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1975-1984

The Loser's GameCharles D. Ellis

D sa gr ee a b l e da t a a r e s t r e a ming o u t o f t he c om-pute r s of BeCker Securi t ies an d Mer r i ll Lync ha nd a ll t he o the r pe r f o r m a nc e me a su r e m e nt fi rms .O ve r a nd ove r a nd ove r a ga in , t he se f a c t s a ndf igur e s i n f o r m us t ha t i nve s tme n t ma na ge r s arefa i l ing to per form. Not only a re the na t ion ' s lead-ing por t fol io managers fa l l ing to produce pos i t iveabsolute ra tes of r e turn (a f te r al l, i t ' s been a long,long bear marke t ) but they a re a l so fa i l ing topr oduc e pos i t i ve relative ra tes of r e turn. Cont ra ryto the i r of t a r t icula ted goa l of outper forming thema r ke t a ve r a ge s , i nve s tme n t ma na ge r s a r e no tbe a t i ng t he ma r ke t : T he m a r ke t i s be a t i ng t he m.Fa c e d w i th i n f o r ma t ion t ha t c on t r ad i c t s w ha tthe y be li e ve, hu m a n be ings t e nd t o r e spon d i n oneof two w ays . Som e wi ll assimi la te the informat ion,c ha ng ing i t - - a s oys t e r s c ove r a n obnox ious g r a inof s i l i c a w i th na c r e - - so t he y c a n i gnor e t he ne wknow le dge a nd ho ld on t o t he i r f o r me r bel ie fs ; a ndothers wi l l accept the v a l idi ty of the n ew informa-t ion . I ns t e a d o f c ha ng ing t he m e a n ing o f t he ne wdata to f i t the i r o ld concept of r ea l i ty , they adjus tt he i r pe r c e p t i on o f r e a l i t y t o a c c ommoda te t hein f o r ma t ion a nd t he n t h e y pu t i t to use .Psyc ho log i s ts a dv i se us t ha t t he m or e impor -tant the old concept of r ea l i ty i s to a per son- - themo re imp or tan t i t is to his sense of se l f -es teem andse nse o f i nne r w o r f l l - - t he mor e t e na c ious ly he w i llho ld on t o t he o ld c onc e p t a nd t he m or e i ns i s te n t l yhe wi l l ass imi la te , ignore or r e jec t new evidencetha t conf l ic t s wi th I ri s o ld and fami l ia r concept ofthe wor ld . This behavior i s par t icula r ly commona m ong ve r y b r igh t pe op l e be c a use t he y c a n soeas i ly deve lop and a r t icula te se l f -persuas ive logicto j us ti f y t he c onc lus ions t he y w a n t t o ke e p .Fo r e xa mple , mos t i ns t it u t iona l i nve s tm e n tmanagers cont inue to be l ieve , or a t leas t say theybe l ieve , tha t they can and so on wi ll aga in "ou tper -f o r m t h e m a r k e t . " T h e y w o n ' t a n d t h e y c an ' t. A n dthe purpose of th is a r t ic le i s to expla in why not .M y e xpe r i e nc e w i th v e r y b r igh t a nd a r ti c u la t einv es tm ent ma nag ers i s tha t the i r ski ll s a t ana lys isand logica l ext rapola t ion a re very good, of ten

Reprinted from Finandal Analysts Journal (July~August 1975):19-26.

superb, but tha t the i r br i l liance in exte ndin g logica le x t r a po l a t i on d r a w s t he i r ow n a t t e n t i on f a r a w a yf r om the some t ime s e r r one ous ba s i c a s sumpt ionsupo n w hic h t he i r s c he me s a r e ba sed . M a jor e rr o r sin r e a son ing a nd e xpos i ti on a r e r a r ely f ound i n t helogica l dev e lop me nt of th is ana lys is , but ins tead l iewi thin the premise i t se l f . This i s what wor r iedMar t in Luther . I t 's wha t The Best and The Brightest isa l l about . I t 's wh at l i f ted LTV above $100; wh y th eE mpe r or w e n t f o r da ys w i thou t c lo the s ; a nd w hycom edians a nd sc ience fic t ion wr i te r s a re so care fulf i r s t to es tabl i sh the "premise" and then quic ldydiver t our a t tent ion f rom i t so they can e labora tethe persuas ive de ta i l s of deve loping " logic ."T h e i n v e s t m e n t m a n a g e m e n t b u s i n e s s ( i tshould be a profess ion but i s not ) i s bui l t upon as imple and bas ic be l ie f : Profess iona l money man-a ge r s c a n be a t t he ma r ke t . T ha t p r e m i se a ppe a r s t obe false.I f the p remise tha t i t i s feas ible to out per fo rmthe ma r ke t w e r e a c c e p t e d , de c id ing how to goa bou t a c h i e v ing suc c e s s w ould be a ma t t e r o fs t ra ight forward logic . F i r s t , the marke t can ber e pr e se n t e d by a n i nde x , suc h a s t he S&P 500 .Since this is a passive and public l ist ing, thesucc e ss f ul , ma n a ge r ne e d on ly r e a r r a nge h i s be t sdi f fe rent ly f rom th ose of the S&P " ' shi ll . " He canbe an ac t ivis t in e i ther s tock se lec t ion or marke tt iming, or both. S ince the manager wi l l want his"be ts" to be r ight most of the t ime , he wi l l assem-ble a grou p of br ight , wel l educa t ed, h ighly mot i -va t e d , ha r d w o r k ing you ng pe op le , a n d t he i r co l-lec t ive purpose wi l l be to bea t the marke t by"be t t i ng a ga ins t t he house " w i th a "good ba t t i nga ve r a ge . "The be l ie f tha t ac t ive managers can bea t themarke t i s based on two assumpt ions : (1) l iquidi tyof fe red in the s tock marke t i s an advan tage , and (2)ins t i tu t iona l inves t ing i s a Winner ' s Game.The unhappy thes is of th is a r t ic le can bebr i ef l y s t at e d : O w ing t o impor t a n t c ha nge s i n t hepa s t t e n ye a r s , t he se ba s i c a s sumpt ions a r e nolonger t rue . On the cont ra ry, marke t l iquidi ty i s aliability r a the r t ha n a n asset, and ins t i tu t iona l inves-tor s wi l l , over the long te rm, underperform th e

