The $100,000 Buy-and-Hold Challenge
FORECASTS & TRENDS E-LETTER
IN THIS ISSUE:
1. Introducing Roger Schreiner
2. Schreiner’s $100,000 Challenge to John Bogle
3. The Inevitable Rebuttals
4. Conclusions – Unlearning Buy-and-Hold
If you have read my weekly E-Letters for long, you know that I am not a big fan of Wall Street’s traditional “buy-and-hold” investment philosophy, certainly not for all of your investment portfolio. However, many investors, including some regular readers of this E-Letter, are not fully convinced that active management works.
Long ago, I decided against passive buy-and-hold portfolios because I did not want my portfolio enduring bear market losses of 40-50-60% or more. That is why I sought out “active management” investment strategies (also referred to as “market timing” strategies) that have the flexibility to get out of the market from time to time in an attempt to avoid huge losses. Of course, this stance put me at odds with a majority of the financial services industry who see buy-and-hold investment strategies as a means to virtually lock up investor money in their mutual funds and brokerage accounts.
Fortunately, I’m not alone in my resistance to Wall Street’s conventional wisdom. This week, I bring you the story of how a respected active manager, whose investment programs I recommend, challenged one of the stalwarts of the buy-and-hold mutual fund industry to a $100,000 head-to-head competition. If you are a mutual fund investor, and especially if you have bought into the buy-and-hold mantra, you need to read what follows.
This week, I am going to introduce you to Roger Schreiner and allow him to share his thoughts directly with you by reprinting excerpts from his original challenge to those who promote buy-and-hold strategies. In this discussion, he outlines the definitive case for active money management and reveals the inherent weakness in passive buy-and-hold investing.
However, I’m not going to leave it there. By issuing this challenge, Roger has become a lightning rod for criticism from some in the buy-and-hold community, even though they won’t take his bet. Therefore, I’ll also fill you in on some of his critics’ comments and why they are, or are not, relevant to the active management discussion. This is about as close to a “reality show” that financial journalism can get, so it promises to be very interesting reading.
An Active Management Maverick
Roger Schreiner has been a staunch proponent of active money management strategies for most of his 30-year career in the financial services industry. His firm, Schreiner Capital Management, has been instrumental in spreading the word about active management and Roger himself has spent a lot of his own time and money to promote investment strategies that are designed to manage risks.
As one of the earliest proponents of active management strategies, he and his firm have been involved in virtually every aspect of active money management, from developing trading strategies to seeking out third-party managers and even blending multiple strategies into a single investment.
Roger was also instrumental in the development of one of the most comprehensive databases of active money managers in existence, which later became Theta Investment Research. Theta is one of the primary databases we use to identify and monitor active money managers for our AdvisorLink® Program.
To say that Roger believes in the superiority of active money management strategies is an understatement. Last year, Roger issued a $100,000 challenge directly to Vanguard founder, John Bogle, in an effort to prove the merits of active management. The Vanguard Group is one of the oldest and largest mutual fund families in the world. Mr. Bogle has long been an outspoken advocate of passive, buy-and-hold investing, and a similarly outspoken critic of active management strategies that move out of the market from time to time – the very strategies that I have recommended for years.
Schreiner’s challenge to Vanguard was to pit Bogle’s passive buy-and-hold strategy against Roger’s active management strategy, with $100,000 going to the winner’s charity of choice. So far, Bogle has not responded to the challenge, so Roger has expanded it to any passive manager. Again, no takers so far.
Why Challenge Bogle?
Early last year, as we were enduring the second major bear market within a decade, we were all reminded that buy-and-hold investment strategies simply don’t work in down markets. You may recall that I wrote articles in previous E-Letters discussing how average buy-and-hold investors had experienced virtually no growth in their portfolios, and many had smaller portfolios than they did ten years ago.
However, rather than seek out more effective risk management techniques, the big financial firms and mutual fund companies counseled investors to stay the buy-and-hold course. In light of the mutual fund industry’s lack of concern for risk management, Roger decided to take action.
On September 11, 2009, Roger issued his challenge to one of the best known buy-and-hold advocates in the US, John Bogle. Originally, Roger issued the “$100,000 Challenge” directly to Bogle, but later in 2009 opened it up to any passive buy-and-hold strategy advocate that would agree to the contest.
So far, no one has been willing to take on active management in a controlled setting. It seems somewhat hypocritical that buy-and-hold advocates will claim that “no one can time the market,” yet none will take on a challenge to prove the supposed superiority of passive investing. With that background, let’s move on to Roger’s challenge to the buy-and-hold investment world.
