How much of this industry is LUCK v. SKILL? Honest assessment needed
Just wanted to ask everyone's views on the question I've been dwelling on for a while now: how much of this Hedge Fund and Asset Management industry do you think is skill v. luck? Like quantify as a % where the two %s add up to 100%.
The reason I ask is that most of the fund managers I've met over many years seem to have a lot of "good track records", but if you look carefully, most of those (not all) were done during a bull market cycle. A lot of people built great track records from the 2009 to 2014 period, and started their funds in 2014 to 2015 only to crash and burn. Some others started earlier in 2004 and rode the bubble all the way up to 2008 and thought they were "master stock pickers" only to see their results crash in 2009-2010.
The reason I ask this is that having worked in this industry for a while as a fundamental generalist globally, I really AM NOT convinced that doing fundamental work and rigorous due diligence and making extensive discount cash flow models etc.... really make a difference at all. There's simply too much information and uncertainties that could impact stock valuations both mid-and longer term, and so many people are already looking at most of the investable names out there that it's almost impossible to have an edge, even if you use "expert networks" or meet with management. Moreover, a lot of people's returns they garner over the years seems LARGELY correlated with overall market cycles (catching a good timing and bull market). I see a lot of fund managers who seem to confuse a good timing and market cycle with thinking they are a natural "genius" at picking stocks. Many of those fund managers seem to have dismal returns recently b/c surprise, surprise, the overall market has been flat.
Even if you look at legends like Buffett or Soros, who seem to have outperformed over longer periods of time, the great majority of their overperformance came from decades ago where the markets were overall just "less efficient" and the practice of value investing wasn't so institutionalized and rampant as it is today. Today, the advent of algo and instantaneous information transfer and rapid trading really has decreased the time for the market to respond to any new information. I'm not entirely convinced someone like Buffett would be able to generate the same returns if he started his career today, regardless of how smart he is.
So what do you guys really think about this? I'm leaning more to the side of "Luck" rather than "Skill" - honestly, if this industry were so based on skill, and you could analyze the future of a stock performance, then we wouldn't have so many people, many of whom even work at large marquee firms like Visium or SAC, engage in so blatant and dishonest insider trading to get the job done. Just seems to be that if even some of the best out there are "cheating via inside information", then what's really the edge that any investor can get just from old-fashioned fundamental research? It just doesn't seem to make much of a difference to me.
In other words, when you see a hot-shot fund manager who runs a half billion dollar fund b/c of a short track record he build over a pretty clear bull cycle bragging about how he's the "master of the universe" - have you really found someone who is inherently smarter than other investors, or is it more likely to be someone who is just destined by the gods to be rich in this life and who isn't much smarter than many other analysts who also work equally hard but didn't go in the market at the right time?
Even though I haven't started working yet. From what I read and from what I can gather, the finance industry has reached a plateau even for people who work with quantitative strategies. People are using the same strategies so it's pretty clear that they won't be having great gains. At the same time, the world economy in general is pretty mediocre and I would put the blame on regulation. The free market doesn't really feel "free" anymore and since regulation has put on a cap on leverage funds won't be getting the same returns anymore. I think it's necessary to have a huge deregulation and permit institutions to gain massive leverage and bet on complex financial products.
Complex Financial Products? looks like you've been watching some Lloyd Blankfein interviews.
No but I have been reading a lot of finance related books, and they all mention that they managed to get the returns they got because they were leveraged. Nowadays, I think it takes a lot of skill to pull in big gains.
the market is supposed to be regulated; a totally free market would be ridiculous.
Skill, in every walk of life, is quite rare... Finance, and the HF industry in particular, is no exception.
Some things in life require more skill than others though, which I believe is the heart of what he is asking.
If you work in the industry, I think there's a decent chance you've heard about/read Michael Mauboussin, but for those who haven't, this is an interesting read on the luck vs. skill divide:
http://www.forbes.com/sites/investor/2013/11/05/the-role-of-luck-and-sk…
The relative contributions of luck and skill to investing success also change over time. Skill in our game is measured relative to that of other market participants, and over time, the maximum excess skill that any given individual can have over the rest of the market will shrink, given all the technology and brainpower that has been flowing to this industry since its birth. If skill levels are all approximately the same, then the maximum available skill differential will compress, and outcomes will increasingly come to be dominated by luck. So at inception of the hedge fund industry, maybe 80% of the success of the pioneers was driven by skill and 20% by luck, and these days that balance has probably shifted to maybe 20% skill and 80% luck (made up numbers, but you get the trend).
My personal experience is that this job can, in fact, be about skill, assuming you're sampling performance over a sufficiently long horizon. Specifically, I have seen and interacted with a few people who, while not necessarily smarter, are much better investors than average. Such people are extremely rare, for a variety of reasons.
100% agree. Believe it's particularly true for short and medium term directional trading imho, because its mostly an intuitive 'non-edge' speculative form of trading yet a large return sample can be quickly accumulated for validation. For styles such as rates rv etc the embedded edge is apparent so there's less of a luck factor.
Out of curiosity, what do the best investors/ traders that you've met have in common?
