Bridge over ocean
12 July 2018 Financial Analysts Journal Book Review

Winning the Loser's Game (a review)

  1. Martin S. Fridson, CFA
This book’s greatest value to investment professionals is its analysis of the organizational dynamics of institutional investing. It offers unconventional advice to investment committees and describes a built-in conflict of interest between investment consultants and their pension and endowment clients. The author also documents changes in market structure that have made it increasingly difficult over time for active managers to outperform their benchmarks. Private wealth managers can benefit from an excellent chapter on trusts and estates, as well as other material aimed primarily at individual investors. Now in its seventh edition, Winning the Loser’s Game richly deserves its reputation as a must-read classic.

An ideal investment committee meeting takes only five minutes, with no decisions reached to change either managers or investment policies. This idea may seem counterintuitive, but in a well-administered fund, nothing interesting—that is, problematic—is going on in the portfolio. Manager reviews should include almost no discussion of the economic outlook, interest rates, or the manager’s latest changes in sector weightings—all details of investment operations with which the investment committee ought not concern itself. Investment committees should hope to retain existing managers forever and seriously consider allocating additional funds to those who have underperformed recently.

These unconventional propositions come from the chapters most relevant to investment professionals in the excellent Winning the Loser’s Game, a book aimed in large measure at individual investors. Author Charles Ellis has advice for those readers as well. He cautions them against attempting to vie with professional managers in an effort to outperform the market, especially considering that even the professionals rarely succeed in doing so.

During the past several decades, Ellis documents, success has grown more elusive for active managers. Institutions have become by far the dominant players, resulting in less opportunity to profit from the naive mistakes of non-professionals. Corporate information has become more widely disseminated, making it harder for portfolio managers to gain an edge against equally well trained and motivated competitors. That story is well told in Ellis’s The Index Revolution, reviewed in the Financial Analysts Journal® in November 2016.

To be sure, this book contains many nuggets useful to both individual investors and professionals, including those who manage money for individuals. For example, Ellis informs fans of commodities that in early 1980, an ounce of gold sold for more than $2,250, in inflation-adjusted terms. (The early 2017 price was under $1,200.) Concerning the likely futility of market timing, he notes that over a 20-year span, all of the return on stocks was earned on just five trading days. Ellis also points out that the more that a manager invests in asset classes outside the investment mandate, the more difficult it becomes to distinguish luck from skill in measuring the manager’s performance. The chapter on trust and estate issues could literally be worth millions to well-heeled readers, and their advisers should study it carefully.

For CFA® charterholders, however, the book’s most valuable contribution is its trenchant analysis of the organizational dynamics of institutional investing. For instance, Ellis points out that the rational business strategy for consultants to pensions and endowments is to focus above all on client retention, because the marginal profit on a client, once the cost of creating and maintaining a database of managers has been covered, is 90%. A proven way for consultants to minimize client defections is to induce clients to hire multiple managers within each asset class, thereby limiting the risk of one recommended manager’s poor performance causing an institution to lose confidence in its consultant. Unfortunately, this strategy is contrary to the clients’ interests. Given the availability of low-cost institutional index funds, says the author, “the use of multiple active managers cannot be justified as a way to diversify a public securities portfolio.”

Winning the Loser’s Game is not free of minor flaws. Notwithstanding the author’s assertions, Ben Franklin never said, “A penny saved is a penny earned,” and Ernest Hemingway did not actually remark, in response to F. Scott Fitzgerald’s observation that the rich are different, “Yes, they have more money.” Contrary to Ellis’s statement, companies seek to move down, rather than up, the experience curve, which plots cumulative units produced against unit cost. Finally, several of the book’s data-rich graphs omit source lines.

Notwithstanding these small imperfections, Winning the Loser’s Game is a gem. Building on Ellis’s immensely influential 1975 Financial Analysts Journal article “The Loser’s Game,” the book has richly earned Martin Leibowitz’s description as “a must-read classic that has stood the test of time.” This seventh edition conveys lessons from the still painful experience of the Global Financial Crisis and Bernard Madoff’s infamous Ponzi scheme. Novice and veteran practitioners alike will profit from repeated readings of it.

We’re using cookies, but you can turn them off in Privacy Settings.  Otherwise, you are agreeing to our use of cookies.  Accepting cookies does not mean that we are collecting personal data. Learn more in our Privacy Policy.