The book - Winning The Losers Game by Charles D Ellis is a fascinating read. It is clearly THE BOOK we would recommend for individual investors – we are almost tempted to buy one copy for each of our clients!!. The ideas in the book are simple, but nevertheless bring into focus some key points that investors must pay attention to. In a delightful comparison with tennis, Mr. Ellis quotes Dr. Simon Ramo who “observed that tennis is not one game but two: one played by professionals and a very few gifted amateurs , the other played by all the rest of us.” He goes on to say that in both versions of the game, players employ the same equipment, dress, rules and scoring but they play two very different games. Through extensive statistical analysis, Dr. Ramo sums it up as : “Professionals win points; amateurs lose points.” i.e in expert tennis, the ultimate outcome is determined by the actions of the winner. “Professional tennis players hit the ball hard with precision with long rallies until one player is able to drive the ball out of reach or force the other player to make a mistake”. Amateur tennis on the other hand is totally different. Amateurs seldom beat their opponents. Instead, they beat themselves. The actual outcome is determined by the loser. There are no exciting shots or long rallies or miraculous recoveries. Instead the ball is often played into the net or out of bounds, or there are double faults on serves. The victor in amateur game wins because the opponent is losing even more points. Dr. Ramo points out that in expert tennis 80 percent of the points are won, whereas in amateur tennis about 80 percent of the points are lost.
Mr. Ellis illustrates to us that 100 years ago, 90 per cent of NYSE trades were done by individuals and 10 % by professional investors and institutions. Today it is reversed. 98 per cent of today’s NYSE trades are done by institutions or algo trades (computers). Trades in the market are dominated by professional traders and sophisticated algorithms backed with data current enough to the nearest milli second. It is a hopeless ask for the lay retail investor to find a consistent edge in the market. Participating as an active manager in the stock markets of today, even for professional investors is akin to playing the losers game. The markets today have been sliced and diced by so many professional investors, that price discovery is near perfect and a price-value discrepancy is hard to find. In other words, the markets of today are akin to the losers game, wherein the strategy should be to curtail mistakes rather than score winners.
Delving deeper into the costs of active management, Mr. Ellis points out that the fees charged by most active managers of say 2% (in India) of assets do seem low as a percentage of assets – but is this the correct way to look at it ? Definitely no !!. The reason is that investors already have their assets, so charging them fees as a percentage of their already self acquired assets seems dubious. Also charging investors a fixed 2% of assets for a market return would again be dubious since the effective return to the investor after fees will be less than market return. Active investment management should really be about what incremental return investors are getting for the actions of the manager. If future stock returns in India average 12%, then a fixed fee of 2% of assets should be worked out as a percentage of the incremental return above 12%. For the fixed fee of 2% to be about 20% of incremental returns, the out-performance of the active manager must be 10% - in other words a total return of 12% (market) + 10% (out-performance) = 22% !! This to my mind is clearly asking for too much – anyone who promises a 22% return per annum is most likely a fraud or has not been tested long enough in the market.
What then should be a retail investors strategy ? What should she focus upon which will give the greatest value for her in the long run ? Mr. Ellis has a few simple rules. First he says : know thyself. ie know your personal financial goals and know how much risk you can accept. This would indicate that the decision of much you are to allocate to risky equity is a very important decision – and most likely will have the largest contribution to the success of your investing journey. Second he says minimise active investing and keep costs low. i.e stick to index funds and avoid paying large fees to active managers. Low cost Index funds charge barely 0.10% of assets as fees. In other words understand that you are basically playing the losers game – so be defensive and stick to indexing largely. Third he says keep the drag of taxes on your investments to a minimum. Fourth he says even if you do chose an active investment manager, chose one who has a niche, focusses upon risk mitigation and uses a process driven methodology for stock selection.
So where do we – the Investment Adviser community come in. Clearly the Investment Adviser comes in all of the above points. The first being – know thyself. A clear and detailed Investment Policy where the investors goals and risk appetite is well articulated will enable the investor to stay the course of a long investing journey – this can be the foundation of knowing thyself. The Investment Adviser can bring into sharp focus the various tensions that exist between the investors financial goals, financial assets, savings and risk appetite and create an Investment Policy Statement that suits each investor uniquely which will decide the likely range of exposure to risky assets – this is a clear value add to the investor. The second – keeping costs low and chose indexing. The Investment Adviser should be knowledgeable on what products have the lowest costs and are in sync with the Investment Policy Statement of the client. Two examples can be brought to fore immediately (in India at-least)– a genuine Investment Adviser acting with fiduciary intent will chose the lowest cost Index Funds in Direct mode rather than chose any other active Mutual Fund in Regular mode. Increasingly active mutual funds in India are under-performing their benchmarks. Most of them are index huggers and have such large asset bases that they are not nimble enough because their sheer size creates huge price implications either when they buy or sell shares. Furthermore an Investment Adviser acting in a fiduciary role will always insist that an investor buys the DIRECT mode rather than the REGULAR mode of a fund which will avoid expensive distribution charges (about 1% of assets) which are hidden from the investor. A second example on costs which comes to mind is the investment in debt. Today debt fund investments are dominated by insurance companies or debt mutual funds. They seem to have a monopoly over debt investments. Further, direct investment in individual debt paper is tax inefficient as the interest is taxed at the marginal rate of the investor. Insurance companies are notorious for using the bait of tax exemptions under section 10(10D) of the income tax act to generate tax exempt maturities. However the other costs associated with investing in a ULIP for example, are not clearly brought to light. The high premium allocation charge, fund management charge, mortality charge, service tax, administration charge – all add up and in every case I have studied so far wipe out the tax advantage created in the first place. However, today investors have access to Bharat Bond ETFs of varying maturities which are managed at just 0.005% management charges (a fraction of the fund management charges of insurance companies and mutual funds). Investors can at very low costs get invested in high quality quasi government bonds which have the advantage of being taxed in the Long Term Capital Gain mode (a mode in which taxes are just 10% of the gain). On the fourth point of Mr. Ellis – which is focussing on managers who emphasize risk mitigation and process – here the Investment Adviser should scour the landscape for active managers who are active in segments of the market that give them an edge, who walk the talk on their investment philosophies and have a long term vision about their active management strategies with a focus on eliminating losers. Further more, Active Managers must keep their fixed charges low or nil and their charges must primarily be a percentage of incremental return.
The guiding principle in Winning the Loser’s game by Mr. Ellis is that in investing we are playing the losers game. The focus should be on risk mitigation rather than on scoring winners. We cannot agree more.
Mr. Ellis illustrates to us that 100 years ago, 90 per cent of NYSE trades were done by individuals and 10 % by professional investors and institutions. Today it is reversed. 98 per cent of today’s NYSE trades are done by institutions or algo trades (computers). Trades in the market are dominated by professional traders and sophisticated algorithms backed with data current enough to the nearest milli second. It is a hopeless ask for the lay retail investor to find a consistent edge in the market. Participating as an active manager in the stock markets of today, even for professional investors is akin to playing the losers game. The markets today have been sliced and diced by so many professional investors, that price discovery is near perfect and a price-value discrepancy is hard to find. In other words, the markets of today are akin to the losers game, wherein the strategy should be to curtail mistakes rather than score winners.
Delving deeper into the costs of active management, Mr. Ellis points out that the fees charged by most active managers of say 2% (in India) of assets do seem low as a percentage of assets – but is this the correct way to look at it ? Definitely no !!. The reason is that investors already have their assets, so charging them fees as a percentage of their already self acquired assets seems dubious. Also charging investors a fixed 2% of assets for a market return would again be dubious since the effective return to the investor after fees will be less than market return. Active investment management should really be about what incremental return investors are getting for the actions of the manager. If future stock returns in India average 12%, then a fixed fee of 2% of assets should be worked out as a percentage of the incremental return above 12%. For the fixed fee of 2% to be about 20% of incremental returns, the out-performance of the active manager must be 10% - in other words a total return of 12% (market) + 10% (out-performance) = 22% !! This to my mind is clearly asking for too much – anyone who promises a 22% return per annum is most likely a fraud or has not been tested long enough in the market.
