Speaker 1: Hello, and welcome to another edition of the Odd Thoughts Podcast.
Speaker 1: I'm Tracy Alloway and I'm Joe Wisenthal. So Joe, Um.
Speaker 1: Every once in a while, we like to talk about
Speaker 1: poker on this show, right, that's true. We've had a
Speaker 1: few Poker in Gambling episodes. I think it's one of
Speaker 1: our popular recurring themes. Yeah, and every time I usually
Speaker 1: managed to make my complete incomprehension of poker quite obvious.
Speaker 1: But one thing I do understand, and I think one
Speaker 1: reason we end up talking about poker so much, is
Speaker 1: because it's a game that's kind of all about a
Speaker 1: combination of luck and strategy. Right, Yeah, you know what.
Speaker 1: I like you always point out with these poker episodes
Speaker 1: that you don't really play poker, that you're not much
Speaker 1: of a gambler. It's my caveat, but you do seem
Speaker 1: to intuitively recognize that through the study of poker, there's
Speaker 1: a lot of interesting stuff there. So even though it's
Speaker 1: not your thing, you grasp it's power as a metaphor. Okay,
Speaker 1: all right, Well I would hope so I would hope
Speaker 1: that I'm able to talk about poker in the most
Speaker 1: basic sense. But please don't ask me about any hands
Speaker 1: and things like that. Okay, wait, Tracy, which is better
Speaker 1: a full house or a flush? Uh um, a full house?
Speaker 1: Yeah that's right. Okay, maybe I should play poker? Should
Speaker 1: we play? Okay? Okay. Look, the reason I'm bringing up
Speaker 1: poker yet again is because there's someone who's actually going
Speaker 1: to be able to connect poker with one of the
Speaker 1: biggest trends that's currently happening in financial markets, and that is,
Speaker 1: of course, the debate between active versus passive investment management. Right.
Speaker 1: I think we've also talked about this topic to or
Speaker 1: if we haven't, we really should have this idea that
Speaker 1: there's this huge wall of money every month, every day
Speaker 1: leaving traditional mutual funds, traditional investing strategies and opting for
Speaker 1: more passive strategies that are lower fees, not really intended
Speaker 1: to beat the market, but at low cost essentially replicate
Speaker 1: the market's performance. Yeah, that's right. And so the guy
Speaker 1: who we're going to speak with today has actually written, um, well,
Speaker 1: he's written a lot about poker, he's written a lot
Speaker 1: about luck and investment strategy, but he has also specifically
Speaker 1: written a really great paper about how passive investing the
Speaker 1: rise of passive investing provides both opportunities and challenges for
Speaker 1: active managers, and he kind of likens it to the
Speaker 1: idea of, you know, weak poker players either staying at
Speaker 1: the table or leaving. So it's a really interesting analogy.
Speaker 1: So should we should we get started? Let's introduce him? Okay,
Speaker 1: so we have Michael Mobison. He is, of course, the
Speaker 1: head of Global Financial Strategies at Credit Suez. Uh, Michael,
Speaker 1: thank you so much for joining us today. Tracy Joe.
Speaker 1: Great to be with you, guys. I mean, shall we
Speaker 1: start with that poker analogy? Why did you reach for
Speaker 1: poker when it came to describing the dynamic between active
Speaker 1: versus passive management? Right now? You know, Tracy, I actually
Speaker 1: think it's a very very powerful way to think about
Speaker 1: this problem. So let's imagine I say, Tracy, Joe, do
Speaker 1: you want to come to my house Friday night to
Speaker 1: play poker? Your first question, I suppose, assuming you like
Speaker 1: to make money, is who else will be there? First
Speaker 1: of all, I would just I'm just gonna say, yes,
Speaker 1: I'm junking, but yes. If I were smarter and more rational,
Speaker 1: I would ask that. But I would Okay, Joe, you
Speaker 1: ask you say who else will be there, And I say, hey,
Speaker 1: couple really rich players who are very bad at poker,
Speaker 1: You'd be like, I'll be right over right, because you
Speaker 1: could see where your money is going to come from.
