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Where to start with S&S?

Investment discussion for beginners. Why you should invest your money, get help getting started
AleisterCrowley
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Re: Where to start with S&S?

#117576

Postby AleisterCrowley » February 12th, 2018, 12:19 pm

Alaric wrote:
You can replicate an index by buying all the stocks it contains. Suppose you then went through each company with a fine accounting tooth comb and discarded all those where the balance sheet or business proposition didn't make for a long term profitable and dividend paying business. If you managed to dodge the likes of Carillion or even short sell them, I suspect you can beat the portfolio index. But is the extra cost in research worth the extra performance from not having the dogs? Perhaps it's different for institutional investors paying for research as compared to private ones who would do their own legwork.


I assume all the 'professionals' have done that already, and any doubts about viability as 'a long term profitable and dividend paying business' are reflected in the current price.
If Carillion, for example, was easy to spot as a dog, the price would have collapsed. The fact that the it didn't until various skeletons started dropping out of the cupboard suggests otherwise

Alaric
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Re: Where to start with S&S?

#117584

Postby Alaric » February 12th, 2018, 12:34 pm

AleisterCrowley wrote:If Carillion, for example, was easy to spot as a dog, the price would have collapsed. The fact that the it didn't until various skeletons started dropping out of the cupboard suggests otherwise


Perhaps analysts are too trusting of accounts. The Carillion balance sheet was full of "goodwill" as an asset. That can vanish very rapidly particularly if "goodwill" was only present to balance the books after an acquisition.

By way of explanation, when one Company takes over another, it frequently has to pay more than the notional net worth of the purchased company. So it might pay 130 for an accounted 100 of new assets. When the two balance sheets are consolidated, there's a 30 hole, because 130 has been paid for 100 of net assets. So 30 is added to the balance sheet as "goodwill", else otherwise a loss of 30 would have to be declared.

GeoffF100
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Re: Where to start with S&S?

#117587

Postby GeoffF100 » February 12th, 2018, 12:39 pm

I looked at the first article on Buffet's performance:

https://www.statslife.org.uk/economics- ... orang-utan

This article just considered Buffet's performance in isolation, and concluded that the probability that his result was due to chance was about 1 in 50,000, over the period considered. However, Buffet was not the only fund manager entering the race. If 50,000 fund managers entered the race, there would be an even chance that one of them would achieve Buffet's success.

There are currently about 10,000 fund mutual fund managers in the US:

https://www.statista.com/topics/1441/mutual-funds/

In the world as a whole, there are substantially more investment management managers of all kinds, and the turnover is high. Fund managers typically start up lots of funds, and quickly wind up the unlucky ones. The total number of investment managers in the relevant period is likely to be more than 50,000. There is therefore no reason to believe these results were not due to chance.

hiriskpaul
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Re: Where to start with S&S?

#117613

Postby hiriskpaul » February 12th, 2018, 2:24 pm

SalvorHardin wrote:
hiriskpaul wrote:I would really like to see the analysis that Buffett's returns have been statistically shown to be due to skill. I strongly suspect such analysis is lacking in much rigour. That is not to say Buffett is not a brilliant and eloquent businessman. In fact I rather like the advice he gives to private investors ;)

https://www.youtube.com/watch?v=y4tITwhEfFE

My statistics ability has atrophied due to a lack of use in the past decade, so I'm unable to do a t-test!

Here are a few starters. If you've got access to academic databases you might be able to find some of the papers in the 1980s which looked into Buffett. I know from conversations with people over the years that academics started to ignore Buffett after a while because his performance contradicted efficient market theory.

https://www.statslife.org.uk/economics- ... orang-utan

http://brooklyninvestor.blogspot.co.uk/ ... s-etc.html

https://www.theglobeandmail.com/globe-i ... cle624079/

Academia has come a long way since the 1980s. For one thing, they no longer think in terms of a single risk factor. Here is an article by Larry Swedroe that explains the modern thinking behind Buffett's success: http://www.etf.com/sections/index-inves ... nopaging=1

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Re: Where to start with S&S?

