The Risk of Trading Markets — Do You Feel Lucky, Punk?

Wealth warning: 79% of retail investor accounts LOSE money

Last week I had a coffee with a fellow who manages money for an institutional investor. He mentioned, ‘Did you know the Europeans made it compulsory for brokers to display the firm’s win/loss ratio on its site?

In 2018, the European Securities and Markets Authority (ESMA) introduced new measures requiring brokers to perform standardised risk warnings and include the percentage of losses on retail investor accounts involved in foreign exchange trading and CFDs (contract for difference).

As reported by news, the 2020 broking data makes for grim reading:

We have collected a total of 33 brokers’ data…the average winning rate is 24.98%, while the average losing rate is 75.02%

Here’s a sample of what brokers are required to display on the home page:

Port Phillip Publishing

Source: CMC Markets

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It’s not all that different to the HEALTH WARNINGS on cigarette packets.

Trading is ruinous to your wealth…and if you lose enough money, your health as well.

Trading markets is another form of gambling.

Not only are you betting on price action heading in a certain direction at a certain time, you are also wandering into a playground full of institutional bullies.

And these heavyweights love nothing more than beating up the naïve newbies and stealing their lunch (or in some cases, retirement) money.

Even the market bullies get beaten up pretty bad by the market. They too have appalling win/loss ratios.

Port Phillip Publishing

Source: MarketWatch

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According to the article (emphasis added):

“This poor performance appears to be driven by the bigger funds. 2020 represents the worst year since records began in 2005 in terms of the underperformance of big hedge funds relative to the smaller ones,” wrote analysts at J.P. Morgan’s global quantitative team, led by Nikolaos Panigirtzoglou.

No great surprise there.

Hedge funds underperform…again. Yawn. It’s such a well-known fact within the industry.

Investing with hedge funds is just another form of gambling.

Except for the managers. They’re on a guaranteed winner. Whether the fund performs or not, they collect their fees.

In my 2017 book, How Much Bull Can Investors Bear, the one-sided arrangement between hedge fund manager and investor was a topic of discussion…

Industry insider Simon Lack shone the light on the inequity of the hedge fund fee structure in his 2011 book The Hedge Fund Mirage:

  • “From 1998–2010, hedge fund managers earned $379 billion in fees. Over the same period, the investors in their funds earned only $70 billion in gains.
  • “Managers retained 84% of investment profits while the investors, who put up the capital, received a paltry 16%.
  • “To make matters worse, up to one-third of the hedge funds are only accessible via feeder funds or a fund of funds approach. This adds a further layer of administration fees to be absorbed by investors. Simon Lack estimates the additional administration fees are approximately $61 billion. When you account for the additional fees, investors actually received $9 billion ($70 billion less $61 billion), and the industry raked in $440 billion ($379 billion plus $61 billion). The final split: hedge funds 98% and investors 2%.”

Despite what you may have been led to believe, hedge funds are not in the investment business. They are in the fee-capturing business.

Sure, some hedge funds are worth their weight in gold. But which ones?

Picking the outperformer in advance is random luck, and failure to do so (which is where the majority end up) comes with a hefty price tag.

When it is distilled down to the basics, Wall Street is nothing more than a casino. And the golden rule of any casino is the house always wins. Always.

So why do people bother trying to beat the house? The odds are stacked against you from the very start.

Thanks to European bureaucracy, we now know that retail traders get hammered 75% of the time.

And, on average, hedge funds underperform. Yet, courtesy of the lopsided fee structures, the managers end up with 84% of whatever they make off your money.

This is…

How not to gamble in the market

On 19 December 2007, Warren Buffett made a $1 million bet with asset management firm Protégé Partners.

The bet was a simple one.

Buffett backed the S&P 500 Index to outperform, over the next decade, a group of actively managed hedge funds handpicked by Protégé Partners.

A decade later, Buffett gave this report in the 2017 Berkshire Hathaway Annual Letter (emphasis added):

Protégé Partners, my counterparty to the bet, picked five “funds-of-funds” that it expected to overperform the S&P 500. That was not a small sample. Those five funds-of-funds in turn owned interests in more than 200 hedge funds.

