Portfolio Management in Practice: Cautionary Lessons from the Financial Sector

Written by: David Casalaspi

Primary Source: Green & Write, February 3, 2016

Note: It has been speculated that Detroit Public Schools may transition to a portfolio management school district model. What is a portfolio management district and what does the research say about the effectiveness of this type of model? Check out Green & Write all week for new posts on what we know and what we can learn from the portfolio management model.

Portfolio Management Models (PMMs) are a type of school district governance in which district officials, rather than administering a set of uniform schools, operate instead like investment managers who oversee a diverse portfolio of education service providers. In PMMs, district portfolios can include a variety of offerings for parents, including traditional public schools, charter schools, private schools, for-profit schools, online schools, specialty centers, and others. According to the Center on Reinventing Public Education, more than 45 cities serving about 5 million students are currently experimenting with portfolio management.

Downtown Manhattan. New York City is the financial capital of the world and also a portfolio school district. Photo courtesy of Flickr.

Downtown Manhattan. New York City is the financial capital of the world and also a portfolio school district. Photo courtesy of Flickr.

PMMs represent an attempt to disrupt existing school governance arrangements. Under PMMs, there is less involvement from district officials in day-to-day school operations. Instead, district officials focus their energy on continuously evaluating the performance of individual schools – deciding which ones are effective enough to continue supporting and which ones should be removed from the portfolio. Because this system operates as an investment regime, where outside providers contract with the district to run schools themselves, district staffers are not necessarily responsible for solving educational problems; they simply have to act like financial experts who shed low-performers from their portfolio and replace them with high-performers.

The hope is that by assembling a diverse portfolio of schools and rigorously evaluating performance over time districts can essentially “beat the market.” But can we really expect actively managed portfolios to do this consistently? To answer this question, let’s take a look at the performance of portfolio managers in their natural environment: the financial sector.

Portfolio Management in the Financial Sector

Experience shows that actively managed portfolios virtually never beat the market consistently. S&P Dow Jones regularly conducts a study titled “Does Past Performance Matter? The Persistence Scorecard” which studies whether stock and mutual fund performance in one year tends to persist in subsequent years. The portion of the study that spanned the bull market between March 2009 and March 2015 began by identifying 2,862 actively managed domestic stock mutual funds that were in operation between 2009 and 2010. This list was then trimmed to include only those mutual funds that were in the top 25% of market performance that year. Those mutual funds were then followed over the next several years, with the focus being on how many of them remained in the top performance quartile in each succeeding 12-month period. Of the 2,862 mutual funds identified originally, only 2 of them (or 0.07%) performed in the top quartile every year for the first five years. After six years, that number had dropped to 0 (or 0.00% for you math junkies).

Photo courtesy of Flickr.

Photo courtesy of Flickr.

Put another way, between 2009 and 2015, not a single actively managed mutual fund consistently ranked in the top quartile of performance. In fact, probability models demonstrate that the actively managed mutual funds performed even worse than would have been predicted if the fund managers had simply flipped coins to select stocks rather than spend hours poring over financial reports and evaluating stock performance.

Because only about a quarter of actively managed mutual funds can be expected to beat the market in any given year, and those that do so in one year are unlikely to do so across several consecutive years, the wisest advice investors can receive is to simply not try beat the market at all. Indeed, the consensus among economists is that investors should invest their money not in stock portfolios, but in index funds, which match average market performance. Burton Malkiel, a Princeton finance professor, wrote as much in his popular guide to investing A Random Walk Down Wall Street: “A blindfolded monkey throwing darts at a newspaper’s financial pages could select a portfolio that would do just as well as one carefully selected by the experts.”

Rethinking Our Goals

Before districts rush headlong into PMM governance, they should pause to consider exactly how their theory of school improvement might operate in reality. The neat analogy of portfolio management may have great appeal to many education reformers, especially those whose primary residence is in the business community. However, the performance of actively managed portfolios in the financial sector appears to quash any hope that PMMs will by themselves produce consistently high performance. For all we know, replacing PMM district officials with blindfolded, dart-throwing monkeys might produce just as good, if not better, outcomes. This is not a statement about the skill or knowledge of these district officials. It is a statement about the relative difficulty of beating the average year after year.

Instead of audaciously trying to beat the market, education reformers should commit themselves to the long, hard work of producing steady median growth in their district or state. After all, it is impossible to escape the existence of statistical averages, so we ought to aspire for a world where the average is actually pretty impressive.

Contact David: dwc@msu.edu

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David Casalaspi
David Casalaspi is a third-year student in the Educational Policy Ph.D. Program. Before beginning his graduate studies, he attended the University of Virginia, where he received his B.A. in History and spent his senior year completing a thesis on the rise of federal accountability policy between 1989 and 2002. Additionally, while at UVA, David designed and taught a two-credit seminar for undergraduates on the political history of the American education system and also received some practical experience with policymaking through work with the City Council of Charlottesville, VA. His current research focuses on the politics and history of education, and particularly the way that education rhetoric and issue framing efforts affect the implementation of school reforms.