I think the investment floor argument here is actually understated.
Successful investors rapidly find themselves in a world where the vast majority of stocks are too small to buy. Try putting on a multi-million dollar position on for a stock that trades $10k/day on average.
Even index funds struggle with this. There are “small cap[italization]” index funds that have a median firm size of well over $1.6 Billion dollars larger than the vast majority of stocks.
This is reflected also in research showing that fund managers do not exploit the small cap outperformance anomaly nor the fact that other anomalies (like value) are far more powerful in small cap stocks.
You see this reflected also in the reversion to the mean of fund performance as they get larger.
One issue is that fund managers, who control most of the investment funds, live and die by short term performance and cannot implement any strategy that underperforms the relevant index by 6 months or so. This is why fund managers typically do their mean variance optimization on tracking error, not on total returns.
They are in effect only as smart and well informed as their investors. See the 2018 paper “What Do Mutual Fund Investors Really Care About?” for some information on this.
The other main issue is that mispricings can get far worse before they are resolved. This makes it very hard to bet against them. Several people who bet against the toxic waste (subprime) mortgage trusts before 2008 lost a lot of money and were forced out of the trade. See the paper “Toil and Trouble, Don’t Get Burned Shorting Bubbles” by Aaron Brown et al
> After analyzing the data and speaking with traders who actively researched subprime mortgages we highlight latent risks that were associated with shorting subprime mortgages. These latent risks help explain why many smart, informed traders decided not to short subprime mortgages …
Having said that it is actually very hard to beat indexing. People should assume this is a serious and difficult endevour requiring lots of hard work on learning the field and on their own psychology.
I think the investment floor argument here is actually understated.
Successful investors rapidly find themselves in a world where the vast majority of stocks are too small to buy. Try putting on a multi-million dollar position on for a stock that trades $10k/day on average.
Even index funds struggle with this. There are “small cap[italization]” index funds that have a median firm size of well over $1.6 Billion dollars larger than the vast majority of stocks.
This is reflected also in research showing that fund managers do not exploit the small cap outperformance anomaly nor the fact that other anomalies (like value) are far more powerful in small cap stocks.
You see this reflected also in the reversion to the mean of fund performance as they get larger.
Other disadvantages of the smart money are documented in the paper “the limits of arbitrage” https://onlinelibrary.wiley.com/doi/full/10.1111/j.1540-6261.1997.tb03807.x
One issue is that fund managers, who control most of the investment funds, live and die by short term performance and cannot implement any strategy that underperforms the relevant index by 6 months or so. This is why fund managers typically do their mean variance optimization on tracking error, not on total returns.
They are in effect only as smart and well informed as their investors. See the 2018 paper “What Do Mutual Fund Investors Really Care About?” for some information on this.
The other main issue is that mispricings can get far worse before they are resolved. This makes it very hard to bet against them. Several people who bet against the toxic waste (subprime) mortgage trusts before 2008 lost a lot of money and were forced out of the trade. See the paper “Toil and Trouble, Don’t Get Burned Shorting Bubbles” by Aaron Brown et al
> After analyzing the data and speaking with traders who actively researched
subprime mortgages we highlight latent risks that were associated with shorting subprime
mortgages. These latent risks help explain why many smart, informed traders decided not
to short subprime mortgages …
https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3782759
Having said that it is actually very hard to beat indexing. People should assume this is a serious and difficult endevour requiring lots of hard work on learning the field and on their own psychology.