Charley Ellis: Why Active Investing Is Still A Loser’s Game
Few people can claim to understand the world of investment management as well as Charley Ellis does. Here’s why: Charley has been an investment consultant to large institutional investors for their manager selection for almost five decades; he has been a prolific writer on the subject including the biblical “Winning the loser’s game” and also a deep dive into what’s arguably the most successful investment management firm in history – Capital Group; he has taught investing courses in Yale and Harvard; he chaired the investment committee at the world’s most celebrated university endowment at Yale along with the legendary David Swensen and last but not the least he served on the board of the world’s most disruptive investment management firm – Vanguard. Here’s one hour of sheer wisdom from Charley in an insightful podcast with Morningstar. You could listen to it or read the transcript or see the excerpts below of topics he touches on, particularly inspiring for what we are trying to build here at Marcellus:
On his favourite subject of why active investing is still a loser’s game:
“…over a 10-year period 85% of actively managed funds fall short of what they chose as their benchmark. And when they fall short, they fall short by a great deal more than those who happen to win by. And if you say, “Well, I’m going to take the 15% that do well–that they ought to be some pretty good guys there.” They’re talented people. But what you’ll find is about 85% of that 15% will fall short in the next decade. So, as I say, it’s tough out there.”
On where active investing could still work:
“…the Chinese market is still dominated by individual investors. And it’s amazing how individual investors in China are very attracted to seeing a stock price going up and saying, “I know what’s going to happen, it’s going to go up again the next day.” And so long as you’ve got a substantial number of amateur or retail investors, who are governed not by rigorous logic and quantitative analysis and objectivity, but are working on a more spiritual, emotional, and sometimes visual basis, then you’ve got an opportunity. Because if somebody is doing their activity and trading for reasons that are not appropriate to what a skillful stock market practitioner would do, skillful practitioner is going to have a really good opportunity to do better than that particular individual or to that market that’s dominated by individuals.”
On whether there is a recipe to build a successful investment management firm:
“First, you would have to have developed an exceptionally independent way of thinking. It probably would be helpful if you had one or two very close-in colleagues because if you’re a very independent thinker, you may be doing “too independent” and go off the deep end. But very independent thinker. You’d have to be exceedingly good in quantitative analysis. And you’d have to enjoy the game that includes long periods of nothing going on. So, deer hunter skills would be appropriate. Or maybe deep-sea fishing would be appropriate. But long periods when there’s nothing going on and not needing to do something. You’d have to be very, very self-disciplined, so that when you did make a mistake, you would catch it fairly soon, and when you had made a mistake, you would stay with your process long enough.”
On why character is the most important trait to look for in a fund manager:
“..And if you look back over the last 20, 30, 40 years, which of the firms that have done really well, year after year after year after year, I promise you that the single governing characteristic is character. And some people call it culture. That’s fine by me. Some people call it integrity. That’s fine by me. But it’s one of those key words that describes what we all look for in President of United States; what we all look for in leader of our companies; what we all look for in the people that our kids marry. So, it’s really worth all the time and effort and attention that it takes to learn it.
Personally, as you know, I had a long wonderful 17 years on the Yale Investment Committee working with and for David Swensen, and I think it’s one of the most beautiful experiences anybody in the investment world could possibly have to get up close and see exactly how they’ve done it. And one part of it was when due diligence was on for an investment manager, the quality of their digging, backgrounding, backgrounding, backgrounding, digging was at least as high, I would say, higher than we usually have in this country when the President of United States is considering somebody for Secretary of Defense or Secretary of Treasury. They go into any possibility that there might be any difficulty anywhere. Same sort of thing for Yale’s investments and the same sort of thing, I believe, is the single best investment the client can make in getting a great relationship with an outstanding investment manager.
Candidly, if you said, “I have to get somebody who’s smart”–that’s so easy. There is a lot of really smart people. Even worse than that, there are a lot of really smart people, and some of them don’t have anything like character. They’re really terrible. Bernie Madoff was a charming guy and very bright, and he had terrific connections. And he was the SEC’s go-to-person for complex questions about the securities industry, a marvelous person in so many ways, and probably the biggest skunk or a cheat or a crook, any of us know about.”
On why people won’t quit active investing:
“How in the world you’re going to get people to give up the most interesting game, most interesting line of work, highest paid compensation, where you can work–I’ve got a friend who decided on his 100th birthday, he said, “Charley, I’m going to do myself a big favor. It’s my 100th birthday, and I’m going to stop working so hard. I’m going to cut out Saturday, only going to work five days a week.” I laugh at myself. Early 80s. What am I doing? I’m working as hard as I can. I put in 60, 70, 80 hours a week, usually 70 or 80. Gee, that’s interesting. “Why don’t you cut back?” Because it’s so darn interesting….. Well, it’s fascinating work, intellectually challenging, it’s spiritually challenging. And it’s competition with the best in the world. That’s part of it, you can’t change that. And the compensation, as I say, is terrific. Can’t change that. And it’s not just that year-to-year compensation–it’s that extra 10, 20, 30 years that you can continue to practice the same profession, marvelous. Why somebody going to give that up?
On David Swensen:
“…anybody who could be that disciplined and creative, and I would emphasize both the word discipline and creative, is someone that all the rest of us would want to pay attention to, even though we might find it difficult to reproduce what he can do.
…One of the things that he has been doing at the same time is building and establishing a network of friends who, like me–I would rather do David Swensen a favor than anybody I know. A favor that he would accept, that he would say, “Thank you. I appreciate that.” That would to me be a thrill. Have I been able to do that? No. Would I love to do it? You bet, I would. And so would large, large, large numbers of other people all over the world. Sure, the investment managers that have worked with Yale have exactly that feeling. But many, many other people have exactly that feeling also. So, scuttlebutt network, David Swensen’s got far and away the world’s best, and it vibrates.”