The Fundamental Theorem of Investing

-NO AI is used in writing this post!-

While I don't have the proof I believe there IS a proof of, what I call: 

The Fundamental Theorem of Investing

Given any market that is 1-attributable, 2-non-opaque, 3-open, 4-free, 5-well formed, 6-where all participants are price takers, and 7-has positive skew (a long term history of rising prices); then, 

A broad based index will outperform active management. 

The proof, if it exists, may be something like this:

The broad based index is always long.

Any active manager must not always be long.

Any active manager must at times be flat or short. 

Any active manager has costs and friction that long only investors do not.

Every flat position has zero return but can avoid long only losses.

Every short position has positive and negative return.

In axiom 7, a positive skew market, the sum of upticks is greater than the sum of downticks.

Therefore, active managers can only beat the index if the sum of avoided downticks + "short downticks" is greater than all the ticks in the market-this may be a contradiction. Therefore the theorem holds. Ok, ok, as I said, this may not be a proof.

In other words, is the return of the flats and shorts enough to avoid the losses of long only and end up beating the long only return? It may be concievable but there is no "public" "audited" "freely available" evidence for this. Is there a fund, in history, that has done this? This is the unlikely prospect facing all active managers. 

And "average" investors, with limited time, capital and no special access to information can easily WIN 70-90% of the time by just buying and holding the largest, lowest cost and most liquid investment in the world. 

Caveat: a stock picker, anytime, can always hit the jackpot and beat the market but does it last? It's kind of like gambling as any long-term holder of Penn Central, Western Union, GE, US Steel, Ford, GM, IBM, Yahoo, AOL, Cisco and Intel (among many others) can tell you. 

One last but major point: Indexing, as beneficial to investors as it may be, if it becomes the dominant investment theme in the market, will end up as a major systemic threat to the entire financial system. The system is based on the concept of rationing, of separating winners from losers and winnowing losers from the market. If too many investors never sell, well, we lose the system that picks winners from losers and that, if it ever happens, is a threat to the system.

Active vs Passive

S&P Global has just issued their 2024 first half SPIVA Scorecard which measures how many actively managed funds outperformed the S&P 500 across standard rolling time periods. Here are the results: 

Percentage of All Large-Cap funds that underperformed the S&P 500®

SPY = SPDR S&P 500 ETF continuously compounded annualized return.

Closing Price Source: Microsoft Stockhistory function 
%Under = Percent of Active Funds Underperforming the S&P 500 

Source: https://www.spglobal.com/spdji/en/research-insights/spiva/ 

For the year ending 6/30/2024, 76% of ALL comparable actively managed funds, as defined by S&P, could NOT BEAT the S&P 500 index! Looking at the 3, 5 and 10 year periods, it becomes ridiculous with 80% of all active managers underperforming. The year-end 2023 results, were slightly better for the one year period (60% vs 76%) but the longer term results were just as bad for active managers.

I added the annualized returns for the SPY ETF (the largest S&P 500 ETF) to highlight that market returns have no little or no effect on active manager performance. Neither up nor down markets appear to give active managers the advantage. In fact, down markets could be expected to show where active managers shine-they can sell or go short and avoid or capitalize on losses where indexers must take the hits and survive the drawdowns. Results show that their outperformance, if any, is fleeting. There is NO persistence of top ranked active managers from one period to the next. See the SPIVA Persistence Scorecard ( https://www.spglobal.com/spdji/en/spiva/article/us-persistence-scorecard/ ) if you have any doubts about this. 

The SPIVA scorecard has been published for almost 20 years and I do not have this data. You can actually find some historical SPIVA data (2002 to 2017) at Bogleheads websites with links to Google Sheets here: https://www.bogleheads.org/wiki/SPIVA_scorecards and here: https://www.bogleheads.org/wiki/Talk:SPIVA_scorecards .

Suffice it to say that for as long as it has been published, active managers cannot beat the S&P! What does this say for the trillions in active assets? What does this say for individual investors facing a barage of ads and promotions to buy into the next big thing or star fund manager? Is active management just a grift?

Blackstone, Fidelity and Merrill Lynch beg to differ but they do not have the performance to back their claims. One could arguably make the case that If these investment firms and IF the world's largest and richest fund managers cannot beat the passive S&P, then NOBODY can! Futhermore if nobody can consistently and reliably beat the passive index, WHY WOULD ANYBODY invest in anything else?

