Investment decisions

Fooled by Randomness: Investors Don’t Properly Evaluate Fund Manager Skill

Investors are “Fooled by Randomness” and when chasing returns to make investment decisions in funds more often than not do not take into account key considerations that paint a true picture of the manager’s skill, says a study.

In the paper “Fooled by Randomness: Investor Perception of Fund Manager Skill,” the paper’s authors assert that the role luck plays in high return generation is not given proper weighting in investment evaluation nor is volatility given appropriate consideration.

Investment decisions

Fund Manager Skill: Investors overly subscribe to mutual funds

The study found that investors overly subscribe to mutual funds that underperform the market. “There is ample evidence that investors, once they have decided to invest into actively managed funds, buy the wrong funds. They chase returns and, by doing so, lose money on average.

Why do investors select the wrong mutual funds? The study says that first, investors “fail to derive information from the cross section.” In other words, they don’t assess the role luck plays in returns generation. They don’t understand that in a large cross section of fund returns, there must be a few strong performers by pure chance.

Second, investors fail to incorporate the fund volatility when determining the probability of manager skill. As a result, the study concludes, “gambling fund managers” will find it easier to attract investor money than more conservative managers. While investors are able to notice different levels of riskiness in time-series of returns, they are unable to draw conclusions about fund manager skill. Looking at past returns performance, the role of volatility in the creation this performance is an elusive concept to investors.

Investment decisions Fund Manager Skill

It’s not just that investors are not good at selecting the right funds, many also know it.

Fund Manager Skill: Investors cannot or can rather not identify skilled managers

The problem also seems to be one of confidence as well. Half the investors who participated in the study said they “cannot” or “can rather not” identify skilled managers, noted researchers Justus Heuer, Christoph Merkle, Martin Weber from the University of Mannheim in the United Kingdom.

The study evaluated various personality characteristics and demographics influence how people judge skilled and unskilled managers. Older study participants assume a higher share of skilled managers in the market than do younger investors. Men, on average, estimate the percentage of skilled managers to be lower than that of women. Higher educated study participants also were found to believe there are less skilled managers and more unskilled managers in the market than did less educated study participants.

Investment decisions

Investment decisions

 

The full study can be found here SSRN-id2493053

LEAVE A COMMENT


Saved Articles
X
TextTExtLInkTextTExtLInk

The Life and Career of Charlie Munger

Charlie is more than just Warren Buffett’s friend and Berkshire Hathaway’s Vice Chairman – Buffett has actually credited him with redefining how he looks at investing. Now you can learn from Charlie firsthand via this incredible ebook and over a dozen other famous investor studies by signing up below:

  • Learn from the best and forever change your investing perspective
  • One incredible tidbit of knowledge after another in the page-turning masterpiece of a book
  • Discover the secrets to Charlie’s success and how to apply it to your investing
Never Miss A Story!
Subscribe to ValueWalk Newsletter. We respect your privacy.

Congrats! Are you a smart person?

We have an exclusive targeted & limited time offer for being a sophisticated and loyal reader.

ValueWalkPremium is a website and newsletter on the latest industry news much of which is not in the public domain and obtained via our sources.

We also have 10 years of resources on how to use this information to better your investment process.

Sign up for  today and get our exclusive content for 40% off. This is our second biggest discount ever!!

Use coupon code VIP20 or click on the button below

Limited time offer only ENDS 2/29/2019 or after next 25 subscribers take advantage whichever comes first – please do not share this discount with others

 

0