Is it all just luck and momentum, or is there some skill involved? The cult of the star fund manage...
Is it all just luck and momentum, or is there some skill involved? The cult of the star fund manager is now so deeply unfashionable that the question seems naïve.
All the most recent academic research challenges the notion that good fund performance persists. In doing so, it also dispatches any idea that some active fund managers might have special ability in addition to basic administrative competence.
In 1994, Californian academic Mark Carhart had already concluded that any persistence in performance was easily explained by common factors such as expenses, transaction costs and investment style. Atlanta-based academic, Jeffrey Busse asserted: "Superior performance dies out quickly. What we find is that it is more important to focus on the last quarter than the last year. Fund performance tends to degrade after only a few months".
In an influential discussion paper published by the UK Financial Services Authority (FSA) in 2000, Mark Rhodes said that if there was - or ever had been - a case for expecting past good performance to persist, it no longer existed. He said the evidence was that when a fund could be shown to have outperformed over time, it was the result of nothing more than momentum and luck.
David Blake and Alan Timmerman, the academics whose review of research for the FSA was published last year, were more measured in their conclusions, but agreed with the view that performance did not generally persist for more than a year. And when it did it was more likely to be bad than good performance that persisted.
All this has been music to the ears of investment houses committed to passive, or index investing and they have not been slow to exploit the fact that the past three years of miserable stock market returns has left the vast majority of active managers covered more in embarrassment than glory. One of the latest broadsides comes from multi-manager firm, SEI Investments, whose researchers concluded that good performance by a manager is better explained by investment style than the individual"s skill.
The real knock out punch seems to come from the famously outspoken John Bogle, whose Vanguard index funds are household names in the US. In a radio interview two years ago, he said: "This industry has reportedly produced all kinds of star managers. But the reality is that these stars are not stars at all, they are comets. They last only for a brief moment and then, like all comets, they black out, the fire goes out and the ashes float gently down to earth.
"...If you get 1,024 people in a room and they are all flipping a coin, one of them is going to flip heads 10 times in a row. The difference between the coin flipping contest and the mutual fund business is that in this business we proclaim thema genius."
But even Bogle, when pressed, agreed that there are people who are consistently good investors and he named Warren Buffet as one. In talking of comets and coin flippers he was not claiming that there were no excellent money managers around. "But they do not light up the heavens. They do a little bit better in most years. And that is good management. That is professional management".
These, then, are probably the true stars. Competence and professionalism are the real star qualities: and there are some managers who can read company balance sheets with the kind of sagacity that others can only marvel at.
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