Thursday, February 10, 2005
Is there no such thing as a skilful investor?
I've posted previously how difficult it is to distinguish whether impressive returns from investment are down to the application of luck or skill in the investment process.
My 2004 result beat the market, as did my performance in 2003. My returns would have been higher still if my portfolio had consisted entirely of either Ben Bailey or Dana Petroleum for the two year period as each more than doubled.
Currently I'm a four stock investor. Someone with a twenty stock portfolio applying similar logic would have a decent case for attributing my outperformance to good luck. Indeed, these returns from a portfolio of that size would be impressive. But do my achievements over the last two years suggest I can win again in 2005?
Burton Malkiel's seminal work A Random Walk Down Wall Street examines the records of investors and fund managers who consistently beat market averages and draws an analogy with a coin-tossing competition between 1,000 competitors.
1,000 contestants flip coins. Just as would be expected by chance, 500 of them flip heads and these winners are allowed to advance to the second stage of the contest and flip again. As might be expected, 250 flip heads. Operating under the laws of chance, there will be 125 winners in the third round, 63 on the fourth, 31 on the fifth, 16 on the sixth and 8 on the seventh.
By this time crowds start to gather to witness the surprising ability of these expert coin- tossers. The winners are overwhelmed with adulation. They are celebrated as geniuses in the art of coin-tossing, their biographies are written and people urgently seek their advice. After all, there were 1,000 contestants, and only 8 could consistently flip heads.
In other words, even if you have beaten the market several times in succession it is no more likely than evens that you will outperform in any given period. Malkiel's swipe at acolytes of Warren Buffett et al. might appear churlish but it raises some crucial questions. Is there anything useful we can learn from the methodology of the superinvestors or are they just super lucky? Is the outcome of an investment decided by luck alone? Is there no way of improving our chance of success?
Malkiel can't hide his envy in this anology. Any curmudgeonly analyst could write off an individual's consistent sucess in a field to luck. Are top surgeons just fortunate craftsmen who have encountered less than their share of fatal complications in the operating theatre? Is the entire golf tour just a travelling circus of jammy sods? Luck plays a part in each of these endeavours. Malkiel says there is no value in the annual letters of Buffett, or Anthony Bolton's frequent interviews in the media: no superior strategy exists and investors should stick to index funds only.
Is there really no-one a keen begineer to investing can learn from? Are Buffett, Bolton and Lynch deluded ultracrepidarians that lack the humility to confess their achievements are down to decades of fluke and nothing more?
I don't believe so and would like to reassert the worth of their opinions, wealth and experience. If the weighting of skill and luck required for an investor to consistently outperform his peers compares better to golf than coin-tossing ask yourself, who would you rather teach you to play the back nine at Augusta, Tiger Woods or Tommy Cooper?
The Artful Dodger
My 2004 result beat the market, as did my performance in 2003. My returns would have been higher still if my portfolio had consisted entirely of either Ben Bailey or Dana Petroleum for the two year period as each more than doubled.
Currently I'm a four stock investor. Someone with a twenty stock portfolio applying similar logic would have a decent case for attributing my outperformance to good luck. Indeed, these returns from a portfolio of that size would be impressive. But do my achievements over the last two years suggest I can win again in 2005?
Burton Malkiel's seminal work A Random Walk Down Wall Street examines the records of investors and fund managers who consistently beat market averages and draws an analogy with a coin-tossing competition between 1,000 competitors.
1,000 contestants flip coins. Just as would be expected by chance, 500 of them flip heads and these winners are allowed to advance to the second stage of the contest and flip again. As might be expected, 250 flip heads. Operating under the laws of chance, there will be 125 winners in the third round, 63 on the fourth, 31 on the fifth, 16 on the sixth and 8 on the seventh.
By this time crowds start to gather to witness the surprising ability of these expert coin- tossers. The winners are overwhelmed with adulation. They are celebrated as geniuses in the art of coin-tossing, their biographies are written and people urgently seek their advice. After all, there were 1,000 contestants, and only 8 could consistently flip heads.
In other words, even if you have beaten the market several times in succession it is no more likely than evens that you will outperform in any given period. Malkiel's swipe at acolytes of Warren Buffett et al. might appear churlish but it raises some crucial questions. Is there anything useful we can learn from the methodology of the superinvestors or are they just super lucky? Is the outcome of an investment decided by luck alone? Is there no way of improving our chance of success?
Malkiel can't hide his envy in this anology. Any curmudgeonly analyst could write off an individual's consistent sucess in a field to luck. Are top surgeons just fortunate craftsmen who have encountered less than their share of fatal complications in the operating theatre? Is the entire golf tour just a travelling circus of jammy sods? Luck plays a part in each of these endeavours. Malkiel says there is no value in the annual letters of Buffett, or Anthony Bolton's frequent interviews in the media: no superior strategy exists and investors should stick to index funds only.
Is there really no-one a keen begineer to investing can learn from? Are Buffett, Bolton and Lynch deluded ultracrepidarians that lack the humility to confess their achievements are down to decades of fluke and nothing more?
I don't believe so and would like to reassert the worth of their opinions, wealth and experience. If the weighting of skill and luck required for an investor to consistently outperform his peers compares better to golf than coin-tossing ask yourself, who would you rather teach you to play the back nine at Augusta, Tiger Woods or Tommy Cooper?
The Artful Dodger
Comments:
Post a Comment