#117619

Postby hiriskpaul » February 12th, 2018, 2:42 pm

Alaric wrote:
AleisterCrowley wrote:If Carillion, for example, was easy to spot as a dog, the price would have collapsed. The fact that the it didn't until various skeletons started dropping out of the cupboard suggests otherwise


Perhaps analysts are too trusting of accounts. The Carillion balance sheet was full of "goodwill" as an asset. That can vanish very rapidly particularly if "goodwill" was only present to balance the books after an acquisition.

By way of explanation, when one Company takes over another, it frequently has to pay more than the notional net worth of the purchased company. So it might pay 130 for an accounted 100 of new assets. When the two balance sheets are consolidated, there's a 30 hole, because 130 has been paid for 100 of net assets. So 30 is added to the balance sheet as "goodwill", else otherwise a loss of 30 would have to be declared.

Intuitively an easy way to beat the market would be to buy the market and short (or just exclude) the obvious junk. However, the evidence suggests this does not work! The difficulty with the strategy lies in identifying the junk. Some junk goes out of business, but some produce miraculous turnarounds. You could do a Buffett and go for quality, but these days quality commands premium prices because too many market participants know all about factors such as quality and value. Another difficulty is what to do when a previously purchased quality company runs into difficulties - most will at some point.

If beating the market was as easy as going for quality, more fund managers would do it and so drive out any price advantage of quality companies.

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Re: Where to start with S&S?

#117630

Postby hiriskpaul » February 12th, 2018, 3:09 pm

GeoffF100 wrote:Mr Shark says that people buy trackers because of XYZ, and goes on to show that XYZ is nonsense. Mr Investor says "I am glad you told me that. These people who buy trackers are clearly daft. I am glad I did not buy one. "Of course," says Mr Shark, that does not mean that beating the market is easy. You cannot do it yourself. In fact most fund managers cannot do it. It requires a special skill, but the good news is that I have that skill." I am glad to hear that," says Mr Investor. "I am afraid that skill is expensive though. You will have to pay me more than you pay yourself, but it will be worth it because I can beat the market." "You seem to be very confident that you can beat the market," says Mr Investor, "What happens if you fail?" "You still pay my fee," says Mr Shark. "Do you compensate me for your failure to beat the market," asks Mr Investor. "No," says Mr Shark.


I used to think that private investors bought into active funds, despite the mounting evidence that this was likely to lead to under performance, because a) they were ignorant of the research and b) expert marketing. However, I now think there is another psychological aspect to it. Even if someone is fully aware of the research and sees through or is not influenced by the marketing, then they may still pick actively managed funds. That is because people are attracted by the possibility of beating the market, even if it is unlikely to happen over the long term. This is a good thing as an efficient market requires investors to behave this way. Someone has to pay for price discovery and those of us who buy market trackers don't contribute to this.

Investors who buy a market tracker will beat most of the investors who opt for the services of the Sharks, but the Sharks do provide the possibility of beating the market and for a lot of people, that is attractive.

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Re: Where to start with S&S?

#117653

Postby GeoffF100 » February 12th, 2018, 4:12 pm

As far as psychology is concerned, I expect that the main factor is that most people believe what they want to believe. They want to believe that the world is predictable, and want to believe that they can get rich with no effort at all. When someone tells them that this is all true, they are all ears. When they are told that this is not true, they do not want to know.

There are of course plenty of other examples of this psychology. Why do politicians who make such obviously unrealistic promises get elected, for example?

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Re: Where to start with S&S?

#117661

Postby Alaric » February 12th, 2018, 4:36 pm

hiriskpaul wrote:I used to think that private investors bought into active funds, despite the mounting evidence that this was likely to lead to under performance,


The theories of index hugging assert that you only beat the market by luck or increasing risk.

Why should a private investor not accept higher risk than a market average? If the theories are correct, don't they give themselves a fighting chance of a higher return?