There are a few traits... Ultimately, it comes down to the exact right mix of arrogance and self-doubt, which the person is able to preserve throughout highs and lows alike. Having a rational process is a way of achieving this, but it's not the only one.
A phrase that comes up in billiards a lot is: It's mostly luck, but I find the more I practice the luckier I get.
Stroh - ironically I happen to be an avid billiards player and have even played on 8-ball and 9-ball leagues. I would say however, investing nowadays cannot be compared to billiards. In billiards, pros can usually clear the rack 70% of the time as long as the balls are not that clustered - you can work on your stroke, shotmaking, banking, kick shots, caroms, etc... and that can definitely improve your game. But for investing, even if you know everything publically available on a stock and do tons of analysis and research, I still fail to see correlation between amount of work done and returns. You could argue that quality of work is different, but there is arguably a limit to the amount of quality work you can do on a stock without bumping into insider information concerns - seems to be the funds that typically perform the best somehow skirt into the "grey" information area that's not exactly insider but definitely not accessible to all. If that's the case, practice doesn't seem to help at all in investing. In fact, I read tons of reports by companies and do my models, but for years I may not be able to find a suitable investment if I am intellectually honest with myself. But if the market were to crash, I would totally be all-in on a quality stock at a cheap price. But if the market never corrects, my returns don't really reflect the amount of work I put into this discipline - you know what I'm talking about?
You're overthinking the analogy.
Don't know if you have already but I'd suggest reading some Nassim Taleb. He wrote a few books on that one question precisely. After reading him you might think everything is attributable to luck and there is no skill involved ever, but a few things keep the debate running (plus this guy prides himself on having very high risk-adjusted returns in all his ventures and has amassed a $600M plus net worth I believe).
Some successful series of events are very unlikely to be random. Take Julian Robertson and Tiger. Overall, the Tiger cubs and seeds that followed him have had abnormally high returns (you could always say it's only global macro riding...). I think it's hard to attribute that to luck.
Another interesting point brought to me by a quant: as long as we bet on human constructs, using human tools, and that humans are humans, there will be inefficiencies. We aren't perfect machines, nor is our way of thinking / assimilating information etc. This is reflected in the world around us and people are being paid big bucks to create strategies that harness these inefficiencies. The possibilities are endless and yes, each individual strategy is not endless but the concept behind probably is. Sounds cliché but it's probably true. When you think that earnings/m&a/event drift is still profitable to this day...
I think that finding alpha-generating managers/businesses/strategies is much harder than we think it is, both in quant and non-quant environments - but I do believe skill exists.
SBed. Agree with the suggestion to read Nassim Taleb.
I'm of the personal opinion that a lot of fund management today is luck - no one (whether in finance or in other industries) has created long term value by doing what everyone else is doing already. Unfortunately, a lot of fund managers (whether due to a dearth in the number of truly investable assets, or following the crowd) seem to do exactly what everyone else is doing.
There probably is the ability to generate alpha, but it requires consistent and correct calls that defy the rest of the market. That skill is incredibly difficult, and probably requires the right amount of intuition, gut checks, intelligence, and the ability to ignore the rest of the market.
A surgeon and an investor are in the same room. The surgeon's desired outcome is to keep his patient alive and healthy whereas the investor's desired outcome is to reach a set level of ROI. Neither of the two are given any tools to work with nor information (background, context, etc.) about their subjects (the company and the patient). The medical doctor will not be able to reach the desired outcome as he cannot conduct surgery and may have trouble identifying the patient's health problem (broken knee/heart attack,etc.). On the other hand, the investor can still reach his desired outcome regardless of whether or not he has access to information or the tools necessary to make an investment analysis. The medical doctor is an EXPERT whereas (and contrary to popular belief) the investor is not and cannot be.
All I proved by the example above is the existence and importance of luck in the industry. I did not say that luck and probabilities are inherently non-existent in the medical field-they certainly have their place. I think quantifying and truly identifying how much success can be accorded to luck versus skill is very difficult. I will also prescribe The Black Swan by Taleb. Although I am still in school, his book has drastically changed the way I think and the way I analyze information/make decisions.
I've been working in the industry for 10 years, and I want to be honest: there is a lot of luck in generating above average performance.
That being said, time diminishes the luck component over the long-term. Think of investing like poker. Your success varies a lot going from game to game, tournament to tournament. The variance of a single game is huge. But once your sample size gets larger over time, i.e. having played games year after year, decade after decade, your skill becomes the bigger determinant of your cumulative success. Thus your long-term track record is the important data point folks look at.
Kelvin
Track records should be looked at as information ratios not just pure return, so that pure bull market performance bias is eliminated.
You can't get lucky for decades. Intuition is just as much of a learned skill as an inherited one for a vast majority of the top performers in the industry. Every top PM, HF manager... etc I've come across usually have something off about them. There's a scary amount of attention to detail, and the ability to absorb large amounts of information around them and use it to make a decision.