An Open Challenge to Passive Investors
QUOTE: His disciples call themselves ‘Bogleheads’ and cling to his ‘Pillars of Wisdom’ as though they were the Ten Commandments. The media adore him and treat his words like gospel. John Bogle is an icon – a God-like figure to thousands of investors.
He is also the founder of the Vanguard Group, and he launched the first index mutual fund in 1975. Since then, he has dedicated his career to encouraging investors to “own the market” by investing in index funds. He stresses the importance of asset allocation and low fees within a passive, buy-and-hold investment approach. No doubt Bogle is sincere and has noble ambitions, but his unwavering faith in the markets is misplaced.
Today, he has taken up what many are calling his final crusade. In February of last year, he appeared before a Congressional committee in Washington, D.C., to tell lawmakers about his vision for ‘an independent Federal Retirement Board to oversee both the employer-sponsors and the plan providers, assuring that the interests of plan participants are the first priority.’
On June 19, 2009 IndexUniverse.com asked Bogle, ‘Do you believe that there are environments that are more favorable to active management than passive management and index investing?’ His response was clear. ‘There is no way that active managers can possibly have an advantage no matter what the circumstances are. It is just statistically, mathematically, tautologically impossible.’
My $100,000 challenge
I hereby challenge John Bogle to a friendly wager. I will bet $100,000 of my own money that my active investment approach can outperform his passive one. I am challenging Bogle directly because he has the loudest voice in the industry, but my challenge is also open to other passive investors and managers. I have set aside $1,000,000, and I am ready to accept up to ten challengers, hopefully including Bogle.
The Wager: Anyone accepting this wager, including Mr. Bogle, and I will place $100,000 in an escrow account at the bank of his or her choice. At the end of the wager, the winner gets his $100,000 back and the loser will contribute his $100,000 to the winner’s favorite charity in his name.
The Portfolio: Should you accept my challenge, you will be free to construct a portfolio of your choice using the index funds that provide good liquidity. I will create an exact replica of your holdings for my portfolio. During the contest, you must passively hold the assets in your portfolio. In my portfolio, I will limit myself to trading the same assets. As an active manager, I will be able to use cash in my portfolio to help control risk. Of course, you can allocate some of your assets to cash too. If you wish, we can set up a web site to allow the public to follow the portfolios and the results. There will be complete transparency.
The Time Period: You can choose the length of the contest – anywhere from one year to a few years, or as many years as you wish.
Fees and Expenses: Your portfolio will incur no (0%) annual management fees. My portfolio will have the disadvantage of incurring a 2% annual management fee in addition to any transaction costs. We will use a tax-deferred, retirement account structure, so there will be no tax implications for short-term capital gains.
The Results: Risk and return are the most basic and logical measures of investment success. In order to win the contest, a portfolio must have both higher return and lower risk. To calculate risk and return, we will use the statistical measures of total return and daily standard deviation.
There you have it. Since Bogle believes ‘there is no way that active managers can possibly have an advantage, no matter what the circumstances,’ my $100,000 must seem like free money to him. I’m waiting for his call.
I’m not holding my breath though, because I am sure he will find a reason to back down. Of course, if he does, he will help prove my point – that my active investment process is superior to his high-risk ‘buy-and-hope’ approach. Any passive investor who believes he or she can generate a safer and higher return with a buy-and-hold portfolio than I can with my active portfolio has an opportunity to relieve me of $100,000. I’m giving the passive investor all the choices, except the one they saddle themselves with – the burden of not managing their money.
Talk is Cheap
I’ve been writing about the flaws of passive investing for over twenty years, but to what end? Articles, debates and media interviews cannot settle the longstanding dispute between active and passive investors. Talk is cheap.
No mere consumer advocate, Bogle is also a lobbyist promoting the products of the company he founded. Unfortunately for investors, he has the ear of lawmakers in Congress, most of whom do not truly understand investing.
Bogle’s philosophy is dangerous to investors’ retirement savings, as the results of the last decade have shown. It is based on old, flawed investment models like Modern Portfolio Theory, the Efficient Market Hypothesis (EMH), and the Random Walk Theory. A proper reading of today’s financial research suggests that these theories are unfounded. To some in our industry, that’s blasphemy, but it’s what I believe to be the truth.
Passive investing is ill-equipped to handle the unpredictable events and market volatility we have experienced over the last ten years. It ignores reality.