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1975-1984m a r k e t b e c a u s e m o n e y m a n a g e m e n t h a s b e c om e aL o s e r ' s Gam e .Before dem ons t ra t in g wi th mathemat ical ev i -d e n c e w h y m o n e y m a n a g e m e n t h a s b e c o m e aLoser ' s Game, we sh ould c lose off the one path ofescape for those who wi l l t ry to ass imi la te thefact s . They may argue that th i s analys i s i s unfai rb ecau s e s o m u ch o f t h e d a t a o n p e r fo rm an cecomes f rom bear market exper ience, g iv ing anadverse b ias to an evaluat ion of the long- termcapabi l i t i es of managers who have por t fo l io betasabove 1 .0 . "Of course ," they wi l l concede wi thd r i p p i n g i n n u en d o , " t h es e i n t e r e s t i n g an a l y s esm ay h av e l e s s t o s ay ab o u t d y n am i c fu n d m an ag -e r s o p e ra t i n g i n a d ecen t m ark e t . " Pe rh ap s , b u tcan t h ey p res en t u s w i t h ev i d en ce t o s u p p o r t t h e i rh o p es ? C an t h ey s h o u l d e r t h e b u rd en o f p ro o f?Af t e r m an y h o u r s o f d i s cu s s i o n w i t h p ro t e s t i n gm o n ey m an ag er s a l l o v e r Am er i ca an d i n C an ad aan d E u ro p e , I h av e h ea rd n o n ew ev i d en ce o rp e r s u as i v e ap p ea l f ro m t h e h a rd j u d g m en t t h a tfo l lows the ev idence presented below. In br ief , the"problem" is not a cycl ical aberrat ion; i t is along- term secular t rend .The bas ic character i s t i cs of the envi ronmentwi th in which ins t i tu t ional inves tors mus t operateh av e ch an g ed g rea t ly i n t h e p as t d ecad e . T h e m o s ts ign i f i can t change i s that ins t i tu t ional inves torshave become, and wi l l cont inue to be , the domi-n an t f ea t u re o f t h e ir o w n en v i ro n m en t . T h isch an g e h as i m p ac t ed g rea t l y u p o n a l l t h e m a j o rfeatures of the inves tment f i e ld . In par t i cu lar ,ins t i tu t ional dominance has conver ted market l i -qu id i ty f rom a source of profits to a source of costs,