There may be a reason, and its the same reason we have casinos, bookies and horse races...it's that there's a chance. There's a chance you could pick a winner and a big life changing winner. There's a chance you could be an original investor in Penn Central, US Steel, GE, IBM, Walmart, Apple Computer, Microsoft, AOL, Yahoo, Google, Facebook, Tesla or bitcoin, even. 

Chance belongs to those with risk capital. Serious capital, large or small, may gain from investment with historically exceptional returns. 

Vista Basket Up 14.2% Year-to-date

 Vista continues its rise and outperformance through the third quarter.

Normalized monthly performance since Vista inception, 4/30/2009  = 1000

Vista = Vista Commodity Basket

BCOM ER = Bloomberg Commodity Excess Return Index

GSCI ER = S&P GSCI Commodity Excess Return Index

Sources of closing prices: barchart.com, bloomberg.com,spglobal.com 

Continuously compounded returns for rolling perionds as of 9/30/2024.

For almost ANY period and not just the ones shown above, the long-dated, diversified Vista basket has outperformed both the diversified frequently rolled Bloomberg index and the energy weighted frequently rolled GSCI index. Vista is helped by the rise in precious metals. The GSCI has been weighted down by the decline in energy futures whereas Bloomberg is also seeing the effects of a general revaluation of ags, energies and commodities in general. YES, inflaition IS coming down. 

WHY "Excess Return" indexes? Because excess return indexes do not incude any collateral interest and neither does the Vista basket. Vista makes no assumptions about how you finance your commodity positions, Vista assumes that your commodity account is fully collateralized with cash. The Vista basket only includes commodity futures contract returns. Thus, the excess return indexes are comparable measures.** 

Why does Vista beat the major commodity indexes? Three reasons: Vista includes the right names, the right months and the right rolls. 

Right names-The Vista basket only includes major price discovery commodities. While commercial accounts can affect market prices, all participants are price takers in Vista names. Even Saudis cannot control oil prices. Markets where participants have price power are not free markets and are avoided by Vista. This selection is a proprietary art of Vista.

Right months-trading is the friction/the enemy of market returns. Too much trading, including frequent rolls, reduce investor returns. But futures have expiration dates so rolls are a necessary evil. Vista carries the longest dated months with suitable liquidity. This is a proprietary art of Vista.

Right rolls: when to roll and when to hold long-dated futures contracts is another determinant of investor return and another proprietary art of Vista.

All of the above above plus holding only well-formed markets and other minor factors all contribute to Vista's significant 300 to 2000 basis point outperformance versus the headline commodity indexes. 

What is the Vista Commodity Basket? The Vista Basket is a futures account that buys and holds 15 commodity futures contracts. As of September 30, 2024 the Vista Basket is composed of the following:

Note that the Vista Commodity Basket, when held by investors, was valued at $1.22MM on 12/30/24. Since this account is fully colleteralized, i.e. margined at 100%, the full $1.22 MM is posted on the account. Actual quantity and contract size is proprietary and an art of Vista. 

**Note that fully collateralized/100% collateral positions will never have margin calls (assuming prices do not go negative). Further, since the excess returns and the Vista basket ARE fully collateralized, the investor return will always be higher than the excess return since cash WILL be invested in TBills. Ine key feature of excess returns is the lack of forced liquidations due to margin calls. 

Vista Commodity Basket Resumes Rally

The Vista Commodity Basket of long-dated diversified commodity futures contracts extends it six-year rally up 10.5% for the year to date as of 8/31/2024. The compound annual growth rate for the past 5 years is 12.5%!

Vista Commodity Basket actual closing price.

Data source for all closing prices: barchart.com

Vista Commodity Basket compound annual growth rates as of 8/31/2024 and Vista's 4/30/2009 inception.

Vista Commodity Basket compound annual growth rates as of 8/31/2024 and Vista's 4/30/2009 inception. Below are the continuously compounded calendar year returns since inception.

2024 is looking good for commodity investors. 

Stock Indexes Whirlwind Tour

Since mid-July All TIME HIGHS the stock market has been in a whirlwind tour dropping almost 10% in 15 trading days and then a mixed recovery to today.

DIA = Dow Industrials SPDR
SPY = S&P 500 SPDR
QQQ = Nasdaq QQQ Invesco ETF
IWM = Russell 2000 Ishares ETF

The Whirlwind chart shows how $100,000 invested in the major stock index ETFs would have fallen and recovered during this time period. The DOW! The much maligned Dow Jones Industrial Average as represenbted by DIA has fully recovered to its all time high! 

