Gyroscopic Investing

Bean wrote: Do you have proof?

Sure, heres one: https://en.wikipedia.org/wiki/Renaissance_Technologies

From the stats I've seen, above average active management after expenses starts to occur in the top two deciles of all aggregate managers.  But only the upper portion of the top decile will contain outsized returns.

rocketdog wrote:My favorite example of this is the common gastric ulcer.  For decades it was generally accepted that spicy or acidic foods were the cause.

And thousands (hundreds of thousands?) of peer-reviewed studies supported the incorrect hypothesis for decades.

I agree that there is strong incentive to publish status quo-breaking research, but I would argue there is even a greater incentive in the modern peer-review process to sit still in the boat (e.g. grant-funded research).

Out of frustration, Barry Marshall, one of the two scientists who made the connection between h. pylori and gastric ulcers, drank a petri dish of the bacteria (with before and after endoscopy) to prove upon himself the connection.  Had he not taken that extraordinary step, acceptance and appropriate treatment with antibiotics might have taken even longer.

WildAboutHarry wrote:

rocketdog wrote:My favorite example of this is the common gastric ulcer.  For decades it was generally accepted that spicy or acidic foods were the cause.

And thousands (hundreds of thousands?) of peer-reviewed studies supported the incorrect hypothesis for decades.

I don't believe so.  As far as I can tell there were no peer-reviewed studies indicating that spicy and/or acidic foods caused ulcers.  It was only known that they exacerbated existing ulcers, so incorrect assumptions were made, probably because dietary changes and acid-reducing medications seemed to do the trick. 

That's been the history of medicine and science in general: assumptions are made that seem perfectly plausible given the set of observations available.  It's only when someone actually sets about to do the work of testing the assumption that we discover if it's true or not. 

Another example comes from a documentary I just saw about the Panama Canal.  The French first tried to build a canal and failed miserably, due in large part to widespread malaria and yellow fever among the workers.  The French believed the diseases were caused by swamp gases or "bad air", and they refused to accept new research that suggested mosquito bites were the cause.  As a result of their refusal to accept the scientific findings backed by evidence, over 20,000 workers died unnecessarily of preventable mosquito-borne diseases. 

The U.S. was next to try building a canal.  But this time they trusted the science, and Dr. William C. Gorgas mandated that measures be taken to prevent the spread of diseases based on the science.  Screens were installed in windows, standing water was eliminated where possible, and where not possible it was sprayed with oil to smother mosquito eggs, workers were given a daily ration of quinine, and so on.  As a result, they all but eliminated malaria and yellow fever from Panama, and the rest is history as they say.

Yet another example of a "boat rocker" who changed the world.

MachineGhost wrote: That's a great analogy except the S&P 500 isn't a passive index nor is it the best constructed index

Technically there's no such thing as a purely "passive" index, because at some point in the process one or more human beings have to construct and then maintain the index.  One might say there are only degrees of "passivity". 

We can all debate whether or not the S&P 500 is the "best constructed" index, but it's safe to say that it's by far the most widely used index, both by economists and Wall Street.  It is generally regarded as the best representation of the market as well as a bellwether for the U.S. economy. 

MachineGhost wrote:

craigr wrote: I remember when US car companies were going on an ad spree attacking the Honda Accord. I saw ads from Ford, GM, etc. comparing their vehicles to the Accord. I thought to myself: "Obviously the Accord is the car to buy because all these other guys are gunning for it. It must be pretty good." The Honda had become the benchmark (for good reason).

Same for the index. The industry compares stock trading against the S&P 500 or broader index. It is, after all, the benchmark. And unlike other benchmarks in the world that could be quite expensive (Ferrari, etc.), this benchmark is ironically the cheapest thing to buy. For me it's a no-brainer to just own the benchmark and leave the active managers fighting amongst themselves for the crumbs.

That's a great analogy except the S&P 500 isn't a passive index nor is it the best constructed index on par with a Honda Accord... more like a Chevrolet Vega.  So, this would imply that if active managers can't even beat what is a subpar index, they're just hopelessly lost to all the cognitive and institutional biases.  And over time if informed investors adopt better benchmarks for the standard to compare to, it will become even more and more difficult for active managers to sustain an edge.  I'm not worried about that happening anytime soon, though.  Maybe within 10-20 years as more and more "worthless" jobs are eliminated through Baxterification.

For those reading this later, Baxter refers to the Helper Manufacturing Robot.

http://www.youtube.com/watch?v=rjPFqkFyrOY

rocketdog wrote:I don't believe so.  As far as I can tell there were no peer-reviewed studies indicating that spicy and/or acidic foods caused ulcers.  It was only known that they exacerbated existing ulcers, so incorrect assumptions were made, probably because dietary changes and acid-reducing medications seemed to do the trick. 

I'm not a physician, but I imagine that there are numerous articles from JAMA, New England Journal of Medicine, The Lancet, etc. that are titled something like "Gastric Ulcer Response to [pick your treatment of choice or environmental cause] - A Double Blind Study" and numerous variations thereon.  All peer reviewed studies.

It is someone breaking out of the peer-reviewed mold that often advances science and medicine.  From the CDC:

1982 - Australian physicians Robin Warren and Barry Marshall first identify the link between Helicobacter pylori (H. pylori) and ulcers, concluding that the bacterium, not stress or diet, causes ulcers. The medical community is slow to accept their findings.

I might add the "peer-reviewed medical community".

I am not disagreeing with the importance of break-out research, but the peer-review process does not necessarily produce it, and in some cases can actually inhibit revolutionary findings.

rocketdog wrote: Yet another example of a "boat rocker" who changed the world.