Speaker 1: But by by by contrast, if I say, hey, the
Speaker 1: players that come are really great players, they're really sharp,
Speaker 1: you probably know they're better than you. You probably say
Speaker 1: I got I got better things to do, right, So
Speaker 1: to me, there there are a couple really big lessons
Speaker 1: from poker and thinking about this active indexing discussion. One
Speaker 1: is it's very important for active managed to recognize for
Speaker 1: every winner, there has to be a loser. Right, A
Speaker 1: thousand dollars walks into my house to play poker on
Speaker 1: Friday night, A thousand dollar walks out, right, So it's
Speaker 1: gonna get shuffled around. But that's the main thing is
Speaker 1: there's got to be a winner for a loser for
Speaker 1: every winner. And second is, if you pay to play,
Speaker 1: the amount of money walking out will be slightly less
Speaker 1: than the money walking in the house takes a cut.
Speaker 1: The house takes a cut, and we call that fees. Right,
Speaker 1: So here's the here's the interesting provocation is it might
Speaker 1: be might it be the case that as we've seen
Speaker 1: the shift from active to indexing, that the people who
Speaker 1: are leaving the table or taking their money away from
Speaker 1: active managers are going to be our indexers. And so
Speaker 1: the weaker players, in effect are leaving the table. And
Speaker 1: so while it may may superficially make seem to make
Speaker 1: sense that if these people are leaving, it's gonna make
Speaker 1: it easier for us, in a sense, it actually makes
Speaker 1: it more difficult because the people who are remaining at
Speaker 1: the table are the smart players, the more motivated players,
Speaker 1: the players are more resources. So in a sense, it
Speaker 1: doesn't make it easier to beat beat the market. It
Speaker 1: actually makes it as difficult or maybe even more difficult
Speaker 1: than it did before. And that's somewhat counter into it.
Speaker 1: If you just say, if these people are sort of
Speaker 1: not in participating, right you, you often hear the other
Speaker 1: are the opposite. It's like, oh, there's all this dumb money.
Speaker 1: People are just indexing. People are not discriminating between one
Speaker 1: stock or the other. Active has got to be really
Speaker 1: easy now. But as you explain it pretty nicely there,
Speaker 1: the remaining tables, of the remaining players at the table
Speaker 1: are all really good or are getting better and better
Speaker 1: and I'll just say Joe and talking to managers. UM,
Speaker 1: there's a really interesting distinction that behavioral economists make between
Speaker 1: the price is right, which means markets are informational, e efficient,
Speaker 1: sort of fancy, and what they call no free lunch,
Speaker 1: which means there is no strategy that consistently beats the market.
Speaker 1: And here's the thing I think active managers struggle with.
Speaker 1: If there's no if the prices are right, there is
Speaker 1: no free lunch. I think we'd all agree on that.
Speaker 1: That's easy, but it could be the case there's no
Speaker 1: free lunch and prices are not right. So I think
Speaker 1: a lot of actor active managers see these sort of
Speaker 1: inefficiencies out there, but it's very difficult to exploit them.
Speaker 1: Let me give you a really sort of trivial example.
Speaker 1: Let's say you're a hedge fund manager and you know
Speaker 1: you're investing in the restaurant sector, and you buy the
Speaker 1: inexpensive one attractive one, and you short the expensive one
Speaker 1: and not so good quality one. Well, so you like
Speaker 1: your trade. Right. If investors decide we like restaurants, what
Speaker 1: do they do? The answer is, today they typically go
Speaker 1: right to the e t F. They buy the restaurant
Speaker 1: et F and they all rise together, so there's no discrimination.