and th i s i s the main reason behind the t rans forma-t io n o f m o n e y m an ag em en t f ro m a Wi n n er ' s G am eto a Loser ' s Game.B efore an a l y z in g w h a t h ap p e n ed t o co n ver tins t i tu t ional inves t ing f rom a Winner ' s Game to aL o s e r ' s Gam e , we s h o u l d ex p l o re t h e p ro fo u n dd i ff e r en ce b e t w een t h es e t wo k i n d s o f "g am es . " Inmaking the conceptual d i s t inct ion , I wi l l use thewri t ings of an em inent sc ient i st , a d i s t inguishe dhis tor ian , and a reknowned educator . They are ,respect ively , Dr . Simon Ramo of TRW; naval h i s -tor ian , Admiral Samuel El l io t Morr i son; and pro-fess ional go l f ins t ructor , Tommy Armour .Simon Ramo ident i f i ed the crucia l d i f ferenceb e t ween a Wi n n er ' s Gam e an d a L o s e r ' s Gam e i nh i s excel len t book on p lay ing s t ra tegy , Extraordi-nary Tennis for the Ordinary Tennis Player. O v e r ap e r i o d o f m an y y ea r s , h e o b s e rv ed t h a t t en n i s wasn o t one g a m e b u t two. On e g am e o f t en n i s i s p l ay edby profess ional s and a very few g i f t ed amateurs ;the o ther i s p layed by a l l the res t o f us .A l t h o u g h p l ay e r s i n b o t h g am es u s e t h e s am eequipment , d ress , ru les and scor ing , and conformto the same e t iquet te and cus toms , the bas icnatures of thei r two gam es are a lmos t en t i re lydifferent . After extensive scient i fic and stat is t icalanalys i s , Dr . Ramo summed i t up th i s way: Pro-fess ional s win poin t s ; amateurs lose poin t s . Profes -s ional t ennis p layers s t roke the bal l wi th s t rong ,wel l a imed shots , th rough long and of ten exci t ingral l ies , unt i l one player is able to drive the bal l justb ey o n d t h e r each o f h i s o p p o n en t . E r ror s a r es e l d o m m ad e b y t h es e s p l en d i d p l ay e r s .

Exper t t ennis i s what I ca l l a Winner ' s GameFor the ten years ending December 3!, 1974, the funds in the Becker Secunties sample had a medianrate of return of 0.0 percent. The S&P total rate of retum over the same pedod was 1.2 percent perannum. (Within the Becker sample, the high fund's annual rate of return was 4.5 percent, the first quartilefund's retum was 1.1 percent, the median 0.0 percent, the third quartile 1.1 percent and the low fund'sannual rate of retum 5.6 percent.)Unfortunately, the relative performance of institutionally managed portfolios appears to be getting worse.Measuring returns from trough to trough in the market, the institutionally managed funds in the Beckersampler are falling farther and farther behind the market as represented b y the S&P 500 Average. Itappears that the costs of active management are going up and that the rewards rom active managementare going down.

S&P 500 Becker InstitutionalAverage Median ShortfallLast thre e market cycles 5.3% 4.1% (0.8%)(9/30/62 to 12/31/74)Las t two market cycles 2.1% 0.4% (1.7%)(12/31/66 to !2/31/74)Las t single market cycle 2.2% (0.3%) (2.5%)(9/30/70 to 12/31/74)

Data:Becker Securities 1974 Institutional Fu nds Evaluation Service.

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1 9 7 5 -1 9 8 4b ecau s e t h e u l t im a t e o u t co m e i s d e t e rm i n ed b y t h eact ions of the winner. Victory is due to winning morepoints than the opponent wins--not, as we shal l see ina moment , s imply to get t ing a h igher score thant h e o p p o n en t , b u t g e t t i n g t h at h i g h e r s co re b ywinning poin t s .Amateur t ennis , Ramo found, i s a lmos t en-t i rely different . Bri l l iant shots , long and exci t ingral l i es , and seemingly mi raculous recover ies aref ew an d f a r b e t ween . On t h e o t h e r h an d , t h e b al l i sfa i rly of ten h i t into the n et o r ou t o f bou nds , anddouble fau l t s a t serv ice are no t uncommon. Theam at eu r d u f f e r s e l d o m beats h i s o p p o n en t , b u t h ebeat s h im sel f a ll the t ime. The v ic tor in th is ga meof t ennis get s a h igher score than the Opponent ,bu t he get s that h igher score because his opponent islosing even more points.As a scient is t and stat is t ician, Dr. Ramo gath-ered data to t es t h i s hypothes i s . And he d id i t in av e ry c l ev e r way . In s t ead o f k eep i n g co n v en t i o n a lgame scores - - -"Love," "Fi f t een Al l , " "Thi r ty-Fi f -t e e n , " e t c . - ~ a m o s i m p ly c o u n t e d p o i n ts wo n ver-s u s p o i n t s lost. An d h e re i s wh a t h e fo u n d . Inexper t t ennis , a bou t 80 perce nt of the po in t s arewon; in ama teur t ennis , abo ut 80 percent of thepoin t s are lost. In o ther words , p rofess ional t ennisi s a Wi n n er ' s Ga m e- - t h e f in a l o u t co m e i s d e t er -mine d b y the act iv i t ies of the winner--and am at eu rtennis i s a Loser ' s Game--- the f inal ou tcome i sdeterm ine d by the act iv i ti es of the loser. T h e t wogames are , in thei r fundamental character i s t i c , no ta t a l l the same. They are oppos i tes .From th i s d i scovery of the tw o k inds of t ennis ,Dr . Ramo bui lds a complete s t ra tegy by whichord inary t ennis p layers can win games , se t s andmatches again and again by fo l lowing the s imples t ra tegem of los ing less , and le t t ing the opp one ntdefeat h imsel f.Dr . Ram o expla ins that i f you c hoose to win a tt e n n i s - - a s o p p o s e d t o h a v i n g a g o o d t i m e - - t h es t ra tegy for winn ing i s to avoid mis takes . The w ayto avoid mis takes i s to be conservat ive and keepthe bal l in p lay , l e t t ing the o the r fe l low have p len tyo f ro o m i n wh i ch t o b l u n d e r h i s way t o d e fea t ,b ecau s e h e , b e i n g an am a t eu r ( an d p ro b ab l y n o thaving read Ramo's book) wi l l p lay a los ing gamean d n o t k n o w i t .He wi l l make er rors . He wi l l make too manyerrors . Once in a whi le he may h i t a serve youcan n o t p o s s i b l y h an d l e , b u t m u ch m o re f r eq u en t l yhe wi l l double fau lt . Occas ional ly , he m ay vol leybal l s pas t you a t the net , bu t more of ten than notthey wi l l sa i l far ou t o f boun ds . He wi l l sl am bal l sin to the net f rom the f ron t cour t and f rom the back