You're still blowing up a minor fat tail and ignoring the groupthink that chokeholded progress for however many eons.  Your examples are actually supporting the opposite of your argument!  I'll give you a cookie and say that adversity and extreme conditions make people more desparate and thus, more open minded to new approaches.

And it was stress that was widely believed to cause ulcers.  Overturning that took a lot of Herculuean effort because people are stubborn assholes.

rocketdog wrote: Technically there's no such thing as a purely "passive" index, because at some point in the process one or more human beings have to construct and then maintain the index.  One might say there are only degrees of "passivity".

I'll agree to that.  I will argue the more that humans are involved, the worse the index performance.  It's somewhat known that when S&P 500 adds a stock to its index by committee, it underperforms for several years and vice versa.

We can all debate whether or not the S&P 500 is the "best constructed" index, but it's safe to say that it's by far the most widely used index, both by economists and Wall Street.  It is generally regarded as the best representation of the market as well as a bellwether for the U.S. economy.

And yet, its very easy to beat with other construction schemes (even equal weight!).  Yet, 60% of Wall Street can't do it in actual practice, and the remaining 45%-49% can't do it in actual practice by more than 1% net a year.  If we take your previous argument to the logical conclusion, then groupthink predominates on Wall Street and the proverbial "boat rockers" that are so despised in here are the ones cleaning up.  You can't have it both ways.

MachineGhost wrote:

rocketdog wrote: We can all debate whether or not the S&P 500 is the "best constructed" index, but it's safe to say that it's by far the most widely used index, both by economists and Wall Street.  It is generally regarded as the best representation of the market as well as a bellwether for the U.S. economy.

And yet, its very easy to beat with other construction schemes (even equal weight!).  Yet, 60% of Wall Street can't do it in actual practice, and the remaining 45%-49% can't do it in actual practice by more than 1% net a year.  If we take your previous argument to the logical conclusion, then groupthink predominates on Wall Street and the proverbial "boat rockers" that are so despised in here are the ones cleaning up.  You can't have it both ways.

If there are people who are regularly "cleaning up", why aren't they working on Wall Street?  I know if I had figured out a system to "clean up", I'd want to capitalize on it and use it to start an investment firm or hedge fund or some other vehicle to execute my system on a large scale to vastly compound my profits.  I'd love to see the last 10 years of annual investment statements and tax returns from anyone who claims to be "cleaning up". 

Sure, there might be a small population of people who fit into that category, just as there is a small population of people who have lost everything over the past 10 years.  But by and large those people are blowing up the "fat tails" as you say. 

MachineGhost wrote:

rocketdog wrote: Yet another example of a "boat rocker" who changed the world.

You're still blowing up a minor fat tail and ignoring the groupthink that chokeholded progress for however many eons.  Your examples are actually supporting the opposite of your argument!  And it was stress that was widely believed to cause ulcers.  Overturning that took a lot of Herculuean effort because people are stubborn assholes.

My examples don't ignore that group think is a problem.  My point is that it can be overcome by the scientific method and proper peer review.  The problem isn't that the peer review process doesn't work, it's that some peers are unfortunately unwilling to invest the time and effort to do a proper review.  But again, that is not a weakness of the peer review process. 

The peer review process, like the scientific method, works just fine.  But like any tool it has to be used properly to be effective.  To say that the peer review process doesn't work because academicians sometimes play politics is a criticism of the academicians, not of the peer review process. 

The purest analogy I can think of is math.  Math works.  Always.  If you calculate a math problem and arrive at the wrong answer, you can't blame the mathematics. 

rocketdog wrote: My examples don't ignore that group think is a problem.  My point is that it can be overcome by the scientific method and proper peer review.  The problem isn't that the peer review process doesn't work, it's that some peers are unfortunately unwilling to invest the time and effort to do a proper review.  But again, that is not a weakness of the peer review process.

I don't think I can say I've seen many peer review processes--in academia and outside of it--where this isn't true. If the process is flawless but the dumb humans can't use it properly, maybe it's time to use a different process.

Pointedstick wrote:

rocketdog wrote: My examples don't ignore that group think is a problem.  My point is that it can be overcome by the scientific method and proper peer review.  The problem isn't that the peer review process doesn't work, it's that some peers are unfortunately unwilling to invest the time and effort to do a proper review.  But again, that is not a weakness of the peer review process.

I don't think I can say I've seen many peer review processes--in academia and outside of it--where this isn't true. If the process is flawless but the dumb humans can't use it properly, maybe it's time to use a different process.

Humans can use it properly, they just don't always choose to do so.  And they suffer professional and personal embarassment as a result (not to mention a missed opportunity to win a Nobel prize for discovering something new). 

Like my earlier math analogy, just because not all of us are good at math is not a weakness of math itself. 

rocketdog wrote: If there are people who are regularly "cleaning up", why aren't they working on Wall Street?  I know if I had figured out a system to "clean up", I'd want to capitalize on it and use it to start an investment firm or hedge fund or some other vehicle to execute my system on a large scale to vastly compound my profits.  I'd love to see the last 10 years of annual investment statements and tax returns from anyone who claims to be "cleaning up".

Being a success investor/trader and running an investment firm/hedge fund are two entirely different approaches.  One is a necessary vocation, the other is an optional business.**  Not everyone has such a driving insecurity or such a lust for power or greed to put up with the warts of the latter (it's not even remotely romantic).  There's many examples of successful buy-side firms if you look for them.  Individuals are a lot more private by nature, but there's been some media exposition there as well.  It's only "extraordinary" when viewed through the lens of self-serving, sell-side Wall Street propaganda.

** I'm speaking of this from the perspetive of the owner/entrepreneur, not a job/employee.  Until an employee quits his Wall Street job to start trading on his own or start his own hedge fund and risking his own capital, its nothing but a talk is cheap, comfortable, cushy handout.