Vista Commodity Basket up 11% in 1H2024

In the first half of 2024, the Vista Commodity Basket rose 11% while the comparable GSCI and Bloomberg indexes were up only 9% to 3% for the same period. 

Commodity benchmark continuously compounded returns normalzed toinception date of Vista basket, 4/30/2009 = 1000. 

Vista = Vista Commodity Basket
BCOM = Bloomberg Commodity Excess Return Index
GSCI = S&P GSCI Excess Return Commodity Index
Data Sources: barchart.com, bloomberg.com and spglobal.com

Note: Vista outperforms across the board! So, why Excess Return indexes? Because the Vista Basket is a simple basket of long-dated commodity futures contract price changes with no add-ons for interest or any other gains or charges. Excess Return indexes simarly include ONLY futures contract price changes with no add-ons for TBill collateral interest. The "Headline" or Total Return indexes DO include these credits.

While the Vista Basket beat the energy weighted GSCI and diversified BCOM, AGAIN, in the first half this is just a repeat of almost every rolling period since the inception of the Vista Basket in 2009. How did the Vista Basket do it this year? Look at the sector returns:

Vista's weighting of metals has given it the leg up on both the Bloomberg and GSCI commodity indexes. Individual commodities give a different picture:

These are good times for West Africa and other cocoa and coffee producing countries. We will see how long it lasts. 

ZFN vs SPY

Touted on LinkedIn: #ZFN #ETF units are up 22.6% Year to Date, compared with a gain of 13.92% for the S&P 500 Index 

Normalized performance since inception (12/10/2018 = 1000 ): Not so much!

ZFN = BMO SIA Focused North American Equity Fund ETF Series (ZFN.TO)
SPY = SPDR S&P 500 ETF Trust (SPY)
Source: finance.yahoo.com

Global X Funds - Emerging Markets Consumer ETF (EMC) vs SPY

 I don't get it! This fund is being touted on LinkedIn. WHO buys this underperforming stuff? 

Normalized continuously compounded return, adjusted for any distributions and splits, where the inception date of EMC, 5/16/2023,  = 1000

EMC = Global X Funds - Emerging Markets Consumer ETF 

SPY = SPDR S&P 500 ETF Trust

QQQ = Invesco QQQ Trust

Source: finance.yahoo.com

How many times do you have to prove it that paid managers cannot beat the S&P, let alone the QQQ??? Answer: Everytime!

Fundrise Flagship Fund versus the S&P500

While I admire Scott Galloway in many things, especially his "Prof G" and "Pivot" podcasts, I have questions about his personally touting/endorsing/selling the "Fundrise Flagship Fund". 

What is this fund? It's an LLC! Well here it is direct from the chatbot on the Fundrise website:

"Fundrise is not listed on a public stock exchange; instead, it operates a platform for investing in shares of its funds, which are structured as REITs and are not publicly traded. If you're looking for a stock symbol for Fundrise itself, such a symbol does not exist because the company's funds are not traded on public markets."

Sorry Scott, touting private investments to unaccreddited investors is irresponsible. Unsophisticated investors have NO place in underperforming illiquid investments. Of course anyone can buy real estate and almost anything else directly themself. But does anyone need an illiquid, non-public LLC to charge fees and lose money? Terrible returning private Venture Cap funds are usually the purview of billionaires.

Since this is NOT a publicly traded fund, information is hard to get and IMHO misleading, at best. As the website says: These publicly registered  [not publicly traded] funds are our largest and most diversified, and are akin to mutual funds of alternative assets.

Here's the best I could find from Fundrise.com:

Fundrise Real Estate Interval Fund, LLC

"During 2023, the Fund returned -11.79%, its third year of operations. During the same period the S&P 500® Total Return Index, a bellwether for the overall U.S. stock market, returned 26.29%..."

Fundrise Income Real Estate Fund, LLC

"The Fund returned 7.93% in 2023, its second year of operations. During the same period the S&P 500® Total Return Index, a bellwether for the overall U.S. stock market, returned 26.29%..."

Fundrise Growth Tech Fund, LLC

"...with the illiquid nature of the asset class... The Fund returned +1.53% during the year ended March 31, 2024. The Cambridge Associates LLC U.S. Venture Capital Index returned -2.53% in the third calendar quarter of 2023 and -0.47% in the second calendar quarter of 2023. The Fund returned 2.31% and -0.80% in those respective quarters."

