Do They Really Know?

No-it-alls admit they don’t - part one

It’s almost impossible to keep the self-proclaimed “market experts” from acting like they know the future. If they couldn’t claim to have superior insights, they wouldn’t get the press they need to thrive. Yet, do they really believe what they say?

Take a 2013 article by Steven Rattner for the New York Times. If that name sounds familiar, it’s because Rattner followed and unusual path to financial industry success. He began his career with the New York Times, as both a reporter and chief correspondent in Washington. From there he jumped to Lehman Brothers, the Morgan Stanley, Lazard, and then founded his own money management firm. He was recruited to help manage the affairs of GM and Chrysler in 2009. 

Rattner suffered a “fall from grace” when he was prosecuted in a scheme to pay to manage for New York State pension assets, which he eventually settled out-of-court. Bouncing right back, Rattner continues to manage money privately (including Michael Bloomberg’s fortune) and has returned to write op-ed pieces for the New York Times. 

In November, 2013, just after the Nobel Prize for economics was awarded to Eugene Fama and Robert Schiller, Rattner entered the debate about which Nobel laureates philosophy was better (as if they were mutually exclusive). Fama believes that markets are inherently efficient, while Schiller states that investors' erratic psychology make markets inherently unstable.

In the article, Rattner stated: “I get Mr. Fama’s theory, but the evidence points decidedly in the opposite direction. I have met many investors who have consistently outperformed the market. Take, for example, the world’s most famous — and most successful, if judged by personal net worth — investor, Warren Buffett.”

You can smell a spurious argument from a mile away as soon as someone invokes the holy name of the “Oracle of Omaha.” Mr. Buffett is far from a typical investor. The man buys (and operates) entire businesses. He doesn’t passively invest and hope someone else will properly invest his money.

Rattner also bases his argument against efficient markets on the success of university endowment funds: “A significant number of endowments and foundations have also succeeded in posting stellar results. Since 1993, Yale’s endowment appreciated by 13.5 percent per year, while the S.&P. rose by 8.6 percent.”

There are two problems with this argument. One, endowments can take extraordinary risk as they have no “use by” date. Individuals usually need their money by a certain time and can’t take open-ended risks. Two, he makes the mistake of comparing apples and broccoli. From 1993 through 2013, a globally diversified portfolio of stocks from DFA returned about 11% per year (yes, still 2.5% less), but Yale’s numbers could have been skewed by luck. In fact, over the past 10 years, Yale’s fund have posted a more market like 11% per year (while that same DFA global equity portfolio returned just over 12%).

About halfway through the article, Mr. Rattner does seem to support to one part of the Efficient Market Hypothesis, “Of course, for every investor who is beating the market, another must be falling short. That’s certainly true, and among the losers are mutual funds that cater to small, individual investors who do not generally have access to top managers.”

So, apparently he believes that some people have the power to be on the winning side more often, those “top managers” We apparently need to find them because we are really bad investors, “According to a recent study by the research firm Dalbar; typical equity mutual fund returns over the last 20 years were about half (4.25 percent) of market gains (8.2 percent). That suggests that individuals should not park their money in actively managed mutual funds, let alone pick stocks or try to time the market.”

Wait, we shouldn’t use active managers or try to exploit market inefficiencies? What should we do?

Rattner continues, “Fortunately, Mr. Fama’s work on efficient markets did a favor for the small investor: it spawned low-cost index funds that replicate market averages. That’s where the non-expert should park his money… when it comes to active investing, ‘don’t try this at home.’”

Color me confused. He states that Professor Fama is wrong. Markets are inefficient. Yet, his advice to all of us poor slobs without Buffett/Bloomberg/Yale sized portfolios is “don’t try this at home” and buy index funds instead? Couldn’t he have save himself an entire column and just written a single paragraph.

Mr. Rattner’s conclusion sounds a lot like a statement made by Eugene Fama himself, a few years ago, when asked what he thought of all of those who claim that his “Efficient Markets Hypothesis” is flawed: “If markets really were inefficient… they would be better able to exploit these inefficiencies in some practical way that investors could really use, but they generally punt on that one…”

It seems to me that, like so many others, tried to score some points but ended up being forced to “punt.”