cour t . His gam e wi l l be a rou t ine cata logue of gaffs ,goofs and gr ief .He w i l l t r y to b ea t y o u b y w i n n i n g , b u t h e i sn o t g o o d en o u g h t o o v e rco m e t h e m an y i n h e ren tadvers i t i es of the gam e i t sel f . The s i tuat ion do esnot a l low h im to win wi th an act iv i s t s t ra tegy andhe wi l l ins tead lose . His ef for t s to win m ore poin t swi ll , unfor tunate ly for h im, on ly increase h i s er rorra te. A s Ramo ins t ruct s us in h i s book, the s t ra tegyfor winning in a loser ' s game i s to lose less . Avoidt ry ing too hard . By keeping the bal l in p lay , g ivethe Opponent as many oppor tuni t i es as poss ib le tom ak e m i s t ak es an d b l u n d e r h i s way t o d e fea t . I nbr ief, by los ing less beco me the v ic tor .In his thoughtful t reat ise on mil i tary science,Strategy and Compromise, Ad m i ra l M o r r i s o n m ak esthe fo l lowing poin t : " In warfare , mis takes areinevi table. Mil i tary decisions are based on est i -m a t es o f t h e en em y ' s s t r en g t h s an d i n t en ti o n s t h a tare usual ly fau l ty , and on in te l ligence that i s neverco m p l e t e an d o f t en m i s l ead i n g . " (T h i s s o u n d s agreat deal l ike the inves tment bus iness . ) "Otherth ings being equal , " concludes Morr i son , " thes ide that makes the fewes t s t ra teg ic er rors wins thew a r . "War , as we a l l know, i s the u l t imate Loser ' sGame. As General Pat ton sa id : "Let the o ther poordum b b as tard lose h is l ife for h is co unt ry ." Gol f i san o t h e r L o s e r ; s Gam e . T o m m y Arm o u r , i n h i sg rea t b o o k How to Play Your Best Golf All the Time,s ays : "T h e wa y t o w i n i s b y m ak i n g f ewer b ads h o t s . "Gam b l i n g i n a cas i n o wh ere t h e h o u s e t ak es a tl eas t 20 percent of every pot i s obviou s ly a Loser ' sGam e . S t u d p o k e r i s a L o s e r ' s Gam e b u t N i g h tBasebal l wi th deuces , t rays and one-eyed Jacks"wi l d " i s a Wi n n er ' s Gam e .Camp aigning for e lected off ice i s a Loser ' sGame: The e lectora te se ldom votes for one of thecan d i d a t e s b u t r a t h e r against the o ther candidate .Profess ional po l i t i c ians advise thei r candidates :"He l p t la~ v o t e r s f i n d a wa y t o v o t e against theo ther guy , and you ' l l ge t e lec ted ."Recent s tud ies of profess ional foo tbal l havefoun d that the mo s t ef fective defens ive p la toonmembers p lay an open , ad hoc, en terpr i s ing , r i sk-tak ing s ty le- - the proper s t ra tegy for a Winner ' sGam e- -wh i l e t h e b es t o f f en s i v e p l ay e r s p l ay acarefu l , "by the book" s ty le that concent ra tes onavoid ing er rors and e l iminat ing uncer ta in ty ,which i s the requis i t e game p lan for a Loser ' sGame. "Keep i t s imple ," Said Vincent Lombard i .T h e re a r e m an y o t h e r L o s e r ' s Gam es . So m e ,l ike ins t i tu t ional inves t ing , used to be Winner ' s

