The following are in response to C. Thomas Howard’s response to Michael Edesess’ article, Luck versus Skill in Mutual Fund Alpha Estimates:
To the Editor:
Dr. Howard states that the Fama-French “thesis is that if managers are skilled stock pickers, then the average long-term performance of all funds will reflect this skill.” He then concludes, “This is like asking… tourists to identify mineral deposits along the route by looking out the windows of the bus.”
Really? The Fama-French methodology of digging for signs of manager skill within average long-term performance data sounds more like intensive excavating to me. Apparently Dr. Howard doesn’t feel they’ve done enough digging. Fair enough. But the research that Dr. Howard cites as more compelling effectively says that it’s not fair to look at stock picks that didn’t work and that mutual fund managers should instead be evaluated based on their best plays. He specifically sites a recent Harvard Business School working paper that employs this spurious approach to support the contention that “virtually all active managers are superior stock pickers.” Dr. Howard then offers various reasons for why manager performance is buried under “the smothering effect of over-diversification that fails to produce excess returns.”
What Dr. Howard doesn’t say is that this is identical to a losing football team arguing that they really won if you just ignore all of the things that cost them the game. This argument doesn’t work in investment management any more than it does in football. A loss is a loss.
If some do not like the structure and limitations of conventional mutual funds they don’t have to own them. If one prefers to hold 15-20 individual stocks, as some suggest many professional money managers do with their personal portfolios, fine. If there is alpha to be gained this way then people are free to chase it. However, the question then becomes “alpha compared to what?” What benchmark is being outperformed to justify the claim of alpha? The overwhelming avalanche of academic research indicates that structure, not stock-picking, determines performance. Therefore, regardless of the “best picks” an active manager owns, a passive approach using completely different but structurally similar stocks in terms of market cap and valuation will yield effectively the same results over time – without the hefty fee.
When adjusted for the risk factors that determine performance, all evidence of manager skill completely disappears – and no one has credibly challenged this conclusion. Those who try continue to sound more and more like a losing team arguing that they really won – if only you could see past the fact that they lost.
Very truly yours,
Steven A. Weydert, CFP(R), MS
Executive Vice President
Bowyer, Weydert Wealth Planning Partners, Inc.
Park Ridge, IL
