Yes, Your Favorite Hedge Fund Manager Is Probably Just Lucky: "Your favorite hedge fund manager has walloped the market by 5% per year for the past 10 years, so he's obviously a genius, right?
Actually, no. He had a one-in-five chance of doing that just by throwing darts."
From the April 29th Q&A with Ken French:
"If we pretend his returns are normally distributed, the probability that his average abnormal return exceeds 5% per year for a ten year period is more than 20%. In other words, in a group of hedge fund managers with standard deviations of 20%, we expect one in five to have a ten-year average annual abnormal return of at least 5%—even if none actually have any skill. We expect one in twenty of the unskilled managers to produce a ten-year average annual abnormal return of at least 10%."
When you consider large number of funds and that many underperforming funds "drop out" of samples (sure not for academic papers anymore, but in reports and marketing it is still a major issue), it is easy to see why many believe they (or their fund managers) have the ability to outperform.
2 comments:
Is your comment on dropouts weighted based upon assets under management? Most hedge fund investors have their money with the big funds. Are all those big funds lucky?
Not all, but I would be willing to bet that many are.
But you are definitely right I should have specified that closed funds etc tend to be smaller.
But put another way, the more successful ones (lucky?) do attract more money and are larger.
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