Meet my uncle, he is an incredibly wise man. He was explaining the mechanics of the stock market to me, specifically the part where most people think that it is all about being in possession of superior information, that somehow a small collection of people always call it right, that they know in advance.
He says it is all bollocks. It is all random. Well I was stunned. So he went on to explain.
You see, in order to believe that an asset manager, or “guru” for that matter, has superior selection skills you have to agree that he, somehow, has access to superior information all the time, well at least greater than average. If this is the case then superior performance has to be evident relative to a randomly constructed portfolio. In other words if we were to construct a portfolio by throwing darts at a dartboard, this portfolio should not outperform the “gurus” right?
I mean doesn't it just piss you off that there are always people that apparently have the inside track? The obnoxious chap at the braai that is ALWAYS right, the radio guru making recommendations, many of the financial advisors and your personal stockbroker. The one that sells you something in the morning, and then phones you in the afternoon to tell you, you are "backing the wrong horse".
So I thought I would test my uncle's theory against the best of the best. Surely a random portfolio would be beaten by the "gurus".
Let’s take a look.
I constructed 5 random portfolios (using the MS Excel random number generator) of 10 equal weighted stocks each. I compared these mere 5 to 240 collective investments (unit trusts). So the "gurus" had 32 times as many opportunities to beat the random portfolios.
A random portfolio beat 99.17% of ALL unit trusts?
"The difference between luck and skill is seldom apparent at first glance." - Peter L. Bernstein
I am not suggesting that this is a viable strategy, it isn't. I am merely highlighting that nobody has closely guarded secrets, that lead to superior performance. Moreover, superior performance cannot be judged on a 1 year performance horizon. It will take at least 20 years.
Update: And I bet you if my uncle gave his fund a name, say Blue Sky Alpha Plus, some of you would even invest in it.