SalvorHardin
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Re: Where to start with S&S?

#117671

Postby SalvorHardin » February 12th, 2018, 4:58 pm

hiriskpaul wrote:I used to think that private investors bought into active funds, despite the mounting evidence that this was likely to lead to under performance, because a) they were ignorant of the research and b) expert marketing. However, I now think there is another psychological aspect to it. Even if someone is fully aware of the research and sees through or is not influenced by the marketing, then they may still pick actively managed funds. That is because people are attracted by the possibility of beating the market, even if it is unlikely to happen over the long term. This is a good thing as an efficient market requires investors to behave this way. Someone has to pay for price discovery and those of us who buy market trackers don't contribute to this.

Investors who buy a market tracker will beat most of the investors who opt for the services of the Sharks, but the Sharks do provide the possibility of beating the market and for a lot of people, that is attractive.

The thing is that quite a few private investors have beaten the market consistently. We're our own fund managers. There were a lot of us back in the early 2000s on TMF who did quite a bit of work as a collective looking at small oil companies (I won't name names, they know who they are).

It wasn't too tough; there were companies whose shares were trading with implied prices for oil in the ground for a few cents per barrel when if they were bought in a trade sale the price would have been going for dollars per barrel. These price anomolies shouldn't have existed according to efficient market theory - but they did. So we made hay whilst the sun shone and boy did it shine for a few years. Apparantly we were "lucky". Me; I retired before turning 40, had I relied on passive funds I'd still be in work some 15 years later.

But hey, if people are so desperate to "prove" that no-one can beat the market by skill then if that floats their boat go right ahead (it's nice to have competitors who don't think that it's worth trying). Academics have put in a lot of time trying to prove that no-one can consistently beat the market except by luck, then along comes the Buffett's, Fishers and others, which they have to ignore particularly since in order for their claims to hold they must accept Strong Efficient Market Theory (less strong versions mean that anomolies must exist which in turn can be exploited by some people)

P.S. The Superinvestors of Graham & Doddville, Buffett's 1984 lecture, pretty much demolishes the idea that no-one can beat the market by skill. But hey, if people want to think that he (and the group of value investors mentioned here) are just lucky, go right ahead.

https://www8.gsb.columbia.edu/articles/ ... rinvestors

And as to people buying active funds, if you buy assets at a discount to NAV (as can often happen with investment trusts) then you can outperform the trackers if the discount narrows. And you're getting more income for the same money as the trackers (an important feature for some investors)

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Re: Where to start with S&S?

#117677

Postby hiriskpaul » February 12th, 2018, 5:17 pm

Alaric wrote:
hiriskpaul wrote:I used to think that private investors bought into active funds, despite the mounting evidence that this was likely to lead to under performance,


The theories of index hugging assert that you only beat the market by luck or increasing risk.

Why should a private investor not accept higher risk than a market average? If the theories are correct, don't they give themselves a fighting chance of a higher return?

That is a complicated question! The answer depends on the type of risk being taken - not all risks are compensated, i.e. not all risks have a positive expected return. A simple example is investing in a single stock. In portfolio theory, you don't get rewarded (rewarded on average, you might get lucky) for taking what is known as unsystematic risk - risk that can be diversified away. Hence buying a single stock is riskier than buying the whole market but you would not expected to be rewarded for the extra risk. Actually more stocks underperform the market than outperform it, so investing in just 1 stock means you are more likely to underperform the market than outperform it.*

Other uncompensated risks are currency risk and fund manager risk. Fund manager risk is negative due to the fund management charges.

There are risks that can be taken that are expected to have a positive return (before costs). The classic additional risk factors are Value (low price/book) and Size (smaller caps), but Quality (odd one that) and Momentum also have expected positive return. Gearing is another compensated risk. So with borrowed money, load up on quality small caps on cheap valuations that have rising prices! There is no guarantee this will work of course, but over the long haul it is increasingly likely too, provided you remain solvent. Unless of course the market has priced in all this stuff about risk factors.



*I have a friend from University that started work for a firm shortly after leaving University. He stayed with the same firm for many years, taking up all his share options and investing in the company's shares, and no other shares. A very dangerous thing to do. If the company went bust he would lose his job and his savings, but the company concerned was Microsoft. He stopped work some time ago and now lives off his dividends. Just goes to show how well someone can do with a poor investment strategy.

Itsallaguess
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Re: Where to start with S&S?

#117686

Postby Itsallaguess » February 12th, 2018, 5:36 pm

hiriskpaul wrote:
I have a friend from University that started work for a firm shortly after leaving University. He stayed with the same firm for many years, taking up all his share options and investing in the company's shares, and no other shares. A very dangerous thing to do.

If the company went bust he would lose his job and his savings, but the company concerned was Microsoft. He stopped work some time ago and now lives off his dividends.

Just goes to show how well someone can do with a poor investment strategy.


On the old TMF boards, one of the older posters did a similar thing with Lloyds shares. A huge holding, dividend-reinvestment, the lot....

That didn't work out so well, and just went to show how very very badly someone can do with a poor investment strategy....

Diversify, diversify, diversify......

Cheers,

Itsallaguess

hiriskpaul
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Re: Where to start with S&S?

#117695

Postby hiriskpaul » February 12th, 2018, 6:36 pm

SalvorHardin wrote:
hiriskpaul wrote:I used to think that private investors bought into active funds, despite the mounting evidence that this was likely to lead to under performance, because a) they were ignorant of the research and b) expert marketing. However, I now think there is another psychological aspect to it. Even if someone is fully aware of the research and sees through or is not influenced by the marketing, then they may still pick actively managed funds. That is because people are attracted by the possibility of beating the market, even if it is unlikely to happen over the long term. This is a good thing as an efficient market requires investors to behave this way. Someone has to pay for price discovery and those of us who buy market trackers don't contribute to this.

Investors who buy a market tracker will beat most of the investors who opt for the services of the Sharks, but the Sharks do provide the possibility of beating the market and for a lot of people, that is attractive.

The thing is that quite a few private investors have beaten the market consistently. We're our own fund managers. There were a lot of us back in the early 2000s on TMF who did quite a bit of work as a collective looking at small oil companies (I won't name names, they know who they are).

It wasn't too tough; there were companies whose shares were trading with implied prices for oil in the ground for a few cents per barrel when if they were bought in a trade sale the price would have been going for dollars per barrel. These price anomolies shouldn't have existed according to efficient market theory - but they did. So we made hay whilst the sun shone and boy did it shine for a few years. Apparantly we were "lucky". Me; I retired before turning 40, had I relied on passive funds I'd still be in work some 15 years later.


One advantage private investors who pick there own securities have is they don't pay management charges. Lesser researched areas, such as small caps, can and do produce far more anomalies than in the mainstream large/mid cap markets. I invest in distressed debt, which is another area that is often overlooked and can produce excellent risk adjusted returns. Part of the reason is because so many institutional investors become forced sellers once debt drops out of investment grade. Other reasons are hard to fathom, for example, the 2 Lloyds preference shares LLPC and LLPD have identical terms in all respects except one - LLPC pays 9.25% and LLPD 9.75%, yet for several years you could make risk free money by trading back and forth between them. Another example is the Santander UK pref SAN. The payout on this jumped by 11.1% after Osborne changed how dividends were taxed, but it took months for this to be reflected in the price.

But hey, if people are so desperate to "prove" that no-one can beat the market by skill then if that floats their boat go right ahead (it's nice to have competitors who don't think that it's worth trying). Academics have put in a lot of time trying to prove that no-one can consistently beat the market except by luck, then along comes the Buffett's, Fishers and others, which they have to ignore particularly since in order for their claims to hold they must accept Strong Efficient Market Theory (less strong versions mean that anomolies must exist which in turn can be exploited by some people)


I am not sure people are desperate to prove anything. Most academics seek to understand things, especially anomalies. Most (but not all) funds underperform appropriate benchmarks over the long term - this is a well established fact. Another well established fact is that fund performance is inconsistent such that it is not possible to gain an edge by studying a fund's past performance. You may not like either of these facts and may dispute them, but I have looked at the research and can find no flaws, nor any proper evidence that points the other way. Plenty of heresay and marketing material though.

P.S. The Superinvestors of Graham & Doddville, Buffett's 1984 lecture, pretty much demolishes the idea that no-one can beat the market by skill. But hey, if people want to think that he (and the group of value investors mentioned here) are just lucky, go right ahead.

https://www8.gsb.columbia.edu/articles/ ... rinvestors

And as to people buying active funds, if you buy assets at a discount to NAV (as can often happen with investment trusts) then you can outperform the trackers if the discount narrows. And you're getting more income for the same money as the trackers (an important feature for some investors)


I don't think it is disputed that no-one can beat the market by skill. For fund managers to beat the market, other fund managers have to underperform the market as the market is largely owned by fund managers. The problem fund managers have, in mainstream large/mid cap markets, is there are too many skilled fund managers. Years ago there were far fewer skilled managers and large numbers of lesser skilled private investors who could provide the excess returns to the skilled managers. I remember reading a paper several years ago about an anomaly in either Korea or Taiwan (cannot remember which), were en-masse fund managers were beating the market. The conclusion was that there was a net transfer taking place from a large number of private day traders to professional fund managers. That just does not happen any more.

I agree with you about NAV discounts and ITs. ITs on large discounts should be able to beat trackers even if the discount does not narrow, as the additional return to shareholders through buybacks/dividends can wipe out the management fees. This trick does not always work though. I held Alliance Trust for many years due to the large discount and the fact I got reduced fees at ATST. Eventually a large activist investor came along and the discount closed, but this did not make up for the abysmal investment returns.

Absent individual security selection, a private investor has the choice between actively managed funds or tracker funds. Tracker funds are further divided into what I like to call market trackers (broad cap weighted) and various sub-sets such as large/medium/small caps, sector, value, growth, momentum, high yield, etc. I have been migrating out of active funds in the large/mid cap markets because all the evidence tells me that there is now too much skill in these markets, even in EM, so it is more likely than not that my fund picks will underperform market tracker funds over the long term. In other areas, such as small caps/AIM and private equity I stick with ITs (not that there is a choice).

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Re: Where to start with S&S?

#117708

Postby GeoffF100 » February 12th, 2018, 7:06 pm

Academics have put in a lot of time trying to prove that no-one can consistently beat the market except by luck, then along comes the Buffett's, Fishers and others, which they have to ignore particularly since in order for their claims to hold they must accept Strong Efficient Market Theory (less strong versions mean that anomalies must exist which in turn can be exploited by some people).

Not so, on both counts.

The link given by hiriskpaul shows clearly how Bufffet's out-performance arose:

http://www.etf.com/sections/index-inves ... nopaging=1

If you take account of the type of stocks he bought, and his low cost leverage, there was no out-performance. Buffet can, however, claim credit for doing what he did before the academics caught up.

As I have said, nobody believes Strong Efficient Market Theory. Nobody says that no anomalies exist, or says that they cannot be exploited by some people. Nonetheless, that does not help a private investor picking a fund. There is no way for him to pick the winner, except by chance. If he picks an index fund, he is guaranteed to finish in the top 10% (or thereabouts). If he picks a managed fund with typical costs, he has only a 10% chance of doing that well. The choice is yours.

As far as direct investors are concerned, if you take big risks you may reap big rewards. On the other hand, you may just lose your money. Yes, the TMF had its winners, but it had its losers too. It was mostly the winners who stuck around. Be thankful if you were a winner.

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Re: Where to start with S&S?

#117712

Postby hiriskpaul » February 12th, 2018, 7:42 pm

FT article that goes into more detail on the difficulties facing active managers now that stock markets have become almost fully professionally managed.

https://www.ft.com/content/6b2d5490-d9b ... eb37a6aa8e

For those without access, try googling "FT The end of active investing?" in a private window.

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Re: Where to start with S&S?

#117728

Postby hiriskpaul » February 12th, 2018, 8:30 pm

CS Article on the paradox of skill which some may find interesting.

https://research-doc.credit-suisse.com/ ... Oa39p9U%3D

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Re: Where to start with S&S?

#117824

Postby GeoffF100 » February 13th, 2018, 10:30 am

CS Article on the paradox of skill which some may find interesting.

https://research-doc.credit-suisse.com/ ... Oa39p9U%3D

Interesting paper. The main message appears to be that the pricing anomalies are not only small nowadays, but the managers chasing them all have a uniformly high level of skill and information. This makes it doubly difficult for them to beat the market.

The claim that private investors consistently lose out to the professionals is also interesting. Here are two (well known) references:

https://faculty.haas.berkeley.edu/odean ... _final.pdf

https://faculty.haas.berkeley.edu/odean ... s_2009.pdf

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Re: Where to start with S&S?

#117909

Postby hiriskpaul » February 13th, 2018, 4:18 pm

GeoffF100 wrote:
CS Article on the paradox of skill which some may find interesting.

https://research-doc.credit-suisse.com/ ... Oa39p9U%3D

Interesting paper. The main message appears to be that the pricing anomalies are not only small nowadays, but the managers chasing them all have a uniformly high level of skill and information. This makes it doubly difficult for them to beat the market.

The claim that private investors consistently lose out to the professionals is also interesting. Here are two (well known) references:

https://faculty.haas.berkeley.edu/odean ... _final.pdf

https://faculty.haas.berkeley.edu/odean ... s_2009.pdf

The paper on Taiwan chimes very much with another I read which investigated why Taiwan mutual funds were, on aggregate, managing to beat the index. At least I think it was probably Taiwan. Same conclusion - additional returns were being handed to fund managers by private investors. I had a look for up to date info on this, but could not find any research.

Many private investors also shoot themselves in the foot when they invest in funds. They do things like churning their portfolios looking for better funds than the ones they hold and sell out after a sharp drop, then later buy back in at higher prices.

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Re: Where to start with S&S?

#117961

Postby GeoffF100 » February 13th, 2018, 7:26 pm

The paper on Taiwan chimes very much with another I read which investigated why Taiwan mutual funds were, on aggregate, managing to beat the index. At least I think it was probably Taiwan. Same conclusion - additional returns were being handed to fund managers by private investors. I had a look for up to date info on this, but could not find any research.

I read some research commissioned by the FCA on costs and performance of unit trusts / OEICs. They found that the funds as a whole matched the index before costs. The volume of private trade was either too small to have an effect, or the private investors did not underperform much, or both. The most striking information, gleaned by interviewing fund management groups, was the huge cost of market impact. Their round trip cost was much larger than mine.

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Re: Where to start with S&S?

#118025

Postby GeoffF100 » February 14th, 2018, 7:48 am

The negative Taiwan results appear to have mostly the result of mismanaging the order book, and perhaps the Taiwan market was less efficient than the main markets.

The US results are more perplexing. A monkey with a dart board matches the market before costs, but private investors underperform it. How can they possibly manage that?

Suppose that this is indeed a robust phenomenon. That means that a broker can use his database to go long on the stocks that his clients are selling and short on the stocks that they are buying. He should make a fortune, with no market risk. That would be much more profitable than their main business. I am very sceptical.

The whole paper reads like an audience pleaser for a conference of fund managers. Telling them that they are no better than a monkey with a dart board would not go down well. Likening them to star baseball players, and telling them that they fail because they are all so damn good, would go down much better.

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Re: Where to start with S&S?

#118635

Postby GeoffF100 » February 16th, 2018, 3:53 pm

Here is an up to date analysis of performance persistence (or rather lack of it) for S&P 500 funds:

https://seekingalpha.com/article/414337 ... uity-funds


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