes called “factor-based” investing.)   Guess what — so far this year, 82 percent of those investment managers have under-performed the Russell 1000 index, which is huge!

It appears there are too many investment managers chasing the few companies that have one of these characteristics or “factors.”  These causes stocks with those characteristics to become “crowded.”  The ten most crowded stocks under-performed the ten least crowded stocks by a whopping eighteen points so far this year, which is also huge.

This re-ignites the long-running debate as to whether professional investment management is worth the cost or whether the investor should simply buy the index.  The research on this is voluminous, and it is easy to argue both sides.  My observation is that simply buying the index is fine in a bull market but not in a bear market.  Of course, it is always convenient to have a professional manager when making that decision.

Besides, if 82 percent of managers did not beat the index this year, that means 18 percent — or one out of five managers — did beat it.

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