Skill ver­sus luck: Should that be the ques­tion?

Finweek English Edition - - Property Compass - Lynn van Coller RMBAM

MANY STUD­IES HAVE BEEN con­ducted dis­tin­guish­ing man­ager skill from luck ‒ most with in­con­clu­sive out­comes ‒ and very few cases where skill can be iden­ti­fied with sta­tis­ti­cal ac­cu­racy. Even in South Africa, a num­ber of as­set man­age­ment houses that pro­vided good per­for­mance for a few years but then dis­ap­peared from the lime­light or from ex­is­tence ‒ BoE, Nor­wich, Quay­stone, to name just a few.

Part of the dif­fi­culty in dis­tin­guish­ing skill from luck lies in a dis­con­nec­tion that of­ten oc­curs be­tween a man­ager’s views on stocks and fi­nan­cial mar­kets and what’s ac­tu­ally rep­re­sented in his port­fo­lio. That hap­pens un­in­ten- tion­ally. In­vest­ment con­straints are the main cul­prit, as they limit the man­ager’s abil­ity to ex­press his view in the port­fo­lio. But volatil­i­ties and cor­re­la­tions be­tween stocks also play a part. That lat­ter phe­nom­e­non is hardly ever men­tioned and is the fo­cus of this ar­ti­cle.

First, a few def­i­ni­tions. The cor­re­la­tion be­tween a man­ager’s view and the ac­tive weights in his port­fo­lio ‒ that is, how well the port­fo­lio re­flects the man­ager’s view ‒ is called the “trans­fer co­ef­fi­cient” of the port­fo­lio. Trans­fer co­ef­fi­cients vary be­tween 0 and 1.* A low trans­fer co­ef­fi­cient means a large por­tion of the risk in a port­fo­lio is in fact ran­dom and hence there’s lit­tle con­nec­tion be­tween the man­ager’s view and the fi­nal re­turn on the port­fo­lio.

For a trans­fer co­ef­fi­cient of 0,5 only 25% of a port­fo­lio’s re­turn vari­ance is re­lated to skill (see C Holt, 2007). If the trans­fer co­ef­fi­cient is lower, then even less of the re­turn vari­ance can be at­trib­uted to skill with any de­gree of sta­tis­ti­cal ac­cu­racy. That is: for low trans­fer co­ef­fi­cients you’d need many years of data ‒ longer than the av­er­age port­fo­lio man­ager’s work­ing ca­reer ‒ be­fore you could dis­tin­guish be­tween luck and skill.

What that means is if your man­ager has good per­for­mance over a pe­riod but a low trans­fer co­ef­fi­cient, then you have no way of pre­dict­ing whether his good per­for­mance

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