Are the top money managers good? Or just lucky?
Sometimes it’s hard to tell. When Gene Fama and Ken French studied outperforming money managers years ago, they found that most of them were just taking big risks. Thus was born the most humble formulation of the Efficient Market Hypothesis: the market is really hard to beat.
They have a good point. A few years ago I was interviewing international equity managers, and when I examined one who seemed to consistently beat the global developed markets, it turned out that he had a big stake in Brazil and China. In other words, he went outside of his index to beat his index. To my way of thinking, that’s cheating. Brazilian investments are riskier than German ones.
But not everyone cheats. We do observe skill in other professions: lawyers, surgeons, baseball players. It’s not a stretch to think that professional investors show skill as well. And since investors work in a numbers-filled line of work, finding a quantitative way to test for skill ought to be possible.
Only it’s not so easy. While return is simple to measure, risk isn’t. Is it variance? Loss? The likelihood of your company’s CEO testifying before Congress? However it’s stated, risk-adjusted return is the proper yardstick for measuring skill. And top managers have it. Investors just need to ask.
Douglas R. Tengdin, CFA
Chief Investment Officer
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