Professor Robert Shiller of YaleUniversity has shown that the instability of asset prices is much greater than EMH predicts. In other words, where the EMH suggests that passive exposure to investment markets can help control risk, real life experience (the best kind there is) shows that markets are actually the source of risk! Even Eugene Fama, the father of EMH, recently admitted that ‘markets are not entirely efficient.’ In a recent interview he told David Salisbury that ‘market efficiency is a simplification of the world, which does a good job on almost everything, but some things it doesn’t do a good job with.’
The problem with building an investment strategy around the Efficient Market Hypothesis (and the other theories EMH supports) is that it only takes one event – one market crash – to wipe out your retirement savings. But every investor’s time horizon is limited – no one has forever to wait for markets to recover.
Baffle a Boglehead: Use facts and logic
Bogleheads won’t admit it, but indexing is high-risk and has delivered low returns historically. According to CrestmontResearch.com, from 1900 through 2008, the stock market has returned just 5.8% on an annualized basis (including dividends and adjusted for inflation). To capture that 5.8% return, investors had to suffer devastating losses along the way, including an 89% loss (1929-32), a 48% loss (1973-74), another 49% loss (2000-02) and, most recently, a 57% loss (2007- 09).
It took investors 25 years and an almost 900% gain just to break even after the 1929-32 bear market. How many years is it going to take Bogleheads to recover from the 57% loss of 2007-09? How much time do they have?
Every quarter, in our Dynamic Investor newsletter, we publish ‘SCM’s [Schreiner Capital Management’s] 5 Rules for Investment Success.’ We think they are so important that we print them every quarter – we want investors to read them time and time again. Our Rules for Investment Success are very different from Bogle’s Pillars of Wisdom. The glaring difference is that our rules focus on risk management and acceptance of uncertainty about the future. Bogle’s Pillars of Wisdom hardly acknowledge that investing is risky.
His first pillar is: ‘Investing Is Not Nearly as Difficult as It Looks.’ Oooo-kay. I don’t know about you, but I don’t want anyone working from that premise anywhere near my retirement savings!
In contrast to Bogle’s first pillar, our first rule is ‘Avoid Significant Loss.’ The man known as the most successful investor of all time, Warren Buffett, agrees. He often reminds investors of his two primary rules: ‘Rule #1: Never lose money. Rule #2: Never forget rule #1.’
That first rule tells you all you need to know about the difference between Bogle’s approach and ours. Frankly, to suggest that investing is easy is ridiculous. In the words of Gerald Loeb, author of The Battle for Investment Survival, ‘Any way one looks at it, nothing is more difficult than succeeding in Wall Street, yet nothing is attempted by such poorly equipped people or is considered as easy.’
‘The greatest protection in all the world’
There are two reasons why I am not concerned about losing the challenge. First and foremost, active management is adaptable, and as a result it has a huge tactical advantage over passive indexing. Sophisticated investors understand this. The risk-management benefit inherent in our investment process gives us an edge that passive investing cannot match. ‘There is a great value in being able to realize the profit or cut short the loss,’ wrote Loeb. ‘There is the greatest protection in all the world in the ability to shift capital quickly and at small cost.’
Second, it is highly unlikely that Bogle or anyone else will accept my challenge. I hope he does, though, because we know some very worthy charities that could benefit from his donation. If passive management truly is superior, or has some kind of built-in advantage, I won’t have any trouble finding ten passive managers to accept my challenge.
Active investing does not ensure success, and it certainly does not guarantee investors will profit. No investment manager can make such a claim, no matter how long the investment time horizon and no matter who is running the portfolio.
In challenging Bogle, my objective is simple: to prove to everyone – especially individual investors who have been misled by the mainstream financial services industry – that active investing can be less risky than buy-and-hold. The proof will come when no passive manager accepts my challenge.
A safer way to reach your retirement goals
If you look objectively at the history of financial markets, it becomes clear that passive, buy-and-hold investing is a high-risk, low-return endeavor. Investors who are close to or in retirement don’t want high risk and unpredictable returns. They want low risk and more predictable returns. For retirees who own tax-deferred retirement accounts, such as IRAs, active management may offer lower risk and more consistent returns.
Investors must unlearn what people like Bogle have been telling them. The greatest threat to your retirement [is] the uncertain future – it’s the next credit crisis, the next financial crisis, the next recession. If you accept buy-and-hold, you must expect that, at some point, your retirement savings will experience a devastating loss. I always tell investors, ‘Your investment process must include an exit strategy; otherwise, you shouldn’t be invested in the stock market.’