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1975-1984G a me s i n t he pa s t , bu t ha ve c ha nge d w i th t hepassage of t ime into Loser's Games. For example , 50years ago, only very brave , very a thle t ic , verys t r ong w i l l e d young pe op le w i th good e ye s igh thad the nerve to t ry f lying an a i rplane . In thoseglor ious days , f ly ing was a Win ner ' s Gam e. Butt ime s ha ve c ha nge d a nd so ha s f l y ing . If you g o tinto a 747 today, and the pi lot came aboard wear -ing a 50-miss ion ha t wi th a long, whi te s i lk scar fa r ound h i s ne c k , you ' d ge t o f f . T hose pe op l e dono t be long i n a i r p l a ne s a ny l onge r be c a use f l y ingan a i rplane tod ay i s a Loser ' s Gam e. Toda y, there ' sonly on e wa y to f ly an a i rplane . I t ' s s imple : Don ' tma ke a ny mi s t a ke s .Pr ize f ight ing s ta r t s out as a Winner ' s Gamea nd be c ome s a L ose r ' s G a me a s t he f i gh tp r ogr e s se s . I n t he f i r s t t h r e e o r f our r ounds , area l ly s t rong puncher t r ies for a knockout . There-a f te r , pr ize f ight ing is a grue l l ing contes t of endu r -a nc e to s e e w h o c a n su r v ive t he mos t pun i sh me n t ,w hi l e t he o the r f e l l ow ge t s so w or n ou t t ha t hel i tera l ly drops to defea t .Exper t ca rd players know tha t a f te r severa lr o u n d s o f p l ay , g a m e s l ik e G in R u m m y g o t h r o u g ha "pha se c ha nge " a f t e r w hic h d i sc a r ds no l onge rimprove the re la t ive pos i t ion of the discardingplayer . Dur ing this la t te r phase , d iscards tend toa d d m o r e s t r e n g t h t o t h e o p p o n e n t ' s h a n d t h a nt h e y r e m o v e w e a k n e s s f r o m t h e h a n d o f th e d i s-c a r de r . T h i s c ha nge s l ong ha nds o f G in Rummyinto a Loser ' s Game, and the cor rec t s t r a tegy inthis la t te r phase of the g am e i s to eva lua te discardsn o t i n t e r m s o f h o w m u c h g o o d t h e y w il l d o f o ry o u r h a n d t o g e t r id o f t h e m , b u t r a t h e r h o w m u c hg o o d t h e y m a y d o f o r y o u r o p p o n e n t .M a ny o the r e xa mple s c ou ld be g ive n , bu tthese wi l l suf f ice to make the dis t inc t ion be tweenWinne r ' s G a me s a nd L ose r ' s G a me s , t o e xp l a inw h y the r e qu i s i te p l a ye r s t r a t e gy is ve r y d i f f e re n tf o r t he tw o k inds o f ga me s , a nd t o show tha t t hef u n d a m e n t a l n a t u r e o f a g a m e c a n c h a n g e a n d t h a tW i n n e r ' s G a m e s c a n a n d s o m e t i m e s d o b e c o m eL ose r ' s G a me s . A nd tha t ' s w ha t ha s ha ppe ne d t ot h e M o n e y G a m e .T h e M o n e y G a m e w a s a p h e n o m e n a l W i n -ner ' s G ame in the mid-1920s wh en Joh n J. Raskob,a p r omine n t bus ine s s e xe c u t ive , c ou ld w r i t e a na r ti c le f o r a popu la r m a ga z ine w i th t he e nc our a g-ing t i tle "Ev eryb od y Can Be Rich." The a r t ic le gavea c ookbook r e c ipe t ha t a nybody c ou ld , t he or e t i -ca l ly , fol low to r iches beyond the dreams of ava-r ice . The Grea t Crash abrupt ly reversed the s i tua-t i on, a n d m a de i nve s t i ng a L oser ' s G a me f o r ne a r lytw o de c a de s .

