Charles Ellis, CFA, on the Investment Profession: “We Can Do Better”

It has been nearly four decades since Charles D. Ellis, CFA, published his seminal article, “The Loser’s Game,” in the Financial Analysts Journal, calling into question the skill of professional money managers. “The investment management business (it should be a profession but is not) is built upon a simple and basic belief: Professional money managers can beat the market,” he wrote back in 1975. “That premise appears to be false.”

Ellis is still shaking things up whenever he can: He is a sought-after speaker and has authored dozens of articles and 17 books, including What It Takes, his most recent work.

At CFA Society Calgary’s recent wealth management conference, Ellis set the tone the minute he got to the podium: “I’m going to make some rude remarks, and those of you who are delicate skinned might want to leave now.”

In a nod to the role that behavioral economics plays in investing, he quipped that the first part of his presentation was “the revelation that we turn out to be human beings.” On a more serious note, however, Ellis said this was “a setting stage for what will come later, which is candidly pretty serious admonitions along the lines of ‘we can do better.'”

Ellis reminded the audience that past performance does not predict the future — and yet the industry remains focused on this metric.

“We emphasize past results if they are any good, we sell the dickens out of past performance. . . . We overemphasize the performance factors enormously, and we never talk about risk,” he said. “And then we have an interesting habit: We incubate new funds all the time, we drop the ones that don’t make it, we incubate some more. . . . The major fund management organizations will have 300, 400, even 500 different mutual funds in being. Guess which ones get advertised? If I had 500 children, do you think I would be able to find one that is pretty damned terrific? I think so.”

He continued: “We flood the system with data without very much explanation of what the data really means, and we do not focus on the clients. We sell products. And we increase our fees, and our fees have increased significantly.”

Ellis said there is “some disagreeable data out there” showing how few professional managers meet or exceed their benchmarks, and while that’s “a dreadful report card for the investment profession,” the business has been doing just fine, especially when you consider the rise in fees. Ellis went on to make a case for indexing by pointing out that performance investing — like amateur tennis, in which the outcome is determined by the loser not the winner — is a loser’s game.

“It’s really hard work, and it’s gotten harder and harder and harder every year for the last 50 years because of all those wonderful people who have come into the business. . . . Think of how many people have gotten really good educations that come in to be practitioners and have been provided with fabulous equipment, tools, and information so that they can compete. Unfortunately each of them is competing against others who also went to great schools also studied also became CFA [charterholders] and also have wonderful facilities, and also have tremendous energy and brain power, and as a result the case for indexing gets stronger and stronger and stronger,” he said.

“It’s never a perfect case, but it’s worth thinking about: ‘Isn’t the tide rising and rising?’ At some point, if you are in there as an active investment manager, one after another you can’t continue to beat the market, because the market is getting stronger and stronger, because the talent that is coming into the market is getting better and better, and the tools and facilities in which they do their work is getting better and better.”

Ellis said the case for indexing is relatively simple: higher rate of return, lower risk, more reliable, and lower cost. (Not surprisingly, Rick Ferri, CFA, wrote a 2012 Forbes column in which he called Ellis “a legend among index fund investors.”)

By keeping it really simple, Ellis said, indexing “allows you to concentrate on something that candidly is considerably more important: It’s easier to change the portfolio structure, and it frees the investor or the investment committee to concentrate on the questions that are really important. My proposition to you is that there are two parts to investment management: price discovery and value discovery, and value discovery is helping an individual find out — or an institution learn and figure out — what is really important to them.”

Here are a few of Ellis’ most tweet-worthy comments and observations from the event:

Indexing’s best benefit is that it puts the focus on clients and their values, says Charley Ellis, CFA, at 2013WMC

— Lauren Foster (@laurenfosternyc) October 18, 2013

Charley Ellis, CFA: If we put our focus more on value discovery, we will be much more the profession we want to be 2013WMC

— Lauren Foster (@laurenfosternyc) October 18, 2013

Charley Ellis, CFA, reminds delegates at #2013WMC: Only one decile is hugely predictive – the bottom decile.

— Lauren Foster (@laurenfosternyc) October 18, 2013

Charley Ellis: We praise investors who have a good run & fire managers after a bad run; we are on average wrong on both decisions #2013WMC

— Lauren Foster (@laurenfosternyc) October 18, 2013

Charley Ellis reminds us: We exaggerate our ability to forecast; experts are fallible too; and confirmation bias is strong #2013WMC

— Lauren Foster (@laurenfosternyc) October 18, 2013

Ellis’s original FAJ article became a best-selling investment classic, Winning the Loser’s Game, now in its sixth edition. In 2007, Bogleheads published a post with 10 “timeless” quotes from the book. To read more from Ellis, see:

• “Charles Ellis, CFA: Lessons on Grand Strategy” (Enterprising Investor)
• “Murder on the Orient Express: The Mystery of Underperformance” (Financial Analysts Journal, PDF)
• “The Winners’ Game” (Financial Analysts Journal, PDF)
• “Beating the Market Has Become Nearly Impossible” (Institutional Investor)

Please note that the content of this site should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute.