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Financing innovation 2013

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Financing innovation 2013

  1. 1. © 2009 Stanford Center for Professional Development 1 Financing Innovation: Common Mistakes Even Great Investors Make Welcome to: Today’s webinar will begin at 10 a.m. PST The audio for this webinar will be broadcasted on your computer’s speakers Hosted by Professor Peter DeMarzo
  2. 2. © 2009 Stanford Center for Professional Development 2 Presenter Paul MarcaPeter DeMarzo
  3. 3. © Peter DeMarzo 2013 Risk & Return: Insights from 86 Years of Investor History $2,655,590 $10 $100 $1,000 $10,000 $100,000 $1,000,000 1925 1935 1945 1955 1965 1975 1985 1995 2005 Year Small Stocks S&P 500 $2,041 Corporate Bonds Treasury Bills CPI $1,261 $20,463 $275,240 3
  4. 4. © Peter DeMarzo 2013 4 Return Volatility • U.S. Markets (1925-) 0 10 0 10 0 10 20 30 0 10 20 30 40 50 -60% -50% -40% -30% -20% -10% 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% >100% Annual Return Frequency(#ofyears) 3-mo Treasury Bills AAA Corporate Bonds S&P 500 Small Stocks
  5. 5. © Peter DeMarzo 2013 Risk vs. Return: The Security Market Line 5 Small Stocks S&P 500 World Portfolio Corporate Bonds Treasury Bills Mid-Cap Stocks 0% 5% 10% 15% 20% 25% 0% 10% 20% 30% 40% 50% Historical Volatility (standard deviation) Madoff
  6. 6. © Peter DeMarzo 2013 Risk vs. Return: The Security Market Line 6 Small Stocks S&P 500 World Portfolio Corporate Bonds Treasury Bills Mid-Cap Stocks 0% 5% 10% 15% 20% 25% 0% 10% 20% 30% 40% 50% Historical Volatility (standard deviation) under-diversificationunder-diversification market timingmarket timing feesfees trading coststrading costs market timingmarket timing adverse selectionadverse selection
  7. 7. © Peter DeMarzo 2013 How Do Individual Investors Behave? • Small investors tend to be under-diversified  Many hold just a few stocks  Often hold stock of the company they work for • Investors sell stocks quickly when they go up, and hold on when they fall  A tax inefficient strategy  But perhaps they know something? • A recent study (Odean & Barber): One-year Performance: Winners Sold vs. Losers Kept -1.06% 2.35% -2.0% -1.0% 0.0% 1.0% 2.0% 3.0% Rwin-Rmkt Rlose-Rmkt 7
  8. 8. © Peter DeMarzo 2013 Individuals Trade A Lot • Especially (single) men… … do they know something? Annual Turnover 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% Married Single Men Women 8
  9. 9. © Peter DeMarzo 2013 Annual Relative Return -3.0% -2.5% -2.0% -1.5% -1.0% -0.5% 0.0% Married Single Men Women Individual Performance • Their performance doesn’t show it … they underperform the market: Net of transactions costs 9
  10. 10. © Peter DeMarzo 2013 WSJ: Heard on the Street • WSJ publishes info from analysts  Already given to clients  Is it useful once it is published? Good news Bad news 10
  11. 11. © Peter DeMarzo 2013 Swimming with Sharks: Picking Stocks, or Picked Off? • Active trading exposes an investor to “adverse selection”  Whenever you buy, you’re filling someone else’s sell  Only one of you can beat the market! • IPOs  Average first day return = 15%  Let’s invest $10k in every IPO! 11 Frequency First Day Return Your Allocation 80% 20% $500 20% -5% $8000 Average: 15% $0
  12. 12. © Peter DeMarzo 2013 Booyah! • Mad Money recommendations (Engelberg, Sasseville & Williams 2009) 12
  13. 13. © Peter DeMarzo 2013 Mutual Fund Performance • Mutual funds don’t fare much better  Underperformance is closely correlated with fund fees • This does not mean it is impossible to beat the market  But it is either luck, or otherwise unsustainable  Or involves hidden risks  Or it is based on something that is hard to copy • Access to information or unique investment opportunities • Investments in trading efficiency • Unique talent Annual Alpha of U.S. Mutual Funds Relative to Broad-Based Market Index (1963-1998) -2.13% -8.45% -5.41% -2.17% -0.39% -0.51% -2.29% -1.06% All Funds Small- company growth funds Other aggressive growth funds Growth funds Income funds Growth and income funds Maximum capital gains funds Sector funds But in this case why would fund managers give it away? 13