While our past is certain, the future is unknowable. Passive management is reckless and irrational because it assumes the market will provide positive returns to all investors. There is no guarantee that your returns will be positive, no matter how long you invest. I advise you to find an investment manager who truly understands risk and has a plan for both good and bad markets. Find a financial advisor that is confident enough to take on today’s uncertain markets but humble enough to know what he does not know.
Roger Schreiner is the founder and CEO of Schreiner Capital Management, Inc.(SCM), an SEC-registered investment advisor located in Exton, Pennsylvania.SCM is a third party investment manager and sponsors the Select Advisors Wrap Program, an investment platform that provides active investment solutions for Advisors and their clients. END QUOTE
The Inevitable Rebuttals
You don’t take on one of the most popular mutual fund industry icons without raising a few hackles, and Roger has certainly drawn more than his fair share of arguments, rebuttals and outright derision for his views on active management. However, no one has yet accepted his challenge, which should tell you something about how strongly these buy-and-hold adherents really believe what they are preaching.
Even so, I think in the spirit of fairness that I ought to at least air some of the criticisms that have come Roger’s way, if for no other reason than to discredit them. Here are a few of the more common arguments.
Schreiner Stacked the Deck: In a long, drawn out article responding to Roger’s original challenge, David B. Loeper, CIMA, CIMC accused Schreiner of stacking the deck. In other words, he said that the challenge was a “shell game” that made it impossible for any passive management strategy to win. Hmmm… it seemed pretty clear cut to us, but let’s see why Mr. Loeper thinks it’s an unfair challenge.
Mr. Loeper notes that to win the challenge, Bogle has to have both a higher return and lower risk, as measured by standard deviation, which is accurate. However, he implies that Schreiner could win the challenge if he only beats Bogle in one of these two areas. Thus, he says that Schreiner could remain in cash and remove all risk and easily win the challenge.
But not so fast. Bogle’s inability to win both return and risk doesn’t mean Schreiner automatically wins the bet, since Roger’s active portfolio would also have lost one of the criteria for success. To win, Schreiner would have to have both higher return and lower risk, so if Bogle’s portfolio wins the return criteria and Schreiner’s wins the risk portion, it’s a tie, not a win for either side.
The reality is that those who hawk passive buy-and-hold strategies know there’s no way they could win the risk side of the bet since the stock market has been hit with some major free-falls in share prices (big bear markets) in the past, and will likely be hit again in the future. That’s why there may never be any passive investors that take up Roger’s challenge.
Where are the Active Management Billionaires? One of the least convincing arguments I have seen involving active management is one where this question is asked. The obvious implication is that if an active manager can tell where the market is going, then he or she would have used this information for their own benefit and become super rich.
Well, some of them have – a number of them are hedge fund managers. In my experience, I have seen a number of active money managers either develop their own hedge funds or be hired away by large hedge funds and cease offering managed accounts for the average investor. They prefer working with sophisticated, high-net-worth individuals who already understand the concepts and value of active management and absolute return strategies and have not been brainwashed by the financial media and mutual fund advertising to make decisions primarily based on low fees.
However, this answer really misses the point. Instead of asking where all the active management billionaires are, I think the better question is why are there so many passive investment billionaires when their clients are still under water after a decade of dismal returns? It doesn’t take a rocket scientist to see that encouraging investors to embrace passive investment strategies benefits those who make money from selling these investments more than the investors who buy them. Take a moment to think about that.
Market Timing is Statistically Impossible: Most mainstream discussions of active management and market timing will claim that “No one can consistently time the market.” They will then trot out studies of mutual funds claiming to actively manage assets, but fail to beat their benchmark indexes.
Actually, both Roger Schreiner and I agree on this concept, to a point. However, we would say that successfully timing the market over time is improbable, but not impossible. This is especially true for individual investors since most are lousy at picking when to move out of and back into the market. Even most professional traders fail at their attempts to anticipate market movements. However, the statement that “No one can consistently time the market” is simply not true. Roger and I both know Advisors who have done it.
Roger has investment programs that have consistently beaten the market with less risk. You can click on the following links to learn more about his Conservative and Moderate programs that we recommend, complete with actual track records, net of all fees and expenses. Plus, you have also read about the Niemann and Potomac managed account programs in this E-Letter, which have been producing consistent returns with less risk since 1996. Of course, past performance is not necessarily indicative of future results.
Granted, the list of successful active managers is relatively short, but they do exist. While past performance cannot predict future results, I am more comfortable with the bulk of my net worth being managed by professionals with active managed strategies than placing my faith in the “buy-and-hope” strategies associated with passive management.