Speaker 1: Likewise that they say we don't like restaurants, they sell
Speaker 1: the E T F and they all go down. So
Speaker 1: we're getting more of these sort of intersector correlations and
Speaker 1: there's less a discrimination between good and bad, which makes
Speaker 1: it very difficult to express your skill as an active manager. Michael,
Speaker 1: can we take a step back, because I'm trying to
Speaker 1: grapple with this concept of life getting harder for active
Speaker 1: managers thanks to the rise of passive But could you
Speaker 1: maybe give us your perspective on why passive has proved
Speaker 1: so popular over the past few years. So, um, it's
Speaker 1: really been eight, right, eight or nine years. I think
Speaker 1: something like our data show the last decade there's been
Speaker 1: one point to trillion dollars taken out of active funds
Speaker 1: and one point for trillion gone into indexing or passive funds,
Speaker 1: so at two point six trillion dollar net swing. So
Speaker 1: I think here's the way to think about this and
Speaker 1: sort of the centerpiece of this report was worked by
Speaker 1: a very famous paper from by Sandy Grossman and Joe
Speaker 1: Stiglets called on the Impossibility of Information Efficient Markets. On
Speaker 1: the Impossibility of Informational efficient markets, So in nineteen eighties,
Speaker 1: and interesting just as a side known interesting date because
Speaker 1: the nineteen seventies was probably the peak of enthusiasm for
Speaker 1: the efficient market hypothesis. So having written this in nineteen
Speaker 1: eight you can see they're writing it sort of a
Speaker 1: counter to the prevailing academic wisdom at the time. And
Speaker 1: here's the basic argument they made. They said, hey, folks,
Speaker 1: markets can't be perfectly informational efficient because there's a cost
Speaker 1: to gathering information and reflecting in prices, and as a
Speaker 1: payoff for that cost, you should get a requisite benefit
Speaker 1: in the form of excess returns in the market. Now,
Speaker 1: you can argue that these things should be roughly inequal portions,
Speaker 1: but there's got to be some inefficient so so some
Speaker 1: academics today have taken to this phrase markets are efficiently inefficient.
Speaker 1: So I think what's happened as a confluence of factors,
Speaker 1: including technology, including things like Bloomberg, this amazing access to information,
Speaker 1: dissemination of information, regulatory shifts, overall cost of computing, and
Speaker 1: so forth. I think markets have simply gotten more efficient.
Speaker 1: So as a consequence, paying a lot for for this
Speaker 1: price discovery function doesn't make as much sense. I think
Speaker 1: there's there's been that natural pressure that's happened. But just
Speaker 1: to be super clear about this, um, the markets can't
Speaker 1: go d indexing, right Obviously, active managers provide two vital
Speaker 1: um contributions to society. The first is what I mean
Speaker 1: the academs call this price discovery. It's a fancy way
Speaker 1: of saying they make markets efficient, and that's a huge
Speaker 1: societal good actually. And the second is they provide liquidity. Right,
Speaker 1: So if you need to buy or sell yourself, if
Speaker 1: everyone's index, no one's moving around, right, so you need liquidity.
Speaker 1: So those are two really vital things. And the index
Speaker 1: and community, I think, by their own admission uh takes
Speaker 1: advantage of that positive externality that comes as a consequence
Speaker 1: of active manager So so they can't go away altogether.
Speaker 1: And I think the operative sort of concept here is
Speaker 1: this efficiently inefficient and and and many factors, not only sophistication,
Speaker 1: but many other factors have contributed to greater broader market efficiency.
Speaker 1: So we can't have a market that's entirely passive, and
Speaker 1: we're still a long way away from that, which raises
Speaker 1: the question, and this really gets to trying to distinguish
Speaker 1: between skill and luck and why poker is a good
Speaker 1: game Because it's a mix of a pure gambling game
Speaker 1: and also a skill game. It's really hard to tell
Speaker 1: who's good. You could have someone who has a mutual
Speaker 1: fund it beats the market for several years in a row,
Speaker 1: but then they blow up. Maybe they were just lucky.
Speaker 1: How do you approach this question? And you've written a
Speaker 1: lot about this, but it seems like it's the crucial
Speaker 1: question for identifying who's good at active management. How do
Speaker 1: you know? How do you start thinking about this question
Speaker 1: of identifying who's actually a good manager. So it's a
Speaker 1: great question, Joe, it's a tricky question. Let's take it
Speaker 1: into resteps. The first step would be something like this
Speaker 1: if if you and I can't really do that or
Speaker 1: not convinced that we should do that, we should be indexed, right,
Speaker 1: So let's just be clear that for most people that's
Speaker 1: the proper prescription, and I think most people who are
Speaker 1: thoughtful about markets would would be on the same page
Speaker 1: with that. Second thing is to think about asset classes.
