The Demon of ChanceA basic knowledge of statistics provides us with the knowledge that with thousands of money managers playing the game, the odds are that a few, not just one, would have turned in a Bill Miller-like performance. Without this knowledge, investors are likely to confuse skill with "lady luck." If the examples of the Lindner Large-Cap Fund and 44 Wall Street have not yet convinced you, I hope that even the most skeptical among you will be convinced by the following example. Disappointed with the performance of its active manager, a multibillion-dollar pension plan decides to fire the manager and initiates a search for a replacement. It performs a thorough screen of potential candidates. Among the screens are a record of superior performance over the prior 15-year period ending in 2002, a high persistency of superior performance, tenure of the manager and turnover. The due diligence process has narrowed the final candidates to the following funds and a benchmark, the S&P 500 index.
|A Mutual Fund to Drool Over |
|Fund||Annualized Returns 1988-2002*|
|Larry Swedroe Investment Trust||14.3%|
|Legg Mason Value||14.1|
|S&P 500 Index Fund||11.5|
On the basis of its track record the winner of the performance derby is the Larry Swedroe Investment Trust. Not only has the fund outperformed its benchmark by a significant amount, but it has also done so with a high degree of persistency, outperforming the index in nine of the 15 years (67%). In addition, the fund has had the same manager in charge for the entire period, and turnover has been extremely low. After being presented with the data, the investment committee votes to award the management of the plan to the Larry Swedroe Investment Trust. At the last moment, one member of the committee suggests that as one final bit of due diligence Larry Swedroe should be brought in to explain his winning strategy. Appearing before the committee, I am first congratulated on the superior results of the fund. I am then asked to explain my investment strategy. I respond by stating that since my wife's name is Mona, my lucky letter is M. I therefore construct a value-weighted portfolio of all U.S. stocks that begin with the letter M and rebalance the portfolio annually. Skill or the demon of luck?