Unfortunately, most investors don’t know where to turn to find the best active managers, or to evaluate them once found. I won’t go into a commercial here, but my firm specializes in doing the front-end evaluation, due diligence and continuous monitoring of money managers on behalf of our clients. We find the successful active money managers like Roger Schreiner so you won’t have to. And, of course, I have my own money with every manager we recommend.
Figures Don’t Lie But…: I have seen other critics of market timing claim that all of the numbers are simply made up. Unfortunately, this is sometimes true, but probably no more so than in the passive investment world. There are always charlatans who will publish bogus return numbers in an effort to separate investors from their hard-earned nest eggs. You just need to have the tools to identify the real numbers from the hypothetical ones. We have those tools.
Critics also point to the deceptive practices of some market timing newsletters and e-mail services. Many of these services don’t actually manage money, but simply publish their forecasts of what they think will happen. Some of these publishers only crow about their successes and keep their failures hidden, something they couldn’t do if they actually managed money, had an actual track record and were regulated as we are.
That’s why it’s important to only use money managers who actually manage client money AND have a significant portion of their own money managed in the same funds. Schreiner Capital Management has been managing client funds since 1989 and has the actual track records to prove it, so any attempt to tar Roger’s firm with this criticism simply doesn’t hold water.
Warren Buffett Says…: Finally, I want to address one of my pet peeves against critics of active management strategies. Tactical asset managers like Roger Schreiner and our other recommended Advisors are often hit with the criticism that Warren Buffett, arguably the greatest investor of modern times, is an opponent of such strategies for individual investors. However, the trouble with this criticism is that Mr. Buffett doesn’t practice what he preaches.
For individual investors, Mr. Buffett suggests buying and holding a diversified portfolio of low-cost index funds. So he’s a buy-and-hold advocate, right? Not quite. As a value style manager, he selects the stocks in his portfolio very carefully and rotates out of sectors that he feels have run their course. By doing so, Buffett is practicing active management in a way similar to most actively managed mutual funds. He’s just a lot better at it than they are!
As recently as February of 2010, CNNMoney.com reported that Buffett was continuing to pare his investments in energy while boosting his stake in waste management. This, my friends, is active portfolio management. He would not have attained the title of “Oracle of Omaha” by simply buying and holding index mutual funds.
I seriously doubt whether any passive investment manager will ever take up Roger Schreiner’s $100,000 challenge to buy-and-hold strategies. They really have nothing to gain, since Wall Street and the financial media keeps pumping out advice to follow passive asset allocation strategies using low-cost index funds. And they stand to lose their $100,000.
The important thing to remember about this article is not that Roger Schreiner issued a challenge to John Bogle, but that active management strategies can help to control the risks of being in the market while buy-and-hold strategies counsel you to stay invested, take your lumps and hope that the market goes back up in the future.
I encourage you to at least consider the possibility that what you have been told all along about buy-and-hold investing is not necessarily true. The ability to move to a neutral position (cash or hedged) during down markets can move your portfolio out of harm’s way, while active/tactical investment models provide signals for when to re-enter the market.
You can check out the Schreiner Capital Management programs that we recommend by following the links to the Conservative and Moderate programs. You can also obtain more information about these programs by completing our online request form. If you would like information on our other AdvisorLink® actively managed investments, click the following link to request an Investor Kit highlighting all of our recommended Advisors.
As always, our staff of Investment Consultants stands ready to assist you in selecting the right investment for your personal situation and answer any questions you may have. Feel free to give us a call at 800-348-3601 or contact us by e-mail at firstname.lastname@example.org.
Wishing you profits in a tough market,
Gary D. Halbert
Forecasts & Trends E-Letter is published by ProFutures, Inc. Gary D. Halbert is the president and CEO of ProFutures, Inc. and is the editor of this publication. Information contained herein is taken from sources believed to be reliable but cannot be guaranteed as to its accuracy. Opinions and recommendations herein generally reflect the judgement of Gary D. Halbert (or another named author) and may change at any time without written notice. Market opinions contained herein are intended as general observations and are not intended as specific investment advice. Readers are urged to check with their investment counselors before making any investment decisions. This electronic newsletter does not constitute an offer of sale of any securities. Gary D. Halbert, ProFutures, Inc., and its affiliated companies, its officers, directors and/or employees may or may not have investments in markets or programs mentioned herein. Past results are not necessarily indicative of future results. Reprinting for family or friends is allowed with proper credit. However, republishing (written or electronically) in its entirety or through the use of extensive quotes is prohibited without prior written consent.