Speaker 1: So we tenderally talked about mark equities, but of course
Speaker 1: there are lots of different markets, including fixed income markets,
Speaker 1: emerging markets, and so forth. And one of the areas
Speaker 1: where skill can be expressed more readily is when there's
Speaker 1: a large dispersion of results. Right, so the difference between
Speaker 1: the very best players and the average players and the
Speaker 1: poor players is wide versus narrow. And in fact, David
Speaker 1: Swinson at Yale has this nice passage in his book
Speaker 1: where he says, what we do at Yales we look
Speaker 1: for this dispersion of returns for the asset class. And
Speaker 1: if there's lots of dispersion, we Yale, we'll try to
Speaker 1: find the skillful person. We're going to pay them fairly
Speaker 1: handsome fees and we go at So so the second
Speaker 1: question would be that of asset class. And then the
Speaker 1: third now would be can we be more sophisticated in
Speaker 1: assessing uh the skill of the managers? And you know,
Speaker 1: there's a very nice paper by Rust Warmers and it's
Speaker 1: Warmers and Jones about some techniques to do this, and
Speaker 1: some things you might want to think about would be uh,
Speaker 1: looking at past performance but adjusting it very carefully for
Speaker 1: exposure to factors and things like skewness. It will be
Speaker 1: looking at the characteristic characteristics of the manager him or herself,
Speaker 1: so their age, their education. Uh, A factor would be
Speaker 1: the size of the fund, this fund strategy, so there
Speaker 1: there there are some ways that you can sort of
Speaker 1: shade the odds in your face once it is also
Speaker 1: a fan of skin in the game right. Measure whether
Speaker 1: a fund manager the degree to which they're putting their
Speaker 1: own money at risk and the skin of the game
Speaker 1: things an interesting one because uh and I agree with that,
Speaker 1: but I also think you can't take it too far.
Speaker 1: So skin of the game is important in the sense
Speaker 1: that people care about it and it dampens down principal
Speaker 1: agent concerns. But by the same token, if someone has
Speaker 1: their net worth and a fund and let's say it's
Speaker 1: two thousand and eight thousand nine, it's going down a lot.
Speaker 1: They start to worry about their own livelihood versus the
Speaker 1: long term interests of their fund. So so I think
Speaker 1: they have to have enough in there so they they
Speaker 1: deal with this principalazon issue, but not so much that
Speaker 1: at some point their objectivity or their responsibilities get distored
Speaker 1: it based on their own worries about paying for the groceries.
Speaker 1: So that's that's the whole skill luck and I would
Speaker 1: just say that, you know, having written a book about
Speaker 1: skill and luck. It's interesting that last thing I'll say
Speaker 1: is that that investing appears to be an activity that's
Speaker 1: luck laden. And I think there's a sort of counterintuitive
Speaker 1: reason that's the case, and we call it the paradox
Speaker 1: of skill, and the paradox of skill says and activities
Speaker 1: were both skill and luck contribute to outcomes, and that's
Speaker 1: certainly true for investing. It can be the case that
Speaker 1: as skill increases, luck becomes more important, which seems not sensical, right.
Speaker 1: But the key here is to think about skill on
Speaker 1: with across two dimensions. The first is absolute skill, and
Speaker 1: I think if you look around the world, look at
Speaker 1: the world of investing, or sports or business, I think
Speaker 1: we can say fairly unqualified that that absolute skills never
Speaker 1: been better. The second dimension of skill, that is the
Speaker 1: important one, and that's relative skill. The difference between the
Speaker 1: very best players and the average players, and that we've
Speaker 1: also seen in almost every domain has shrunk. So we
Speaker 1: see that for example in batting averages for baseball players.
Speaker 1: If you look at you know, running races, you see
Speaker 1: the difference between the gold medal winner and the bronze
Speaker 1: medal winner is much less today than it was a
Speaker 1: generation or two before and in markets that's basically expresses
Speaker 1: mostly efficient markets. So it's a consequence markets appear to
Speaker 1: be mostly luck, but it's actually not because of a
Speaker 1: lack of skill. It's actually because of a surfeit of skill, right,
Speaker 1: too much skill canceling out right, Even in professional athletics,
Speaker 1: we can see this that there's more and more parity
Speaker 1: in many professional sports. And again, the athletes themselves are
Speaker 1: absolutely amazing, and you put them back in the sixties
Speaker 1: and they would clean up. But they're so equal now
Speaker 1: and their skills because of selection of players and training
Speaker 1: and and and so forth, that it appears to be
Speaker 1: more random. So it's this interesting thing in our world.