Maybe this is not the big picture. From the Fundrise website itself , below may be the big picture (the SPDR S&P 500 ETF Trust - SPY added by me):

Who presents the returns of their client accounts*? How odd, how misleading and how dishonest is this? Even with these gerrymandered returns Fundrise STILL can't beat the S&P (represented here by SPY.

Conclusion: AVOID. Do not buy Fundrise funds.  

*Client account returns are NOT fund returns. Client returns depend upon when clients buy and sell. SPY client returns will vary significantly from SPY returns. I mean WHO just buys and holds SPY ALL the time? Nobody!

Why Can't Active Funds Beat the S&P? The Source of Return

Quick answer: they go flat or short. Either strategy is a loser. Why? The return of the S&P (and nearly ALL broad-based indexes) comes from a miniscule number of trading days that are very scattered and very unpredictable. The plot below shows the continuously compounded daily returns of SPY from its 1/29/1993 start date to 5/22/2024.

SPDR S&P 500 ETF Trust (SPY) closing price since 1/29/1993 adjusted for splits, dividends and capital gains distributions. Source: https://finance.yahoo.com/quote/SPY/

SPY has traded 7884 trading days or 31.28 years since inception. Here are the numbers:

CCROR = Continuously compounded rate of return (ln(day 2/day 1).

CAGR = Compound annual growth rate = sum of daily returns.

These are the returns from nonstop buy and hold for SPY from inception to 5/22/2024. These returns outperform 70% to 90% of all active managers, consistently, across nearly any time frame. See S&P's passive/active website here: 

https://www.spglobal.com/spdji/en/research-insights/spiva/about-spiva/

The total return of SPY (and QQQ and IWM, for that matter) is extremely sensitive to the top 10, 20, 100, etc. individual trading days. How sensitive is it? Here are the numbers:

The "Top" table shows how the SPY return changes when an active manager misses the top 10 SPY days. Just missing those specific 10 days reduces your return by 200 basis points (9.79% to 7.26%). Missing the top 20 days cuts you further and missing the 100 top days results in a sub TBill return!

Here are the top 10 and worst 10 days since inception for SPY:

Well what are the odds of that? Probably the chance of missing (or picking) the top 10 or 20 or any fixed number of top days is probably random but every day an active manager is OUT of the market, or worse yet, short the market, is another chance to miss a top day. Note that when tested for just random days, missing say 10 or 100 or 2000 random days (a much more likely scenario), there is much less effect on return.

Missing the "top 20 and worst 20" or any number of  like days also has a smaller effect on return. Returns only go up if you can miss the worst days and not miss the top days-a task as unlikely as any other. 

In sum, THE ONLY WAY TO GUARANTEE THAT YOU DON'T MISS TOP DAYS IS TO BUY AND HOLD.

If you can do it, more power to you, but public audited managers can't. 

How to Invest

 

How to Invest

An investment guide for everyone.

 

Investments are a form of spending but spending on SAVINGS. Savings for yourself, your future, your car, home, retirement, your family, your child or children’s future. 

 

Smart investing involves knowing your needs and goals, researching and MAKING good choices.

 

Needs and Goals

 

We are all unique. But while we all have some things in common: we each answer needs in our own way. Investment needs depend upon your stage of life. Needs and goals include your education, car, home, family, children’s education and retirement and a slew of goals specific to each. 

• For students, your job is school. Max out your education. Challenge yourself and take school seriously; your life will depend upon it. 

Take advantage of every wise opportunity but most importantly, avoid bad choices. NO “for-profit” schools or schools that advertise with promises. Go to community college if you must, use school counseling, government and agency programs/grants for low/no income students. Don’t sign student loan applications.

• 20s? Not a Student? Try and do what you love and whatever you make, SPEND LESS than you make. Take advantage of every opportunity, especially low/no income programs. Your library is your friend. MAX OUT your retirement plan at work and you’ll have thousands saved by your 30s. No work retirement plan? Change jobs or open your own IRA (Individual Retirement Account) at Vanguard or T Rowe Price² and MAX THAT OUT. Save for down payments on a car and home. Put your college and retirement funds into an S&P 500 index fund. Put your down payment savings into a money market account³. 

