Managed Fund Portfolios versus Tracker Portfolios, and the Efficient-Market Hypothesis

It’s a common observation that tracker funds outperform managed funds over the long term. The charges levied on managed funds to support their staff are substantial, and make the effective return lower.

What about the underlying portfolios, though? Do any of them outperform the market in the long run (i.e. in a statistically significant manner)?

I suspect that the answer to this is no, but what if it is yes? What would it mean for the efficient-market hypothesis?

Clearly, if someone is earning excess returns, then the strong form is incorrect1.

The semi-strong form, that all public information is baked in to current prices, can only hold under dubious circumstances if someone is earning excess returns. Those earning excess returns must be party to private information. So if the semi-strong form is true, and some managed fund portfolios do outperform the market, then their charges could be viewed as the price of that private information. The market of managed funds is then a market in the effective obtaining and using of private information.

The weak form need not be challenged by any (statistically significant) outperforming portfolio, provided that it is not managed on the basis of past prices.

Assuming that any successful managed funds are not using private information to generate their excess returns, could there be an argument for a further form of the efficient market hypothesis? This fourth form would effectively lie between the weak and semi-strong form forms. Let’s call it the mild form for the moment.

The weak form prohibits successful technical analysis, and the semi-strong form prohibits successful fundamental analysis on public information. A mild form of the efficient market hypothesis, between those two forms, might look like this:

All past prices are reflected in current prices, and some easy-to-discover public information is also reflected.

Some managed portfolios can then outperform the market by reflecting more public information than the market does. The cost of that public information is external to the portfolio, but included in the cost of the fund. Managed funds then compete to use public information more efficiently than each other.

To re-iterate, all of this discussion turns on the existence of managed portfolios that significantly outperform the market. If managed portfolios do not outperform the market in a significant way, then the semi-strong form can hold.

What have I missed? How am I wrong?

1 – I believe that some investors on fundamentals, famously including Warren Buffett, consistently outperform the market. I’m not sure if these outperformances are statistically significant, although I would guess that they are. If they are, then the strong form is empirically disproved.

Gender Differentials

Thought experiment:

  1. Take a very large group of men
  2. Rank them by physical attractiveness
  3. Count their children of both genders
  4. Compare the results of 3 for the top and bottom quartiles (deciles, whatever) established in 2.

My guess is that with a large enough sample, there would be a difference. I would expect better-looking men to have more male children than female. I wonder if someone else has already done this experiement?

Charity Cheating (Perverse Incentives I)

Some incentives to give to charity
A notice to employees

“Sponsor a colleague and [we] will double match your donation – £2 for £1”; “Volunteer with a charity in your own time and [we] will ‘time-match‘ with a cash donation to the charity up to the value of £1, 200 p.a.”

I believe this employer has just created the right incentives for charities to pay their employees to donate to them! Not, I’m sure, that anyone would be interested in that.


I am not an economist.

Just listened to The World This Weekend on R4. The presenter talked about bubbles, speaking particularly about gold, and said something along the lines of, “The price of gold is much higher than its value”.

If you think that an asset is overpriced, I assume you mean that future cash flows arising from the asset cannot generate an adequate return compared to its price. If you think goods for consumption are overpriced, I assume you mean that you would rather forego consumption at the asking price, and keep the cash instead.

Gold is, in a basic sense, almost useless. It’s a store of value, and not much else; hence it’s an asset that is not going to be consumed. The only way you can claim it’s overpriced, I think, is if you believe that the price is going to go down before you can sell. But right now, the flight from every other asset class is propping up the price. Isn’t that going to continue for the foreseeable future? Isn’t the value of gold precisely what you think you can sell it for, much more so than other kinds of asset?

Long term modelling

An article on the BBC site discusses the long term impact of the current financial crisis, if the economy keeps growing at 2.2% per year. In short, the the economy grows its way to far more wealth, and the current situation is just a small bump on the road.

But when you start by assuming 2.2% pa growth forever, what does it matter? Growth is what everyone agrees we need, and what everyone claims to be trying to create. Given that it seems to be the variable that people are trying to exert some control over, it seems odd to start by holding it constant. Perhaps the only really valid conclusion from this article is that growth really is a good thing – but I don’t think that was ever in doubt.


In the BBC’s report on Serbian protests over Kosovan independence, a girl by the name of Bojana Vuckovic is quoted as saying, “We don’t want to let it go because it’s ours, even if the majority of people there aren’t Serbian.” The ‘we’ of her statement is presumably Serbians. The majority of the people on the march would presumably agree to that statment or something similar.

What’s interesting is what ‘ours’ means in that sentence. I am no expert, but I guess that large parts of Kosovo are privately owned, and that neither the old Serbian nor the new Kosovan government would claim ownership of them. However, those governments would claim that their laws extend over that land. The ownership that Bojana is talking about is being in charge of, rather than having exclusive rights to.

So what I’m left thinking is that Bojana believes that, no matter who buys the land of Kosovo, Serbia must remain in charge. Even when Kosovo is 90% or more ethnic Albanian, Serbia must be in charge. I doubt that it’s cost-effective for Serbia to rule a land that doesn’t want to be ruled. So in the absence of an economic motive, why do some Serbs want so badly to be in charge of Kosovo?

Life Quickly Imitates Art, Even Sci-Fi

Charles Stross is now one of my two favourite currently publishing SF authors (the other is Iain M. Banks). I got a copy of his latest, Halting State, from Amazon a couple of days ago. I haven’t finished it yet, but so far it’s about economic sabotage in an MMORPG, set in 2016.

Like another modern Aristotle of SF, Neal Stephenson, Charles Stross seems to understand everything, including economics. More importantly, he understands why it’s important (something I only started to grasp a couple of years ago) and can explain it without killing the story. So Halting State spends some of its time discussing money supply and inflation within virtual worlds. So far ahead of the curve, so Charles Stross, I think.

Last night I picked up this week’s Economist, to find mention in the business headlines of Second Life‘s financial crisis. Halting State‘s characters refer to Second Life as a metaverse, not a MMORPG, but I still find this amazing. Theoretical GDPs and game-currency-to-hard-currency exchange rates have been published for a while now, but maybe the crossover from amusing sideline to area of serious interest is closer than even Charles Stross thinks.