Thanks for that Nuntius; in fact, it sounds like bootstrapping is 90% of what I do everyday. The rest is making tea and eating lunch. Hone your bootstrapping skills and I am sure you will be an excellent portfolio manager.

I did learn this in stats, but I’ve already forgotten most of it (which is unfortunate, given that I’m still in college). Still, the fact that a classically minded portfolio manager doesn’t recognize the term gives me hope, as I’d rather like to be one at some point.

The links are very interesting; the guy in the first one got a bit shirty at one point, equating active managers with communists. Never heard that one before. The indexistas were clearly a bit desperate in 1995.

What on earth is a “bootstrap analysis”? I hope it is not dodgy.

It seems the 75% rule will remain unattributable. My wife (who did a CFA) assured me she has seen academic articles which derive the figure, or ones like it, but when I pressed her she also couldn’t remember names or dates. It is clearly some urban myth, so infused into our consciousness by simple repetition, passed on by word of mouth, that it has the Status of Truth. I hope they paid Vanguard marketing guy who came up with it a LOT of money.

I did find this, however, an index fund proponent in 1995 stating the 75 percent figure.

I also think you’d be very interested in this 2006 study: “We find that a sizable minority of managers really do pick stocks well enough to more than cover their costs. Moreover, our bootstrap indicates that the superior alphas of these managers persist.”

I take your point about the 25% of outperformers (assuming the law holds) not necessarily being the same ones in each period. But again, you don’t know that that is NOT the case, either; we are both speculating in the absence of the data. I imagine that a large proportion of that 25% in any period you see again in the next; at least that is what your hairy colleague Zubin blogs about the Norwegians.

I do not see that paying people to manage money actively is foolish, or unlikely to pay off. The fact that a lot of people do it, and the industry exists, and has done for centuries, makes it unlikely to be total bollocks.

In general, it’s easy to outperform if you’re long risk in a bull market. Vilar was long the riskiest bits of tech in a period when tech went from nothing to bubble.

And of course then there’s the question of benchmarks. My underperforming index fund can still outperform your outperforming small-cap fund if small caps go down and the broader market goes up. As a result, absent some improbable portable-alpha strategy, hiring an outperforming PM is secondary to getting your asset allocations right.

And this is where things get profound, Mr Spinoza. It might be possible for a super-smart telecoms analyst to find himself better at picking telecoms than the market as a whole. But to beat the market as a whole, it’s not enough to be smart at telecoms. You have to be smart at asset allocation too, and you need to be able to find the clever PMs in every asset in which you want to invest. NOW do you see why paying buy-side professionals to invest your money is not so likely to pay off, in aggregate? There are so many places where things can go wrong: a bad sector bet here, a bad PM choice there. Added to the fact that things here in Extremistan have a habit of blowing up quite spectacularly — rather more often, indeed, than you’ll find truly astonishing performance on the upside.

But suppose I was to ignore that part of your comment, while I have to agree with you that the market is not able to outperform itself, it is certainly theoretically possible for all portfolio managers as a class to outperform an index, assuming that the total set of market participants are not all portfolio managers. Look at the exampe of small-mid cap European PMs I mention above. Simple observation backs this up: the market is also made up of large corporate holders, lazy individuals, insane quants, index funds, central banks, PE houses, broker inventory, VC guys waiting to exit, treasury holdings and incompetent hedge fund managers. All these have vastly different time horizons and investment goals from what we are calling PMs in this discussion, many are not even aware they are underperforming a benchmark in one year or another and many do not care if they do. They don’t mind holding the crap stocks.

In some market periods, such as the tech markets of 1999 to March 2000, even lobotomised PMs can outperform (and there is evidence that if you damage the emotional parts of your brain it actually helps). I do not know of anyone who did not outperform in that era. Again, that’s just anecdotal.

One of my major objections to the 75% “law” is that it is just irrelevant; flip it around. Again, if 25% of PMs consistently outperform net of fees, THAT is the astonishing statistic. It destroys the efficient market myth upon which most financial theory is based, it provides more than enough investment capacity for the most basically informed punter to find someone decent to manage his nest-egg. These 25% clearly have something that they do which works, and it would seem prima facie possible, with enough study, to find out what that thing, or things, is, and then we shall all be rich.