The last few days have been a feast of entertainment for the sporting enthusiast; the Champions League Final, the Monaco Grand Prix, and the NBA Conference Finals were all on the menu. While the sports represented are distinct, these events have something notable in common: the persistence of their participants. The same two teams reached the NBA Finals for the fourth consecutive year, the Champions League was won by the same team for the third year in a row, and the Monaco Grand Prix title went to a driver from a team that has regularly featured in the upper echelons of the sport. In other words, in the sporting world, past performance has been a reasonable guide to future results.
One possible explanation for this persistence is that championship teams possess more skill than their competitors, and that, at the highest level of athletic competition, success depends importantly on skill. Indeed, we might take the persistence among winners in football, basketball and motor racing as evidence that these activities reward – and are dependent upon – the skill of the participants. (This very question – the relative importance of skill vs. luck in sporting outcomes – has actually been litigated for darts, pinball, and poker.)
In the popular imagination, active investment management mimics the engaging combination of luck and skill that sport can provide. Certainly, the fame and fortunes accrued by the most skillful athletes are comparable to those of the most successful active managers. But has the performance of active managers shown a similar degree of stability?
Over the last few years, S&P Dow Jones Indices has published a series of “Persistence Scorecards”. Initially focused on the persistence of returns of domestic U.S. equity and fixed income managers, these scorecards have been extended to cover Australia and, most recently, Latin America. The results in each of these markets are clear; active managers have found it extremely difficult to consistently outperform their peers. For example, Exhibit 1 shows that only 3.56% of the 1151 domestic U.S. equity funds whose returns were above the majority of their peers in the 12 months ending September 2013 could boast of a similar achievement at each September in the four consecutive years. For context, the probability of flipping a coin and getting four consecutive heads is 6.25%.
Exhibit 1: Performance Persistence of Domestic U.S. Equity Funds.
This is by no means the first time that sports and the investment management industry have been considered side by side – Charles Ellis’ brilliant analysis is required reading in this regard. While skill appears to be rewarded in sports, the evidence suggests luck dominates in the investment management industry. Hence, investors may find it worthwhile to recall the sentence inserted into many a prospectus: “past performance is no guarantee of future results”.