  14. 14. © Peter DeMarzo 2013 Institutional Fund Managers 14 0.0 0.5 1.0 1.5 2.0 2.5 3.0 3.5 4.0 -3 -2 -1 0 1 2 3 Years Relative to Hiring Date Hiring Date Average
  15. 15. © Peter DeMarzo 2013 Active vs. Passive Investing • Why Passive Investing Must Win on Average  Avg. Passive Investor Earns: ?  Avg. Active Investor Earns: ?  Less: Trading Costs (2-3%)  Less: Tax Costs (2-4%)  Avg. Investor Earns: ? • For some investors to beat the market, other investors must be willing to lose to the market Market Index Return Market Index Return Market Index Return 15
  16. 16. © Peter DeMarzo 2013 Are There “Hot Hands”? • Can we use past performance to pick winning funds?  From 12/31/90 until 12/31/00, invest in the “model portfolio” from the best performing newsletter of the prior year • S&P 500: $100,000 → $513,000 • Newsletter: $100,000 → $ 70,752  Forbes Honor Roll of Outstanding Mutual Funds • Invest in Honor Roll funds each year for 25 years • Annual Return = 13.6% (not counting sales loads) • S&P 500 Return = 14.3% 16
  17. 17. © Peter DeMarzo 2013 A Star has Fallen: Bill Miller’s Legg Mason Value Trust 17 0 200 400 600 800 1000 1200 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 Year End LMVTX SP500 Morningstar “Manager of the Year” Morningstar “Manager of the Decade” Fortune “Greatest Manager of Our Time”
  18. 18. © Peter DeMarzo 2013 Are There “Hot Hands”? • Can we use past performance to pick winning funds?  From 12/31/90 until 12/31/00, invest in the “model portfolio” from the best performing newsletter of the prior year • S&P 500: $100,000 → $513,000 • Newsletter: $100,000 → $ 70,752  Forbes Honor Roll of Outstanding Mutual Funds • Invest in Honor Roll funds each year for 25 years • Annual Return = 13.6% (not counting sales loads) • S&P 500 Return = 14.3%  There is, however, some persistence in mutual fund returns: • Bad funds tend to stay bad! 18
  19. 19. © Peter DeMarzo 2013 Some Final Thoughts… • We can’t all be above average!  For one investor to beat the market, another must lose  You’re “betting against Buffet” when • You try to pick individual stocks, or time the market • It pays to be passive  Only be active when • You have a good reason to be different • You have good reason to think you’re above average • Beware of fees  Active managers often take more than they add  Even 1%/yr over your career > 1/3 of your retirement! 19
  20. 20. © Peter DeMarzo 2013 20 For Further Details… Corporate Finance Jonathan Berk, Stanford University Peter DeMarzo, Stanford University Publisher: Prentice Hall Copyright: 2013
  21. 21. © 2009 Stanford Center for Professional Development 21 • Partnership of the Stanford School of Engineering and the Stanford Graduate School of Business • Online lectures, completely self paced • Exercises and assignments to insure practice and content retention • TA feedback • New and improved user interface Stanford Innovation & Entrepreneurship Certificate
  22. 22. © 2009 Stanford Center for Professional Development 22 Effective product innovation relies on clearly defined financial models and analysis. This course will explore the tools of financial valuation and their role in investment decisions faced by managers, entrepreneurs, and investors. You will learn the difference between earnings and cash flow, the importance of net working capital, and the determinants of a firm’s cost of capital. You will explore the sources and drivers of value and how to maximize created value. Finally, you will apply financial valuation tools to understand how firms are valued by investors, considering both publicly traded and venture-backed firms. New Course Launching in September: Financing Innovation: Valuing Projects and Firms
  23. 23. © 2009 Stanford Center for Professional Development 23 Webinar XINE001: How a Stanford Engineering Professor Engineered a Startup Hosted by Professor Bob Sutton Wednesday, September 18, 2013 10 a.m. – 11 a.m. PT Save the Date: Upcoming Innovation Offerings Learn more at: create.stanford.edu Webinar GW025: Build an Entrepreneurial Culture within Your Organization Speakers: Howie Rosen & Ricardo Levy Tuesday, August 13, 2013 10 a.m. - 11 a.m. PT.

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