Book Review: Winning the Loser’s Game

Winning the Loser’s Game: Timeless Strategies for Successful Investing, Seventh Edition. 2017. Charles Ellis, CFA.

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 Enterprising Investor in December 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.” (Although Hemingway put the line in Fitzgerald’s mouth in the magazine version of his story “The Snows of Kilimanjaro,” in real life the quip originated with literary critic Mary (aka Molly) Colum. It is also doubtful that baseball star Yogi Berra said, as Ellis contends, “It’s déjà vu all over again.”)  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 CFA Institute 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.

More book reviews are available on the CFA Institute website or in the CFA Institute Financial Analysts Journal^®.

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All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.

Martin Fridson, CFA

Martin Fridson, CFA, is, according to the New York Times, “one of Wall Street’s most thoughtful and perceptive analysts.” The Financial Management Association International named him its Financial Executive of the Year in 2002. In 2000, Fridson became the youngest person ever inducted into the Fixed Income Analysts Society Hall of Fame. He has been a guest lecturer at the graduate business schools of Babson, Columbia, Dartmouth, Duke, Fordham, Georgetown, Harvard, MIT, New York University, Notre Dame, Rutgers, and Wharton, as well as the Amsterdam Institute of Finance. Fridson’s writings have been praised widely for their humor, rigor, and utility. He holds a BA in history from Harvard College and an MBA from Harvard Business School.