What It Means To Beat The Market
April 27, 2009 by Tisa Silver
Filed under Finance
I caught some flack about my statement in yesterday’s post that few managers beat the market. Today, I will clarify what I mean when I use the term “beat the market.”
In order to “beat the market” a manager needs to provide consistent positive excess returns. Let me explain each quality of the returns.
Photo by bfishadow, courtesy of flickr
Consistent – Earning a higher rate of return for one or two years could be a string of luck, so a manager needs to achieve a sustained pattern of outperformance to prove that it is due to talent or skill.
Positive - This one is pretty obvious. If the market loses, then the manager should lose less or gain. If the market gains, then the manager should gain more.
Excess – Excess returns are risk-adjusted. Taking on higher risk should provide higher returns, so earning a higher rate of return is not enough.
If you outperform your index while assuming a similar (or lower) level of risk, then you have achieved excess returns.
Given my definition of “beating the market,” now you know why I wasn’t surprised by the results of S&P’s findings that most managers do not beat the market.
It is possible to beat the market, but it is not easy!