I t w a s d ur ing t he se de c a de s o f t he t h ir t ie s a ndfor t ies tha t preserva t ion of capi ta l , emphasis onthe sa f e ty o f bonds , a nd sobe r s ide d c onve n t iona lw i s d o m c a m e t o d o m i n a n c e a n d t h e f o u n d a t i o nw a s l a id f o r t he r e na i ssa nc e o f t he Winne r ' s G a me .The bul l marke t of the 1950s gave dramat ic andc ompe l l i ng e v ide nc e t ha t t he s i t ua t i on ha dc ha nge d , t ha t b ig mone y c ou ld be ma de i n t hema r ke t . A nd th i s ne w s a t t r a c t e d pe op l e w ho l i ket o m a k e b ig m o n e y - - p e o p l e w h o l ik e to w i n .T he pe op l e w ho c a me to Wa l l S t r e e t i n t he1960s ha d a lw a ys be e n- - a nd e xpe c t e d a lw a ys t ob e - - w i n n e r s . T h e y h a d b e e n p r e s i d e n ts o f t he i rhigh school c lasses , var s i ty team capta ins , andhono r s t ude n t s . T he y w e r e b r igh t , a t t r ac t i ve , ou t -go ing a nd a mbi t ious . T he y w e r e w i l l i ng to w or kha r d a nd t a ke c ha nc e s be c a use our soc i e ty ha dg i v e n t h e m m a n y a n d f r e q u e n t r e w a r d s f o r s u c hbe ha v io r . T he y ha d gone t o Y a le a nd t he M a r ine sa nd H a r va r d Bus ine s s Sc hoo l . A nd the y w e r equ i c k to r e c ogn iz e tha t t he b ig Winn e r ' s G a me w a sbe ing played in Wal l S t ree t .I t was a glor ious , wond er ful , e uph or ic t ime . I tw a s a ti m e w h e n a l m o s t a n y b o d y w h o w a s s m a r ta nd w i l li ng to w or k ha r d c ou ld w in . A nd a lmos t al lof us did .T he t r oub l e w i th W inne r ' s G a m e s i s t ha t t he yt e nd t o s e l f -de s t r uct be c a use t h e y a t t r a c t too m uc ha t te n t io n a n d t o o m a n y p l a y e r s - - a ll o f w h o m w a n tto w in . ( T ha t ' s w hy go ld r ushe s f i n ish ug ly . ) But i nt h e s h o r t ru n , t h e r u s h i n g i n o f m o r e a n d m o r ep l a ye r s s e e k ing t o w in e xpa nds t he a ppa r e n t r e -w a r d . A nd tha t ' s w ha t ha ppe ne d i n Wa l l S t r e e tdur ing th e 1960s. R iding the t ide of a bul l marke t ,ins t i tu t iona l inves tor s obta ined such splendidr a t es o f r e tu r n i n e qu i t ie s t ha t mor e a nd mor em o n e y w a s t u r n e d o v e r t o t h e m - - p a r t i c u l a r l y i nm u t u a l f u n d s a n d p e n s i o n f u n d s - - w h i c h f u e l e dthe c on t inua t i on o f the i r ow n bu l l ma r ke t . I ns t i tu -t i ona l i nve s t i ng w a s a Winne r ' s G a me a nd t hew inne r s k ne w tha t by p l a y ing i t f a s te r , t he y w ou ldincrease the ra te of winn ings . But in the process , aba s i c c ha nge oc c ur r e d i n t he i nve s tme n t e nv i r on-m e n t ; t h e m a r k e t c a m e t o b e d o m i n a t e d b y t h eins t i tu t ions .In jus t ten years , the marke t ac t ivi t ies of theinve s t i ng i ns ti t u t ions h a ve gone f r om on ly 30 per -cent of to ta l publ ic t r ansac t ions to a whopping 70pe r c e n t . A nd tha t ha s m a de a ll t he d i ff e re nc e . N olonge r a r e t he " N e w Br e e d on Wa l l S t r e e t " in t heminor i t y ; t he y a r e now the ma jo r i t y . T he p r o f e s -s io n al m o n e y m a n a g e r i s n ' t c o m p e t i n g a n y l o n g e rw i t h a m a t e u r s w h o a r e o u t o f t o u c h w i t h t h ema r ke t ; now he c ompe te s w i th o the r e xpe r t s .

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1975-1984I t 's an impress ive gr oup of compet i to rs . Thereare 150 major ins t i tu t ional inves tors and another600 smal l and medium s ized ins t i tu t ions operat ingin the market a l l day , every day , in the mos ti n t en s e l y co m p e t i t i v e way . An d i n t h e p as t d e -cade, these ins t i tu t ions have become more act ive ,have developed larger in -house research s taf fs ,

an d h av e t ap p ed i n to t h e cen t r al s o u rce o f m ark e ti n fo rm a t i o n an d fu n d am en t a l r e s ea rch p ro v i d edby ins t i tu t ional b rokers . Ten years ago , manyins t i tu t ions wer e s t il l far ou t o f the ma ins t ream ofin tens ive management ; today such an ins t i tu t ion ,i f any ex i st s , wo uld be a rare co l lec tor ' s i tem.Compet i t ively act ive ins t i tu t ional inves t inghas resu l ted in sharp ly h igher por t fo l io tu rnover .The typ ical equi ty por t fo l io tu rnover has gonefrom 10 to 30 percent . As we 've a l ready seen , th i saccelera t ion in por t fo l io act iv ity p lus the grow th inins t i tu t ional asse t s and the sh i f t o f pens io n fun dst o ward eq u i t i e s h av e i n c reas ed t h e p ro p o r t i o n o fmarket t ransact ions of ins t i tu t ions f rom 30 to 70p e rcen t wh i ch h as , i n t u rn , p ro d u ced t h e b as i c"p h as e ch an g e" t h a t h as t r an s fo rm ed p o r t fo l i oact iv i ty f rom a source of incremental p rof i t s to amajor cos t , and that t rans format ion has swi tchedins t i tu t ional inves t ing f rom a Winner ' s Game to aL o s e r ' s Gam e .T h e n ew " ru l e s o f th e g am e" can b e s e t o u t i na s imple bu t d i s t ress ing equat ion . The e lementsare these:(a) Assume equi t i es wi l l re turn an average n inepercent ra te of re turn .1(b) As s u m e av e rag e t u rn o v e r o f 30 p e rcen t p e ra n n u m .(c) As sum e a verage cos t s - - -dealer spre ads p luscommiss ions-- -on ins t i tu t ional t ransact ions arethree perce nt of the pr incipal value involved . 2(d) As s u m e m a n ag em en t an d cu s t o d y f ees t o ta l0.20 per cent .(e) Assume the goal o f the manager i s to ou tper-form the averages by 20 percent .Solv e for "X ": (X . 9) - [30 . (3 + 3)] - (0.20)= (120"9)

