Chronology of the debate

Luck versus Skill in Active Mutual Funds

August 5, 2008.  Robert Huebscher’s original article on the study by Russ Wermers, including an interview with Wermers.  Wermers’ study used a statistical technique known as the False Discovery Rate (FDR) to argue that equity managers added little value over time, net of fees, and the proportion of skilled managers is on the decline.

Letter to the Editor (Tom Howard)

August 12, 2008.  Tom Howard responds to the original article, arguing that fund alpha has been increasing (“an upward alpha slope,” when measured against the S&P 500) and risk (as measured by standard deviation) has been decreasing.

Letter to the Editor (Ron Surz)

August 12, 2008.  Ron Surz argues that the FDR advocated by Wermers provides only one level of analysis and other analytical techniques are crucial to understanding whether skill or luck is the determinant of performance.

Letters to the Editor

August 19, 2008.  Four letters to the Editor take issue with various points raised by Howard in his August 5 letter.  These letters primarily take issue with two points in Howard’s research.  First, they challenge Howard’s claim that Wermers’ research is biased because it fails to include funds less than five years old.  Second, they challenge Howard’s choice of the S&P 500 as a benchmark.

Letter to the Editor (Tom Howard)

August 19, 2008.  Howard responds to the four letters in this issue, arguing that it is easier to find skill among newer funds with less than five years of history.  He also defends his choice of the S&P 500 as the correct benchmark, since he is measuring aggregate performance across all funds, rather than the performance of individual funds.

When Will Objectivity Enter the Active vs. Passive Debate?  (Dave Loeper)

August 19, 2008.  Loeper responded to the original study and to Howard’s arguments by analyzing the data available, finding that the majority of funds underperformed their best-fit benchmark over the time period in question. Loeper concluded that although skill likely exists, there was no clear evidence that out-performance by funds was attributable to skill as opposed to luck on the part of the managers.

The New Ptolemains (Tom Howard)

August 26, 2008.  Howard’s response to Loeper takes the position that breaking the market into fund subsets, based on portfolio characteristics, makes little sense for creating benchmarks. Howard agrees that a manager who has produced good returns may just be lucky rather than skillful but concludes that it is possible to build a portfolio of skilled active managers by taking additional factors – beyond long-term performance – into consideration

Alpha during Market Cycles (Brent Bentrim)

September 2, 2008.  Bentrim provides data showing that alpha is inversely correlated to the S&P 500: alpha surges when the S&P 500 does poorly, and vice versa.  Bentrim cites this as further evidence the S&P 500 is not the correct benchmark for the universe of funds.

Howard is Right. The World is Flat (Dave Loeper)

September 9, 2008.  Loeper moves beyond fund subsets and style boxes to address the universe of all domestic equities and the universe of global equities in search of evidence of skill. With these very broad measures, Loeper finds that less than fifty percent of funds had higher return and a majority of funds had greater risk than the broad all domestic equity benchmark. In conclusion, Loeper restates that skill probably exists but luck is also present and cannot be ignored.

Travels in Four-Packistan (Michael Edesess)

September 9, 2008.  Edesess uses an analogy to cigarette smoking to argue that it is impossible to determine whether a manager who performed well over time did so by virtue of luck or skill.

Luck versus Skill and the Analogy to Astronomy (Adam Apt)

September 9, 2008.  Apt, who studied the history of science, argues that Howard’s analogy to Copernicus and Ptolemy is flawed.

Benchmark Battles (Tom Howard)

September 16, 2008.  Howard responds to the charge that the S&P 500 is the incorrect benchmark.  He measures performance against the broader Russell 3000 index starting in 1984, and finds the S&P 500 was a more difficult index to beat over this time period, reasserting that average fund alphas are increasing over time. 

Howard provided the data in this article in order to be consistent with his original comparison to the S&P 500, which was done from 1980.

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