Essentially, Protégé, an advisory firm that knew its way around Wall Street, selected five investment experts who, in turn, employed several hundred other investment experts, each managing his or her own hedge fund. This assemblage was an elite crew, loaded with brains, adrenaline and confidence.

So, how did the elite crew, loaded with brains, adrenaline and confidence AND other people’s money, go against the index?

This is the performance chart from Buffett’s 2017 Annual Letter…

Port Phillip Publishing

Source: Berkshire Hathaway

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The index beat ALL five of the elite hedge funds…and not just by a few percent, but by a country mile.

Buffett explains why he made the bet:

…to publicize my conviction that my pick — a virtually cost-free investment in an unmanaged S&P 500 index fund — would, over time, deliver better results than those achieved by most investment professionals, however well-regarded and incentivized those “helpers” may be.

For the record, Buffett donated the US$1 million to the Girls Inc of Omaha charity.

Why do people insist on gambling? Simple.

It’s the adrenaline. The rush of getting in the fast lane. People want the excitement of the hare, not the boredom of the tortoise.

But research paper after research paper continues to come up with the same conclusion…over the long term, the vast majority of active managers DO NOT beat the index.

If you’re going to bet, then bet on a sure thing…the index.

But here’s one final and very important word of caution.

There are times when it’s prudent to…

Know when to walk away

While an index fund is a far better bet than trading accounts or hedge funds or active managers, there are times in the market cycle when the odds are firmly stacked against you creating long-term wealth…times like the 1929 and dotcom peaks.

The Hussman Margin-Adjusted PE (MAPE) has a near 90% record in forecasting US market returns 12 years in advance.

The latest MAPE level (as of 18 December 2020) is the highest in US market history.

Based on previous historic peaks, the odds of this ending well are about as good as a snowball in hell.

Port Phillip Publishing

Source: Hussman Strategic Advisors

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According to the latest Hussman update…

I realize that the projection of a 60-70% market loss seems just as preposterous as my 2000 projection of an 83% loss in technology stocks. The problem is that investors don’t seem to understand what they have done by responding to zero interest rates as if there is no alternative but to embrace market risk, regardless of the price. This will likely end badly.

For the record, the NASDAQ did fall 83% after the dotcom bubble burst.

It’s about now I start channelling my inner Dirty Harry…

But being this is the highest MAPE level ever, and, if it blows, it would blow your portfolio to smithereens, you’ve got to ask yourself one question: “Do I feel lucky?” Well, do you, punk?

The difference between Dirty Harry’s situation and this one is he only had one bullet in the chamber, this market has five.

Not great odds.

Don’t gamble your future away.


Vern Gowdie Signature

Vern Gowdie,
Editor, The Rum Rebellion

PS: In a brand new report, market expert Vern Gowdie warns of the dangers waiting in a post-COVID-19 world. Plus, he outlines the steps you should take now to protect your wealth. Learn more.

Vern has been involved in financial planning since 1986.

In 1999, Personal Investor magazine ranked Vern as one of Australia’s Top 50 financial planners.

His previous firm, Gowdie Financial Planning, was recognised in 2004, 2005, 2006 & 2007, by Independent Financial Adviser magazine as one of the top five financial planning firms in Australia.

In 2005, Vern commenced his writing career with the ‘Big Picture’ column for regional newspapers and was a commentator on financial matters for Prime Radio talkback.

In 2008, he sold his financial planning firm due to concerns about an impending economic downturn and the impact this would have on the investment industry.

In 2013, he joined Fat Tail Investment Research as editor of Gowdie Family Wealth. In 2015, his book The End of Australia sold over 20,000 copies and launched his second premium newsletter, The Gowdie Letter.

Vern has since published two other books, A Parents Gift of Knowledge, all about the passing of investing intelligence from father to daughter, and How Much Bull can Investors Bear, an expose on the investment industry’s smoke and mirrors.

His contrarian views often place him at odds with the financial planning profession today, but Vern’s sole motivation is to help investors like you to protect their own and their family’s wealth.

Vern is Founder and Chairman of The Gowdie Advisory and The Gowdie Letter advisory service.

The Rum Rebellion