[30 (3 + 3)] + (0.20) + (120 9)X = 9

1 . 8 + 0 . 2 0 + 1 0 . 8X =12.8

X = - 9X = 142%.

In p l a i n l an g u ag e , t h e m an ag er wh o i n t en d sto del iver n e t re turns 20 percent bet t er than them ark e t m u s t ea rn a g ro s s r e t u rn b e fo re f ees an dtransact ions costs ( l iquidi ty tol ls) that is more than40 percen t bet t er than the market . I f th i s soundsab s u rd , t h e s am e eq u a t i o n can b e s o l v ed t o s h o wthat the act ive manager mus t beat the market g r o s sb y 2 2 p e rcen t j u s t t o co m e o u t ev en w i t h t h em ark e t net .In o ther word s , for the ins t i tu tional inves tor toperform as wel l as , but no be t t er than , the S&P 500,he m us t b e suff ic ien tly as tu te and sk il lfu l to "out -do" the market by 22 percent . But how can ins t i -tu t ional inves tors hope to ou tperform the marketby such a magni tude when, in ef fect , they are th emarket today? Which managers are so wel l s t af fedand organized in thei r operat ions , o r so prescien tin thei r inves tment po l ic ies that they can hones t lyexpect to beat the o ther profess ional s by so muchon a sus ta ined bas i s?

The d i sagreeable numbers f rom the perfor-m an ce m eas u rem en t f i rm s s ay t h e re a r e no m an -ag e r s wh o s e p as t p e r fo rm an ce p ro m i s es t h a t t h eywi l l ou tperform the market in the fu ture . Lookingbackward , the ev idence i s deeply d i s turb ing: 85p e rcen t o f p ro fes s io n a l l y m an ag ed fu n d s u n d e r -perfo rme d the S&P 500 dur ing the pas t 10 years .An d t h e m ed i an fu n d ' s r a te o f r e tu rn w as o n l y 5 .4p e rce n t - - ab o u t 1 0 p e rcen t below the S&P 500.M o s t m o n ey m an ag er s h av e b een l o s i n g t h eM o n e y Gam e . A n d t h ey k n o w i t, ev en i f t h eycannot admi t i t publ ic ly . Expecta t ions and prom-ises have come down subs tan t ia l ly s ince the mid-1960s. Almos t no bo dy st i ll talks in terms of bea t ingt h e m ark e t b y 2 0 p e rcen t co m p o u n d ed an n u a l l y .An d n o b o d y l i s t en s t o t h o s e wh o d o .In t imes l ike these , the burden of proof i s onthe person w ho says , " I am a winner . I can win theM o n ey Gam e . " B ecau s e o n l y a s u ck e r b ack s a"winner" in a Loser ' s Game, we have a r igh t toexpect h im to expla in exact ly what he i s go ing todo and why i t i s go ing to work so very wel l . Thisi s n o t v e ry o f t en d o n e i n t h e i n v es t m en t m an ag e-m en t b u s i n es s .Does the ev idence necessar i ly l ead to an en-t i re ly pass ive or index por t fo l io? No, i t doesn ' tnecessar i ly l ead in that d i rect ion . Not qu i te . Butthe "nul l " hypothes i s i s hard to beat in a s i tuat ionl ike this . At the risk of oversimplifying, the nul lhypo thes i s says there i s no th ing there i f you can-not f ind s tat is tical ly s ignificant eviden ce of i tsp res en ce . T h is wo u l d s u g g es t t o i n v es t m en t m an -ag e r s , "Do n ' t d o an y t h i n g b ecau s e wh en y o u t ryto do someth ing , i t i s on average a mis take." And

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1975-1984i f you ca n ' t beat the market , you cer ta in ly shouldcons ider jo in ing i t. An index fund i s one wa y. Thed a t a f ro m t h e p e r fo rm an ce m eas u rem en t f i rm ss h o w t h a t an i n d ex fu n d wo u l d h av e o u t p e r -f o r m e d m o s t m o n e y m a n a g e r s .Fo r th o s e wh o a re d e t e rm i n ed t o t ry to w i n t h eLoser ' s Game, however , here are a few speci f i cth ings they might cons ider .F i rs t, b e s u re y o u a re p l ay i n g y o u r o wn g am e .Kn o w y o u r p o l i c i e s v e ry we l l an d p l ay acco rd i n gto them al l the t ime. Admiral Morr i son , c i t ing theConcise Oxford Dictionary, s ay s : " Im p o s e u p o n t h een em y t h e t i m e an d p l ace an d co n d i t i o n s fo rf i g h t i n g p re fe r r ed b y o n es e l f . " S i m o n R am o s u g -g es ts : "G i v e t h e o t h e r f e l l o w as m an y o p p o r t u n i -t i es as poss ib le to make mis takes , and he wi l l doSO."

