February 23, 2010
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Leave it to an active activist to play a shell game in proposing a bet that cannot be won by his challengers. Your recent article by Roger J. Schreiner, The $100,000 Challenge to Passive Managers, challenged John Bogle to a wager and Schreiner claims that if Bogle doesn’t accept the bet, it will “prove my point- that my active investment process is superior to his high-risk ’buy and hope’ approach.”
If Bogle wisely doesn’t take Schreiner’s bet, all it will prove is that Bogle is better at math than Schreiner. A passive investor cannot win the bet based on the rules Schreiner outlined. You see, to beat Schreiner in his shell game and to make people think they can win at his casino table, the passive portfolio must produce BOTH a higher return AND lower DAILY standard deviation. Let’s examine how this might play out and see how Schreiner’s rules enable him to make sure he wins.
Say I’m John Bogle and I don’t bother thinking about how Schreiner stacked the deck with his rules and take him up on his challenge. To make my portfolio selection easy I just copy the Wealthcare Capital Management “Growth” Portfolio which is allocated as follows:
77% Total Domestic Equities (R3000, MS Total Domestic or W5000)
13% Foreign Equities (EAFE or World Ex-US)
10% Fixed Income (7-10 Year Treasuries)
I find it ironic that the same day I read Schreiner’s article I was notified by the Informa PSN Manager Database that this simple indexed portfolio was a “Top Gun Manager of the Decade” for their “All Cap Core Equity Universe.” That should be good enough for Bogle.
So, Schreiner is faced with the daunting task of creating a portfolio that will EITHER produce higher Total Return OR less risk to beat Bogle on his Wealthcare Capital Management passive portfolio. Think about this. Bogle needs to create a portfolio that has to produce higher return AND lower daily standard deviation to beat Schreiner, but Schreiner beats Bogle if his returns are lower as long as his risk is lower too. Or, if Schreiner produces higher return with higher daily standard deviation, Schreiner wins.To beat Schreiner you have to produce both; for him to win he only has to produce one or the other. Wait second…that is easy. If I’m Schreiner and I just put the whole portfolio in cash I will produce less daily standard deviation and I win. That is a guaranteed winner. There is no doubt about it. Shazaam…active management genius!
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