No. of Recommendations: 2
Do you think that 'we' could outperform the pros if we restricted ourselves to only 'true' AA and AAA bonds?


Pick any benchmark you choose and a dedicated amateur should always “beat” fund managers on a total returns basis, on average and over the long haul, for two reasons:

(1) The amateur is working for free. (Thus, expenses tend to be less.)
(2) The amateur isn’t burdened with stupid shareholders who yank money away at market bottoms (when the buying needs to be done), and throw money at the fund at market tops (when everything is too expensive and the selling should be done).

However, two further things must be recognized:
(1) The typical fund manager has access to research and trading advantages that the typical amateur, no matter how dedicated, cannot match.
(2) The good fund managers have a passion for the game and a depth of experience that the typical amateur, no matter how dedicated, will probably never match, much less exceed.

Thus, in a one-to-one contest, where each person was only running his own portfolio, the typical dedicated amateur would probably lose to a good fund manager. But in a contest in which an amateur was benchmarking his results against those achieved by mutual funds with the same investment objective, a top 5% performance isn’t hard to achieve. If a top 5% performance is “beating the pros”, then, yes, an amateur can do it.

The question becomes: Does he want to do it? How valuable his is time? What would he rather be doing than managing his own money? If he has a passion for the game, then he’s playing for the personal challenge of it and beating the fundies is just one way of keeping score.

To answer your specific question about restricting bond purchases to AAA and AA, my suggestion is that such a thing shouldn’t be attempted (if you’re thinking of just corporates), because the parameters are too narrow. Pull a list of all companies rated both AAA and Aaa. You can name them on one hand or two at the most. That’s too small an investing universe to bother with. If you include in the AAA/Aaa group agencies, munis, and treasuries, then, yes, the investing universe has now become big enough to discover the sorts of exploitable inefficiencies that a small and nimble player can use to his advantage. If the universe is extended to also include companies that proper due diligence could demonstrate were “genuine” double AA/Aa’s, then the universe gets more interesting.

But the “benchmarking” problem would still remain. No one in the fund world restricts their buying to AAA/AA. They all go at least one tier lower to include single-A’s. Those three levels describe “top-tier”. There’s a few funds that restrict their buying to top-tier, but not many. Thus, if you restrict yourself to AAA/AA, you’d have no one to compete with but yourself, which might not be a problem. There is no requirement that an individual investor has to "beat" an external benchmark as “proof” of the worthiness of his investment goal. Excellence for its own sake can be its own goal.

If you are really and truly serious about this project of seeing just how far you could push the limits of achievement within the constraint of “only AAA/AA”, then start a new thread and I’ll play devil’s advocate. Your idea has merit, but you’re overlooking some things you should consider, such as how you intend to establish “true AAA/AA”, how you intend to manage downgrades, how you want to handle position sizing, etc. In short, you need to create a very detailed investment plan of What? When? How Much? How long?

But if the goal of your project is the Holy Grail of “better-than average returns with safer than average risks”, then stop right here, because you’re wasting your time. That cannot be done. But Ben Graham’s “low-effort, low-risk and reasonable returns”? Yes, that can be done, although an artificial constraint like “only AAA/AA” will make the project harder, not easier, nor safer. In fact, just the opposite will probably be true. As I said, think it through very carefully what it is that you’d like to achieve and then start a new thread (or not).

Best wishes, Charlie
Print the post  


What was Your Dumbest Investment?
Share it with us -- and learn from others' stories of flubs.
When Life Gives You Lemons
We all have had hardships and made poor decisions. The important thing is how we respond and grow. Read the story of a Fool who started from nothing, and looks to gain everything.
Contact Us
Contact Customer Service and other Fool departments here.
Work for Fools?
Winner of the Washingtonian great places to work, and Glassdoor #1 Company to Work For 2015! Have access to all of TMF's online and email products for FREE, and be paid for your contributions to TMF! Click the link and start your Fool career.