How to Differentiate Between Investor Skill and Luck

Finding great fund managers is not just about track records. We explain the key criteria to help us differentiate skill from luck on a cost-adjusted basis

Ruli Viljoen 5 May, 2017 | 2:10PM
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As South African professional golfer Gary Player was famed for saying, “the harder I practice, the luckier I get”. This fine line between the nurturing of skill and the randomness of luck has great importance in the investment management industry, especially when assessing fund managers.

There are questions at the current juncture that insinuates active management could be a dying breed. With asset managers such as Blackrock ‘restructuring’ their active offerings and passive investment continuing to attract inflows, it raises many questions about the relationship between luck and skill. If skill is deemed to be irrelevant in today’s world – akin to efficient market theory – then the lowest fee offerings will continue to win. Yet, while we continue to acknowledge the importance of keeping fees low, we do believe there is sufficient evidence to suggest that skill does matter. 

How Can We Find Skill?

The question is often raised about how we deal with this balance between skill, luck and cost. The obvious first step is to have a preference for low-cost investing. These investors have a lower hurdle rate and therefore require less skill to win. It is akin to handicapping in golf. Yet unlike golf, the highest skilled investors can also have the lowest cost and vice versa. Therefore, we ideally want to find highly skilled investors at low cost and avoid the lowly skilled investors with high costs.

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The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

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About Author

Ruli Viljoen

Ruli Viljoen  is Head of Manager Selection, Morningstar UK