Speaker 1: Our world is grinding towards greater skill, and yet luck
Speaker 1: is becoming more important in many of our outcomes. Well, Michael,
Speaker 1: on that note, I mean you're talking about relative skills
Speaker 1: becoming ever more sort of compressed, or the gap between
Speaker 1: different UM managers I guess in this case becoming ever
Speaker 1: more compressed. You also mentioned dispersion UM. One of the
Speaker 1: big themes that we've had in financial markets, at least
Speaker 1: since the Financial crisis, has been the idea of asset
Speaker 1: classes moving altogether correlation increasing and it basically making life
Speaker 1: a nightmare for active managers. So how much does that
Speaker 1: play into UM the current debate about active versus passive? No, Tracy,
Speaker 1: I think that's a huge issue right now. I do
Speaker 1: think that UM and I think that's one of the
Speaker 1: one of the effects of indexing and e t f
Speaker 1: s is that, as I mentioned before my little restaurant example,
Speaker 1: things do tend to get more correlated and you need
Speaker 1: you need dispersion to express skill. Right, that's really the
Speaker 1: key idea UM the other thing. So so you're I
Speaker 1: think that's exactly right, and you want to look for that,
Speaker 1: and it's it is the dispersions different by asset classes
Speaker 1: and even within industries and sectors. So you have to
Speaker 1: keep a track on that step. But that but that's uh, no,
Speaker 1: I think that's exactly right. Nothing I'll mentioned to you.
Speaker 1: That's that's interesting. It's also uh one of our One
Speaker 1: of my favorite pictures in the report is we show
Speaker 1: a picture of the standard deviation of excess returns of
Speaker 1: mutual funds. Right, so here's what I want you just
Speaker 1: envision that we plot the excess returns for all mutual
Speaker 1: funds in a particular year. It looks like a you know,
Speaker 1: roughly not exactly a bell shape, but pretend it's a
Speaker 1: bell shaped distribution, and uh, we look at how fat
Speaker 1: the bell shape is. Right, So if you're a skillful manager,
Speaker 1: it's like my poker analogy, you want a fat bell, right,
Speaker 1: so you have lots of positive excess returns and lots
Speaker 1: of negative access returns, and if you're a smart player,
Speaker 1: you can see where your profits are coming from. Well,
Speaker 1: what we see if we have and we have these
Speaker 1: data back in nineteen sixties, is that that fat bell
Speaker 1: shaped curve has gotten skinnier and skinnier and skinnier over
Speaker 1: the decades. There was actually a very brief reversal in
Speaker 1: the late nineties early two thousands around the dot com phenomenon,
Speaker 1: which is really interesting because that core coincides with mom
Speaker 1: and pop coming rushing back into the market. So essentially
Speaker 1: they are the ones that were the weak players at
Speaker 1: the table. But as soon as they got showed back
Speaker 1: out after the early two thousand's, we went right back
Speaker 1: to trend. So today as it stands, uh, there's very
Speaker 1: historically speaking, very little positive access return but there's also
Speaker 1: very little negative excess return. So that's another way. It's
Speaker 1: another speaks the same issue of correlations. Just very difficult
Speaker 1: to distinguish yourself. Now, there are ways Joe's questions spoke
Speaker 1: to before, there are ways to do this shade the
Speaker 1: odds in your favor of finding skillful managers. But it's
Speaker 1: just important to bear all these things in mind. It's
Speaker 1: just like other things in life, just very competitive. It's
Speaker 1: interesting the idea that for a brief time the dispersion
Speaker 1: and really widened this sort of you know, after the fact,
Speaker 1: pretty clear evidence that that was a mania or a bubble.
Speaker 1: Can do you ever, can that be used sort of
Speaker 1: as a market timing technique or is it just not
Speaker 1: strong enough of a signal? And really, Joe, it's a
Speaker 1: super interesting question. And we have another picture that's related
Speaker 1: to that, which we're you know, we show on one
Speaker 1: access Mom and Pops participations individual direct participation or markets.
