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.