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mutual-fund-managers-who-take-big-bets-skilled-or-overconfident


AzCactus
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I saw this on Valuewalk and thought it would probably interest a few folks on the board.  If anyone reads it and has opinions either way I would love to hear them.  In any case I will probably give this a read over the weekend.

 

Here's the link (gives brief overview):

 

http://www.valuewalk.com/2014/12/mutual-fund-managers-who-take-big-bets-skilled-or-overconfident/

 

Here's the PDF:

 

http://cdn1.valuewalk.com/wp-content/uploads/2014/12/SSRN-id891727.pdf

 

David

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I didn't read the full link so forgive any out-of-line comments.  I'm not sure I like the question because you could be good or bad and still take concentrated bets (though you wouldn't last long as a money manager if you were bad). 

 

Generally speaking, I'm of the view that less skilled managers are more likely to be benchmark huggers.  If you aren't good, its easy to just stick with the herd, be average at best and keep collecting a paycheck.  If you truly are skilled, you don't want a portfolio that is spread out it diversifies away all of your winners.  You want to make bets that will have a material impact.  Diversification is the enemy of out-performance. 

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Generally speaking, I'm of the view that less skilled managers are more likely to be benchmark huggers.  If you aren't good, its easy to just stick with the herd, be average at best and keep collecting a paycheck.  If you truly are skilled, you don't want a portfolio that is spread out it diversifies away all of your winners.  You want to make bets that will have a material impact.  Diversification is the enemy of out-performance.

 

tede02--you are absolutely right.  Any manager can randomly place 7-10% of net assets in a position and by definition they would be concentrated.  Whether they are skilled because they made that bet for the right reasons is really what the research looked at.  Ultimately, the research found those managers who took concentrated positions typically outperformed their counterparts who owned more positions or who were benchmark huggers.

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I really love Kahneman's book Thinking Fast and Slow. However, I think, his thoughts on human behavior don't add up when it comes to the markets. Kahneman et al have proven in countless experiments that humans make systematic errors when it comes to pricing. To me, this seems to suggest that there will be more or less large inefficiencies in markets that can be exploited by people who behave differently from the consensus. Yet, Kahneman suggests in his book and in talks that thinking this is foolish because nobody can beat the market. While this is certainly true in the aggregate, this is false for individuals even based on Kahneman's own assumptions.

 

EMH suggests constant risk adjusted returns with concentrated portfolios. In the aggregate I think this is correct. Yet, keep in mind that "risk" in the EMH sense is defined as volatility. So, constant risk-adjusted returns in concentrated portfolios mean higher returns with higher volatility. That means that even the average manager is expected to outperform the market on the long run with a highly concentrated portfolio while, at the same time, adding volatility. I think this is correct, but only on average.

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If they make successful bets, they are skilled.

If they make bad bets, they were overconfident.

;)

 

I tend to agree with the paper. Survivorship might be an issue here:

 

Lumpy bets lead to bigger tracking errors, so managers face higher career risk.

 

Unsuccessful ones are let go faster.

 

So maybe there is some survivorshorship in the data in that only the successful managers keep managing their funds.

 

 

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