Speaker 1: At the beginning of the series, it's about fift about fifty,
Speaker 1: and it's now about so it's drifted lower. So some
Speaker 1: mom and propagetting the memo basically right that they shouldn't
Speaker 1: be doing it directly. But but even though there's that
Speaker 1: long term trend is down again. That was that lift
Speaker 1: in the late nine so so there was a temptation
Speaker 1: to come into markets and that was really good for
Speaker 1: active managers they could take advantage of that. Okay, so uh.
Speaker 1: The two other questions would be something like this, one
Speaker 1: is UM, are there other signatures of what individuals are doing?
Speaker 1: And to me, the best lead on that. So if
Speaker 1: you said which would be funds flows? Because it's almost
Speaker 1: always the case, it's true to a lesser degree for institutions,
Speaker 1: but for sure for individuals. They tend to want to
Speaker 1: do today what they should have done two years ago. Right,
Speaker 1: so they tend to inflate certain you know, not as
Speaker 1: dramatic as the dot coms, but you get a little
Speaker 1: bit of excesses. So that the funds flow thing, I
Speaker 1: think it's probably the place I would be looking at
Speaker 1: to see if they're signatures of UM individual performance. The
Speaker 1: one area, by the way, where it's interesting to take
Speaker 1: a look at is UM so called smart beta UH strategies. Right,
Speaker 1: so these are factors that academics typically have unearthed to
Speaker 1: show so called excess returns. And there's a there's a
Speaker 1: very interesting discussion that everyone should think about. One is
Speaker 1: you know. Are these truly just factors? For example, small
Speaker 1: caps do better in large caps, or cheap stocks do
Speaker 1: better than expensive stocks. Are these just measures of risk,
Speaker 1: which case they're not that interesting because you're is getting
Speaker 1: compensated for risk you're assuming. Are they behavioral because they
Speaker 1: arise because people are sub optimal in their behaviors. And
Speaker 1: the third thing, which is really interesting is do they
Speaker 1: work at least in the short run because people believe
Speaker 1: they were right? And if I come to you side,
Speaker 1: Joe Tracy, low ball is awesome and you got, oh great,
Speaker 1: you buy low Ball, what what's your initial reaction? The
Speaker 1: answer is it does well because you bought it and
Speaker 1: a lot of other people did as well. So it's
Speaker 1: neither of those. It's not behavioral or risk. It's just
Speaker 1: this sort of funds flow. So so there's some very
Speaker 1: interesting cross currents and thinking about where people are putting
Speaker 1: their money that to me would be maybe the next
Speaker 1: derivative signature of sort of that question. So, Michael, in
Speaker 1: the battle between active versus passive and indexing, where do
Speaker 1: you see us actually going from here? Because the the
Speaker 1: standard accepted argument seems to be that eventually will have
Speaker 1: so much money wrapped into passive, that that'll just make
Speaker 1: life so easy for the active managers that their returns
Speaker 1: are going to be absolutely color and everyone is going
Speaker 1: to shift back to active managers. But your argument is
Speaker 1: actually much more subtle than that, Tracy. And there is
Speaker 1: a very important paper, it's well known, written by Bill Sharp,
Speaker 1: obviously won the Nobel Prize um called the Arithmetic of
Speaker 1: Active Management. And this is something that needs to be
Speaker 1: people have to bear in mind. And the arithmetic arithmetic
Speaker 1: of active management basically says that the returns for active
Speaker 1: and passive in the aggregate will be equal to one another. Right,
Speaker 1: pre feast. Now just think about this for a second.
Speaker 1: Let's just pretend for simplicity that the market is the
Speaker 1: SMP five, just making this easy, and then let's say
Speaker 1: our population is indexed against it. So they're going to
Speaker 1: earn the market return. That's easy to see. But the
Speaker 1: question is how well the active managers these other and
Speaker 1: the answers they have to earn the market return as well, right,
Speaker 1: because the pieces have to equal the whole. So again
Speaker 1: we goes back to our core argument that for one
Speaker 1: active manager to win, someone else has to lose, and
Speaker 1: that sort of becomes the operative question is where is
Speaker 1: the other side of the trade right? And that's why
Speaker 1: we call the piece looking for easy games? Where are
Speaker 1: the easy games if you're the smart player. So rather
Speaker 1: than saying, hey, here's the ratio some percentage number, I
Speaker 1: think the way active managers, or think people thinking about
Speaker 1: putting money into active management should think about it is
Speaker 1: where are their opportunities for me to be the smart
Speaker 1: player at the table? And you know I've already mentioned
Speaker 1: a couple examples of cases where that might be a
Speaker 1: good one is if you can you compete against individuals.