Second, keep i t s imple . Tommy Armour , t a lk-ing about go l f , says : "Play the shot you 've got thegreates t chanc e of p lay ing wel l . " Ramo says : "Ev-e ry g am e b o l l s d o wn t o d o i n g t h e t h i n g s y o u d ob es t , an d d o i n g t h em o v e r an d o v e r ag a in . " Ar -mour again : "Simpl ic i ty , concent ra t ion , and econ-o m y o f ti m e an d e f for t h av e b een t h e d i s t i n g ui s h -ing features of the great p layers ' meth ods , whi leo t h e r s l o s t t h e i r way t o g l o ry b y wan d er i n g i n amaze of deta il s .' " Mies Van der Rohe, the arch i tec t ,s u g g es t s , "L es s is m o re . " W h y n o t b r i n g t u rn o v e rdo wn as a del ibera te , conscien t ious pract i ce? Makefewer an d p e rh ap s b e t t e r i n v es t m en t d ec i s i o n s .S i m p li fy t h e p ro fes s i o n a l i n v es t m en t m a n ag em en tproblem. Try to do a few th ings unusual ly wel l .T h i rd , co n cen t r a t e o n y o u r d e fen s es . A l m o s ta l l o f the in format ion in the inves tment manage-m en t b u s i n es s i s o r i en t ed t o ward p u rch as e d ec i -s ions . The compet i t ion in making purchase deci -

s ions i s too good. I t ' s too hard to ou tperform theother fe l low in buying . C oncent ra te on se l l ingins tead . In a Winner ' s Game, 90 percen t of a llr e s ea rch e f fo r t s h o u l d b e s p en t o n m ak i n g p u r -chase deci s ions ; in a Loser ' s Gam e, mos t research-ers should sp end mos t of thei r t ime mak ing se l ldeci s ions. Almo s t a l l o f the real ly b ig t rouble thatyou ' re go ing to exper ience in the next year i s inyour por t fo l io r igh t now; i f you could reduce someo f t h o s e r ea l ly b ig p ro b l em s , y o u m i g h t c o m e o u tt h e w i n n e r i n t h e L o s e r ' s Gam e .

Four th , don ' t t ake i t personal ly . Mos t of thep eo p l e i n t h e i n v es t m en t b u s i n es s a r e "w i n n e r s "who have won a l l thei r l ives by being br igh t ,ar t i cu la te , d i sc ip l ined and wi l l ing to work hard .T h ey a re s o accu s t o m ed t o s u cceed i n g b y t ry i n gharder and are so used to bel i ev ing that fa i lu re tosucceed i s the fa i lu re ' s own fau l t that they mayt ak e i t p e r s o n a l l y wh en t h ey s ee t h a t t h e av e rag ep ro fes s i o n a l l y m an ag ed fu n d can n o t k eep p acewi t h t h e m ark e t an y m o re t h an J o h n Hen ry co u l dbeat the s team dr i l l .

There i s a c lass of d i seases which are cai l ed" i a t rog en i c" m ean i n g t h e y a r e d o c t o r- cau s ed . T h eChinese f inger cage and the modern s t ra igh t jacketmos t t igh t ly gr ip the person who s t ruggles tobreak free. Ironical ly, the reason inst i tut ional in-v es t i n g h as b eco m e t h e L o s e r ' s Gam e i s t h a t i n t h ecomplex problem each manager i s t ry ing to so lve ,h i s ef fort s to f ind a so lu t i on- -an d the ef for t s o f h i sm an y u rg en t co m p e t i t o r s - - -h av e b eco m e t h e d o m -inant var iab les. A nd thei r ef fort s to beat the m arketa re n o l o n g e r t he m o s t i m p o r t an t p a r t o f th eso lu t ion ; they are the mos t impor tan t par t o f thep ro b l em .

Foo'rNOTES1. Use of 9 percent is for convenience only, and is an accom-modation to its conventional acceptance. If time permitted,I'd prefer to justify and then use a figure of, perhaps, 12percent for the next decade which would reflect he market'sreflection of expected inflation.

2. This estimate was m ade by the senior trading partner of amajor institutional block rading firm. O ther expe rts indicatethis estimate may be low.

100 Financial Analysts Journal / January-February 1995