What then should be a retail investors strategy ? What should she focus upon which will give the greatest value for her in the long run ? Mr. Ellis has a few simple rules. First he says : know thyself. ie know your personal financial goals and know how much risk you can accept. This would indicate that the decision of much you are to allocate to risky equity is a very important decision – and most likely will have the largest contribution to the success of your investing journey. Second he says minimise active investing and keep costs low. i.e stick to index funds and avoid paying large fees to active managers. Low cost Index funds charge barely 0.10% of assets as fees. In other words understand that you are basically playing the losers game – so be defensive and stick to indexing largely. Third he says keep the drag of taxes on your investments to a minimum. Fourth he says even if you do chose an active investment manager, chose one who has a niche, focusses upon risk mitigation and uses a process driven methodology for stock selection.
So where do we – the Investment Adviser community come in. Clearly the Investment Adviser comes in all of the above points. The first being – know thyself. A clear and detailed Investment Policy where the investors goals and risk appetite is well articulated will enable the investor to stay the course of a long investing journey – this can be the foundation of knowing thyself. The Investment Adviser can bring into sharp focus the various tensions that exist between the investors financial goals, financial assets, savings and risk appetite and create an Investment Policy Statement that suits each investor uniquely which will decide the likely range of exposure to risky assets – this is a clear value add to the investor. The second – keeping costs low and chose indexing. The Investment Adviser should be knowledgeable on what products have the lowest costs and are in sync with the Investment Policy Statement of the client. Two examples can be brought to fore immediately (in India at-least)– a genuine Investment Adviser acting with fiduciary intent will chose the lowest cost Index Funds in Direct mode rather than chose any other active Mutual Fund in Regular mode. Increasingly active mutual funds in India are under-performing their benchmarks. Most of them are index huggers and have such large asset bases that they are not nimble enough because their sheer size creates huge price implications either when they buy or sell shares. Furthermore an Investment Adviser acting in a fiduciary role will always insist that an investor buys the DIRECT mode rather than the REGULAR mode of a fund which will avoid expensive distribution charges (about 1% of assets) which are hidden from the investor. A second example on costs which comes to mind is the investment in debt. Today debt fund investments are dominated by insurance companies or debt mutual funds. They seem to have a monopoly over debt investments. Further, direct investment in individual debt paper is tax inefficient as the interest is taxed at the marginal rate of the investor. Insurance companies are notorious for using the bait of tax exemptions under section 10(10D) of the income tax act to generate tax exempt maturities. However the other costs associated with investing in a ULIP for example, are not clearly brought to light. The high premium allocation charge, fund management charge, mortality charge, service tax, administration charge – all add up and in every case I have studied so far wipe out the tax advantage created in the first place. However, today investors have access to Bharat Bond ETFs of varying maturities which are managed at just 0.005% management charges (a fraction of the fund management charges of insurance companies and mutual funds). Investors can at very low costs get invested in high quality quasi government bonds which have the advantage of being taxed in the Long Term Capital Gain mode (a mode in which taxes are just 10% of the gain). On the fourth point of Mr. Ellis – which is focussing on managers who emphasize risk mitigation and process – here the Investment Adviser should scour the landscape for active managers who are active in segments of the market that give them an edge, who walk the talk on their investment philosophies and have a long term vision about their active management strategies with a focus on eliminating losers. Further more, Active Managers must keep their fixed charges low or nil and their charges must primarily be a percentage of incremental return.
The guiding principle in Winning the Loser’s game by Mr. Ellis is that in investing we are playing the losers game. The focus should be on risk mitigation rather than on scoring winners. We cannot agree more.