What fund managers acknowledge the illusory role of skill and withhold reward for building unpredictably -successful- portfolios?
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Mutual funds are run by highly experienced and hardworking professionals who buy and sell stocks to achieve the best possible results for their clients. Nevertheless, the evidence from more than fifty years of research is conclusive: for a large majority of fund managers, the selection of stocks is more like rolling dice than like playing poker. Typically at least two out of every three mutual funds underperform the overall market in any given year. More important, the year-to-year correlation between the outcomes of mutual funds is very small, barely higher than zero. The successful funds in any given year are mostly lucky; they have a good roll of the dice. There is general agreement among researchers that nearly all stock pickers, whether they know it or notâ and few of them doâ are playing a game of chance. The subjective experience of traders is that they are making sensible educated guesses in a situation of great uncertainty. In highly efficient markets, however, educated guesses are no more accurate than blind guesses. ...the average of the 28 correlations was .01. In other words, zero. The consistent correlations that would indicate differences in skill were not to be found. The results resembled what you would expect from a dice-rolling contest, not a game of skill. Our message to the executives was that, at least when it came to building portfolios, the firm was rewarding luck as if it were skill. This should have been shocking news to them, but it was not. There was no sign that they disbelieved us. How could they? After all, we had analyzed their own results, and they were sophisticated enough to see the implications, which we politely refrained from spelling out. We all went on calmly with our dinner, and I have no doubt that both our findings and their implications were quickly swept under the rug and that life in the firm went on just as before. The illusion of skill is not only an individual aberration; it is deeply ingrained in the culture of the industry. Facts that challenge such basic assumptionsâ and thereby threaten peopleâs livelihood and self-esteemâ are simply not absorbed. Kahneman, Daniel (2011-10-25). Thinking, Fast and Slow
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Answer:
The tilt of the article is accurate but not by the identification of the problem. The issue isn't that manager are rewarded by luck and not skill. Many managers underperform or outperform bencmarks marginally which hints that they are overpaid for those level of skills required to generate these returns. This has nothing to do with luck. And remember correlation goes both ways. So consistent outperformance would be measured as low or no correlation in periods such as 2008/9. By taking average, it tends to aggregate the errors and the result is that its not meaningful. The theory of highly efficient market means market prices in value of securities fully and no chance of outperformance. That is vastly different from buying by luck and chance, i.e buying a basket of securities randomly picked. And again, there are people who have shown time and again that this is also not true. So people who acknowledge that things are unpredictable and indeterminate will pursue diversification to the maximum with a huge number of companies. Its like resume huggers who want to participate every single good brand event or clubs because they are clueless to the future and see it as a option to hedge.
Mervyn Teo at Quora Visit the source
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