Just do the opposite of Gartman and you'll be fine
zh
On a serious note, read Buffett and then read about Renaissance Technologies. They're about as opposite as it gets but both have demonstrated consistent, market-beating skill over the long-run. Read it and then come back, don't just come at me with monkey-dart-throwing-analogies. Also, a) it's probably true that not a lot of people possess the right mix of intelligence, intuition, emotional detachment/attachment, discipline, etc. in order to consistently beat the greater body of money managers, but b) most money managers aren't even incentivized by LONG TERM absolute market outperformance. The typical career track in asset management creates disproportionately larger downside for making contrarian calls and being wrong in the short term than upside for being right on those calls (read "shitcanned in the former scenario, pat on the back in the latter"), hence market-hugging behavior. The typical structure of hedge funds encourages greater short term betting over long-term value investing >> I'll argue one of the structural advantages of PE as an investing platform is capital committed for a longer term and less noise around marks / short-term pressure from investors who stare at their bloomberg terminals all day and pull their money tomorrow.
"Better for reputation to fail conventionally than to succeed unconventionally" oh the echo chamber of finance
Lets remember that RenTech is a HFT, their profits are purely because they can trade faster than most people. Heck, they're evem trying to patent a new technology so they become the fastest.
I read an interesting book once titled "The Drunkard's Walk"...It discussed several ideas like this that hedge fund managers might just be lucky just like the CEO of a movie production company might just be lucky in finding great movies to produce. Highly recommend it.
In short I guess it comes down to whether you believe in certain market theories. If the markets are inefficient then all one has to do is capitalize on said inefficiencies. If on the other hand, we assume that markets are efficient all the time then I think the keyword here is speculation. How does one foresee the direction that the overall market moves in response to key events?
Just keep starting hedge funds. When that one goes bust legally change your name and start another one.
2/20 you only need a few good years to get super rich.
like 70% luck 30% skill my estimate. better to be at the right place right time than to be good at it.
Totally disagree. It's definitely more like 75% luck and 25% skill
Trust me my estimating skills are through the roof
I think the difficult think about investing/business where it is not so much a "skill" like engineering, but good judgement is knowing if the success was actually from good judgement or just right place/right time. I am not sure one can ever know for sure, but I think it is also unfair to claim that all the successful people in business/finance were in no way a part of it. I am sure they had to make nuanced and complex decisions each step along the way when faced with ambiguous and uncertain information.
All the negatives are bad luck. All the positives are skill.
I have never been more amazed as Ive gotten older in understanding how relationship based everything is. The art of getting people to like and see you do well is the most important piece of it all.
the merry go round goes round and round - the amount of unknowns is as vast and deep as the pacific ocean, dont be fooled otherwise
How does one define hard work...as skill or luck? The harder you work, the more responsibility you are given the more you make bank.
I have found that most successful portfolio managers practice witchcraft. Although a gift, I have always questioned why one would use their sooth-saying abilities to determine when to long Boeing, but short General Dynamics.
There are many biases in these kind of discussions. First of all and perhaps most importantly: survival bias. You meet fund managers on conferences, meetups or whatever, but it is probably the successful people who are visiting these events. The ones getting broke just disappear, find other jobs, maybe end up in jail, etc.
The other thing is that people usually list stars like Soros, Buffett, etc. saying that they have talent. Now think about this: if you line up 10k people and ask everyone to toss a coin lets say 100 times, you wont get impressed by most of the results. BUT there will 'probably' be a couple people who were "talented" and got a tail 50 times in a row, maybe there will be one whose tosses all resulted in a tail... You could say that hell yeah, he is talented as f*ck in coin tossing, but it is more likely to be just luck. However, the media/communities/newspapers/etc will admire that one person. You could say that I am more for the efficient markets theory, that is probably true, but lets not start a discussion on that.
Having said all these, skills have probably more significance on markets that are less efficient, less liquid, etc.
Explicabo nemo incidunt officia facilis maxime omnis. Deleniti blanditiis facere accusamus corporis voluptatibus. Et eaque fugiat velit temporibus excepturi rerum.
Mollitia optio placeat numquam quidem. Sit est nobis molestiae facere distinctio. Rem consequuntur aut et consequatur ut possimus velit. Ab illo porro quos ipsam. Qui alias quo qui quaerat vero laborum voluptas et. Nulla et praesentium libero.
Autem eum temporibus recusandae. Ut qui et repellat tempora asperiores. Eaque officia iste ut exercitationem. Laborum cum quidem eligendi delectus. Asperiores repellendus quod et iste. Dolorem ea numquam asperiores dolorem cum eaque. Dolorem nemo vel et qui.
At magni aspernatur est sit dicta voluptatibus similique ipsa. Ea maxime velit dolor soluta fuga ut occaecati sit. Non totam rerum commodi repudiandae ad ipsum.
See All Comments - 100% Free
WSO depends on everyone being able to pitch in when they know something. Unlock with your email and get bonus: 6 financial modeling lessons free ($199 value)
or Unlock with your social account...
Possimus iusto enim nesciunt dolor unde et. Voluptatem praesentium consectetur sunt non error commodi. Commodi est ex amet libero unde nulla necessitatibus. Quia deserunt ea est mollitia maxime aut consequatur.