Speaker 1: So there's a ton of data around the world showing
Speaker 1: that when institutions compete against in individuals, they tend to
Speaker 1: do well. A second example would be are there are
Speaker 1: there people to buy or sell for non fundamental reasons
Speaker 1: and sort of the classic example that is the spinoff literature.
Speaker 1: This has been around for a really long time. Turns
Speaker 1: out for a lot of spinoffs, they're obviously the spinoff
Speaker 1: themselves tend to be smaller, often more levered. If you're
Speaker 1: big some gargangel and mutual fund company, your mandate is
Speaker 1: not to own these little things. You just sell it
Speaker 1: without regard to value you, and as a consequence, those
Speaker 1: things often present opportunities as well. UM. And then the
Speaker 1: third thing I would say is really interesting is this
Speaker 1: notion of wealth transfer. So I'm I'm presenting the market
Speaker 1: as if it's a closed system investor versus investor. But
Speaker 1: there's another set of entities that interact, the big one
Speaker 1: being corporations which buy back stock and issue stock and
Speaker 1: do mergers and acquisitions. And then governments actually are another participants.
Speaker 1: So you have to start to think about their motivations,
Speaker 1: their capabilities, and are the ways to take advantage of
Speaker 1: them or work with them in a way that's constructive.
Speaker 1: On the bill sharp piece, just to finish up, so
Speaker 1: active passive are equal, right, but the second pieces the more. UH.
Speaker 1: It's also worth taking consideration, which is active managers will
Speaker 1: do less for every dollar invested than passive because they
Speaker 1: charge higher fees, and so active management for for fees
Speaker 1: or about a d basis points, passive averages about twenty
Speaker 1: basis points, so that's a sixty basis point differential. And UH,
Speaker 1: as a consequent, active management in the aggregate will always
Speaker 1: underperform the index, and we're underform pass just because the
Speaker 1: math of that right, So that's the people they're there.
Speaker 1: That has always been true and it will always be
Speaker 1: true because it's basically the math of it. So I
Speaker 1: want to sort of take you know, take this out
Speaker 1: of investing, and you you make the point that it's
Speaker 1: very hard for the random person to be able to
Speaker 1: identify who's actually a skilled manager and who's just lucky.
Speaker 1: But what about sort of the inward looking question and
Speaker 1: not just in investing. Some people have different degrees of
Speaker 1: success in all realms, but we only arguably play the
Speaker 1: game of life one time. We only have one instance.
Speaker 1: So how do we know whether one's own uh success
Speaker 1: in anything? How do we identify whether we're skilled in
Speaker 1: something or not, whether we're lucky? How do you sort
Speaker 1: of even identify those traits within oneself? Super super interesting question, Joe.
Speaker 1: So a couple of things I'll say on that. One is, uh.
Speaker 1: One of the things I like to think about is
Speaker 1: what we call the luck skill continuum. And you might
Speaker 1: imagine a continume, and at one extreme would be activities
Speaker 1: that are all luck, no skill, So lotteries and roulette wheels.
Speaker 1: So if you win the lottery, you probably don't walk
Speaker 1: around saying like I'm the best lottery player you know
Speaker 1: on the earth. And the other extreme is all skill,
Speaker 1: no luck, and there aren't that many domains purely over there.
Speaker 1: But you know, running races or chests, if you and
Speaker 1: I played chess, you know, the better players going to
Speaker 1: win more time to not. And then almost everything else
Speaker 1: in life is is a raid between those two extremes.
Speaker 1: So if you can place that activity, whether it's a
Speaker 1: sports or business, on the continuum, you're gonna have a
Speaker 1: sense of the relative contributions. So that's the first point.
