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Fund managers – skilful or lucky?

Posted by: Brian Dennehy
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Some recent fund manager moves and retirements have triggered the question: should I sell a fund because manager X has moved on? What this question really boils down to is: do you think fund managers are skilful or lucky? 
 
This is a crucial point and is fundamental to how you approach your own investing in general, and fund selection in particular.
 
Much of what happens in our lives is a combination of skill and luck, albeit a different balance depending on the precise circumstances.
 
For example, team sports are fun (and less predictable) because the most skilful team doesn’t always win. There is a lot of random stuff going on within the game – luck plays a significant role.
 
At the other end of the scale, when you go and see a dentist, skill is a more over-whelming factor. You are unlikely to lose all of your teeth randomly and unexpectedly.
 
On every occasion before I go to the dentist, I can make a confident prediction about the outcome.
 
On every occasion before I go to a football match, I cannot make such a confident prediction
– which is why the bookies make so much money. 
 
Somewhere in-between are financial markets, and your interaction with them. 
 
There are a vast and complex web of matters which impact financial markets, and whether and to what extent you or I might be impacted by them is largely a matter of luck
 
But what isn’t a matter of luck is how we deal with random, unpredictable, events – more importantly, how we plan to deal with them.
 
Successful investors organise their investments so that they are in a position to enjoy the good luck and avoid or limit the impact of bad luck. 
 
They recognise that very bad things can happen over which they have no control, and/or for which there is no precedent – but where they can limit the impact on them.
 
A great example of someone not doing this is Alan Greenspan, former chairman of the US Federal Reserve.
 
He apologised for not foreseeing the 2008 crisis because “It never happened before”.
 
History can blind us to the possibility of extreme events which are beyond prior experience.
 
No matter how carefully you make your plan, you cannot know precisely how this will be impacted by unforeseeable and uncontrollable events that we call luck (this can be good or bad luck).
 
What successful people (“lucky” people) do is cut losses, whether in investing or jobs or relationships or any other aspect of life – cut your losses and live to fight another day.
 
According to psychiatrists Block and Correnti, the inability to cut losses is one of the traits of the born loser (their words) – harsh words from them, but I think they should be taken on board.
 
I have said on many occasions that fund managers (such as Neil Woodford most obviously in recent times), seem incapable of cutting losses, applying a stop loss – they simply cannot accept that they are wrong.
 
You do not need to repeat this schoolboy error. Have a stop-loss in place, and apply it. Practice practice practice. It will become second nature.
 
Equally, if things go well, do not get too inflated an opinion of your own abilities. Often, “lucky” people begin to think they are fortunate by design rather than luck. Certainly, a run of good fortune is often underpinned by good preparation. But there is always an element of “right place, right time”.
 
This applies to us as individual investors and to fund managers. For instance, we looked recently at the great run that Growth investors have had, and you can read that blog here.
 
But we said: “Don’t confuse a bull market with genius”.
 
The more I practise the luckier I get…
 
Gary Player said that.  Certainly, in sports it is the case that the more you practise the better you get (up to a point). But does that apply to fund management?  Are fund managers skilful or lucky?  No one knows, because no one has an effective way of measuring skill in fund management. The role of chance or luck in investment is self-evident, so fund managers are lucky in the absence of any practical way to identify skill.
 
And if you repeat that to someone and are challenged, just remind your challenger that 92% of fund managers fail to consistently beat an undemanding benchmark. If they still keep arguing, you just need to leave them to their inevitable fate – mediocrity, frustration, wasted time.
 
FURTHER READING
Topic: Market commentary


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