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You're lucky to be so skillful

December 17, 2012
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2012 has been a dire year for mutual fund managers. Industry figures suggest that as many as 75 to 80% of actively managed funds have delivered lower returns - after fees - than passively managed index funds.

There are, of course, funds who’ve outperformed. There always are. But once again, they’re in the minority. And predicting who they would be before the year started would have been very hard indeed. After all, many of this year’s winners were last year’s losers, and many will revert to underperforming in 2013. 

Even so, the year’s ‘star’ fund managers will doubtless be paraded in the money pages over the next few weeks, attributing their success to one brilliant piece of market insight or another. 

Of course we don’t deny that skill has a part to play. And, credit where it’s due, there are some clever managers out there. But far too often when it comes to investing, we ascribe to skill what in fact was plain and simple luck. 

In fact, our brains are hard wired to do it. Once something has occurred, our minds create a narrative to explain the outcome. We start to believe it was inevitable. And when something else happens that fits that narrative - say, for example, a manager who outperforms for three successive years does so again for a fourth - we become even more convinced there’s more to it than chance. 

In the words of the mathematician and finance expert Nassim Nicholas Taleb, investors are 'fooled by randomness'. The more investment managers there are, the greater the probability that some will dramatically outperform the market based on nothing more than chance. 

In a recent paper, Taleb cautions against active fund management as a career. No matter how skilled you are, he argues, you won’t be able to beat the 'hot' managers whose supposed genius, and temporary outperformance, are down to luck. 

Michael Mauboosin, chief investment strategist at Legg Mason Capital Asset Management, also believes that chance is a bigger factor in outperformance than fund managers would like us to think. 

In his recent book, The Success Equation: Untangling Skill and Luck in Business, Mauboussin talks about the ‘paradox of skill’. It’s precisely because most fund managers are so skillful, he argues, that their results end up being differentiated largely by luck. 

Just as sportsmen rarely put their victories down to the rub of the green, the bounce of the ball, or a poor decision by the referee, a fund manager is unlikely to admit the reason why they managed to outperform their peers in any particular year was that they just got lucky. Not least because he’s charging you a small fortune to buy and sell stocks on your behalf. 

So, hats off to this year’s winners. We salute you. And, by the way, can you tell us what Saturday’s winning lottery numbers are going to be?

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