• For all adults-SPEND LESS THAN YOU EARN. Begin planning now, MAX OUT your retirement plan at work. Don’t neglect your basic needs to complete your education, avoid unwise debt and buy a home-a 30-year mortgage is your friend! No work retirement plan? Open your own IRA and MAX THAT OUT. If needed, still save for down payments. 

Buying a home may be the best INVESTMENT you can make. You not only INVEST your money but you LIVE in it and, as you pay down your mortgage, your home equity grows too! Mortgage payment is a form of forced saving and may be one of the best ways to accumulate wealth.

• For parents of newborns, get your child’s SSN right away and open a children’s account. Work with Vanguard or T Rowe Price to make the right choice for you. Investing in a S&P 500 stock index fund these first 3 or 4 years can triple your child’s assets! 

• For middle aged adults with children-kid’s college is looming and then retirement, no time to slouch now, you must juggle spending AND saving. With or without children, live your best life, make your best choices.  

• Near retirement? -You can be retired for 30 years or more, you need growth. Forget income, all income comes from principal or growth. Income funds UNDERPERFORM, buy and hold an S&P 500 Index fund (or Nasdaq 100 index funds, if you can stand it. 

Index fund declines are a COST! A price you pay for superior FUTURE returns. 

NEVER pay fees for a financial planner or broker commissions. Forget buying stocks, commodities, options and ESPECIALLY CRYPTO. These are all gambling. Don’t gamble until you have substantial income and can AFFORD gambling losses.

When it comes to insurance, buy only car and home insurance, and when you have dependents buy ONLY straight life insurance. Insurance has huge commissions and is NOT an investment.

Research 

Your library is your friend. Local, state and federal programs, agencies and non-profit organizations can be lifelines. Learn and know your choices, especially, what to avoid! 

 

WHO you invest with is as important as WHAT you invest in. Almost ALL financial professionals offer products you don’t need, with unnecessary complexity and with exorbitant, explicit or hidden fees. Throughout your financial life do not be lured BY and avoid almost ALL full service advisors, insurance salesmen (except when you NEED to insure your home, life or car) and stockbrokers. 

 

Good advice IS available but sadly without a good MBA one may not know what good advice looks like. In my opinion, for those NOT in the know, only a few investment firms truly exist to serve their customers: Vanguard and T Rowe Price are the major companies that I recommend. Call them, tell them your situation and they will give you excellent unembellished advice (no promises, no misrepresentations).

 

BEWARE ALL GET RICH QUICK SCHEMES. You already know this. As for bitcoin, the stock market, house flipping, etc. etc. these are all forms of gambling and totally depend upon your financial weight class. Choose wisely. 

 

Investment Choices

 

Just like spending, you have choices. Different investments have different risks. Time is your friend. Below is a table of investments ranked by risk, Risk is always a subjective measure-subject to your personality and financial weight class. Time is your friend and reduces your risk for retirement investments. Here’s one standard way to rank investments by risk:

 

Investment	Historical and  Estimated Rates of Return	Risk
Bank Savings	0.1% to 3%, 1%	Very low, FDIC insured
Money Market Funds	-1% to +2%, +3% on average	Very low
Bond Funds	-3% to +5%, +5% on average	Low
Home Ownership	-10% to +10%, +8% on average	Market risk
Stock Market	-20% to +20%, +8% on average	Market risk
Technology Stocks	-40% to +40%, 12% on average	Above Market
Bitcoin	-50% to +50%, no average	Very high

 

Stock indexes have risen over time and this is the major reason honest professionals recommend stock index investments for retirement and long term investors. There is no guarantee this will continue! But, for the last 200+ years, it has.

 

Stock indexes are NOT favored by investment professionals due to their very low fees. Some will lure you with no fees but offer to share in your profits. Again, at Vanguard or TRP, you won’t have to give up very low fees. 

 

Your investment life is just one part of your money life, social and family life. Make the most of what you have with your best possible choices. 

 

Why Vanguard or T. Rowe Price? I don’t work for them but in my experience, they are as good as it gets for investors of all weight classes.. I suggest you call them and once you get your bearings, then you can explore their websites. Their contact information is: 

 

Investor.vanguard.com 877-662-7447

troweprice.com 1-888-285-2612

Money markets have very low risk and are appropriate for short term investments where you can’t afford losses such as for a car or down payments.

 

Volatility is a fancy way of measuring how much an investment has fallen in the past. It does not predict how prices will move in the future.