"Subprime Risks: Overblown" was an article written by John W. Rogers, Jr. on September 17, 2007.
Rogers is the founder of Ariel Capital Management. It has $4.8 billion under management and serves a broad range of corporate and individual clients. It manages the Ariel Fund, the Ariel Appreciation Fund and the Ariel Focus Fund.
Rogers is a regular contributor to Forbes and other publications.
In his Forbes article, Rogers explained that he was a "professional investor for 25 years and the owner of an investment firm." He noted that "[D]uring tough times like these I stay focused on the areas I know best, which keeps me calm and confident in my decisions."
He certainly was confident.
He counseled against over diversification which he noted was a "bad idea." Instead, he advised investors to focus on their "circle of competence", which in his case was financial stocks. These stocks were the "biggest weightings" in his portfolios.
He recommended three stocks, all of which were well within his "circle of competence":
- City National (CYN). Shares were trading at 74 which he noted was "a 29% discount to my $104 estimate of 'private market value.'" City closed at $38.65 on November 27, 2009.
- Assured Guaranty (AGO), which was selling at $26. Assured closed at $22.30 on November 27, 2009; and
- HCC Insurance Holdings (HCC), which was selling at $28. Rogers noted that HCC was selling at a 32% discount to his $41 estimate of "private market value." HCC closed at $26.11 on November 27, 2009.
It has also been rough sledding for the Ariel Funds, although they recovered significantly in 2009.
- The Ariel Fund (ARGFX) lost 48.25% in 2008. It is up 44.44% year-to-date. Its five year average return is a loss of 3.09%.
- The Ariel Focus Fund (ARFFX) lost 35.09% in 2008. It is up 22.21% year-to-date. Its three year trailing return is a loss of 7.10%. The fund was started in June, 2005.
- The Ariel Appreciation Fund (CAAPX) lost 40.74% in 2008. It is up 42.06% year-to-date. Its five year average return is 0.65%.
Imagine my surprise when I read Rogers' most recent article in Forbes, entitled "Separating Luck from Skill". Rogers had read Think Twice: Harnessing the Power of Counterintuition, by Michael Mauboussin. Mauboussin suggested a simple test to determine if an activity involves luck or skill: Determine if you can lose on purpose. If you can (like Roger Federer can lose a tennis match to anyone he chooses), the activity involves skill. If you can't (like playing a slot machine), it involves luck.
Rogers tested "stock picking skill" by asking 71 of his associates to lose on purpose. Each would pick ten stocks that would under perform the market in the second quarter. Only 19 of them succeeded. 73% tried to lose, but failed. Clearly, luck was the big winner in the short term.
Rogers' conclusions from this experiment are interesting. He states that in investing, "luck matters in the short term, but skill matters in the long term." He then proceeds to recommend three stocks based upon his projection of their short term earnings.
If stocks are efficiently priced over the short term, why is that not the case over longer periods of time?
It is. Every study indicates that over the long term, only a small percentage of actively managed funds will equal or beat their benchmarked index.
Active managers like Rogers and others continue to make short term predictions about stocks, frequently including their projections of "private market value." When they are proven wrong, they tell investors to take a long term view.
Investors who do will reject active management and adopt the views of Nobel Prize Winner William Sharpe, who stated: "After costs, the return on the average actively managed dollar will be less than the return on the average passively managed dollar. These assertions will hold for any time period. Moreover, they depend only on the laws of addition, subtraction, multiplication and division. Nothing else is required."
This conclusion is validated by the performance of Vanguard's Total Stock Market Index Fund (VITSX). This low cost index fund tracks the index of all U.S. common stocks traded on the NYSE and NASDAQ. As such, Rogers would no doubt consider it "over diversified." Its five year average return is 1.00%, which is significantly higher than all three Ariel funds.
Market returns are superior returns. They can be hard to find in Mr. Rogers' neighborhood.Dan Solin is the author of The Smartest Retirement Book You'll Ever Read.
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