Speaker 1: And you know, for example, we can place professional sports
Speaker 1: leagues and I'll just give you some sense that you know,
Speaker 1: the NBA is the sport that's farthest away from randomness,
Speaker 1: so most skill to determine the winners and losers, and
Speaker 1: things like Major League Baseball much closer to a particular game,
Speaker 1: much closer to random that's the first thing. The second
Speaker 1: thing to say is that whenever you look at great performance,
Speaker 1: we'll call them positive outliers. Right, it's almost always great
Speaker 1: skill plus great luck, and if you think about it
Speaker 1: for a minute, it sort of has to be true. Right,
Speaker 1: So it's a right side district draw from the skill distribution,
Speaker 1: and a right hand side draw from a luck distribution,
Speaker 1: and that's really easy to show for things like sports,
Speaker 1: like streaks and sports. A guy like DiMaggio hits in
Speaker 1: fifty six straight games in one he's a career hitter.
Speaker 1: He's a fantastic hitter. But he also benefited from a
Speaker 1: lot of a huge count. He never did it again.
Speaker 1: It was time. Well, he actually had a bunch of
Speaker 1: little streaks, but he but but yeah, exactly, so he
Speaker 1: was lots of skill plus lots of luck together. So
Speaker 1: it's very important to recognize whenever you see, whether it's
Speaker 1: corporate performance or an individualist done particularly well. And it's
Speaker 1: interesting you mentioned sort of this introspection. If you're a
Speaker 1: successful person, I mean, undoubtedly you've worked hard and so forth,
Speaker 1: but people have to acknowledge, I mean we we all
Speaker 1: can sit around, you have to acknowledge that luck has
Speaker 1: almost always been a major source of um a contributor
Speaker 1: to your success. And you have to think about that way.
Speaker 1: And the other thing is, we don't people have failed
Speaker 1: people got bad luck. We don't. They're just not in
Speaker 1: our record books, right, we don't know any about them.
Speaker 1: So it's really it's an important way to think about
Speaker 1: life because and it's also if you've benefited from good luck,
Speaker 1: you should be grateful for it. But you have to
Speaker 1: you know, I understand that luck plays a role in
Speaker 1: almost all of our lives. Very good lesson, Michael Mobison.
Speaker 1: Really appreciate you coming on fascinating topic, highly relevant to
Speaker 1: markets these days and everything else. Great conversation. Thank you,
Speaker 1: my pleasure. Thanks guys, so Joe Um, I mean that
Speaker 1: was a fascinating conversation. I do think that the role
Speaker 1: of luck doesn't get as much attention as it should
Speaker 1: when it comes to investing, but also when it comes
Speaker 1: to success in life and wealth creation. And you know,
Speaker 1: you think of all the sort of circumstances that can
Speaker 1: contri tribute to someone, um either being successful in their
Speaker 1: career or getting very wealthy. So much of it can
Speaker 1: be determined by happenstance, right Yeah, And it's so loathsome
Speaker 1: and tiresome when you read these articles someone wildly successful
Speaker 1: and here are my fifteen tips to how I did it,
Speaker 1: or these people have in coming. But here's the real
Speaker 1: question is the next time you come visit New York,
Speaker 1: you take a trip to Atlantic City with me, and
Speaker 1: can we go play poker. Do I feel lucky or
Speaker 1: do I feel skilled? Well? No, but no seriousness. Don't
Speaker 1: you this probably isn't going to be the last time
Speaker 1: we have some odd episode that was sort of gambling
Speaker 1: or poker related. Don't you think it's kind of high
Speaker 1: time you actually sort of you know, see what it's
Speaker 1: like firsthand, so it's not just theoretical, you know. I
Speaker 1: think we should do a podcast out of it. You
Speaker 1: should bring recording device, go to Atlantic City and see
Speaker 1: what happens. No, I don't think Casino's loved people take
Speaker 1: recording devices to the team. It might not be ideal,
Speaker 1: but let's definitely do it. All right, Well, that's it
Speaker 1: for this edition of the Ad Thoughts Podcast. I'm Tracy Alloway.
Speaker 1: You can find me on Twitter at Tracy Alloway, and
Speaker 1: I'm Joe Wisntal. You can follow me on Twitter at
Speaker 1: the Stalwart and you can find Michael on Twitter at
Speaker 1: m J Mobison. Thanks for listening.