Our article, Luck versus Skill in Active Mutual Funds, which appeared on August 5, stirred a lively debate among our readers, led by Tom Howard, CEO of AthenaInvest, and Dave Loeper, CEO of Financeware, Inc.  We thought this would be a good opportunity to summarize where the debate stands, and the key questions that remain unresolved.

The initial article was based on an interview with Russ Wermers, whose academic work has attempted to statistically identify and measure how much luck exists in a universe of funds through a calculation he calls the False Discovery Rate (FDR).

Howard argues that alpha for actively managed funds has increased over time, and this is indicative of an increasing level of skill among fund managers.  Howard further argues that conventional metrics for identifying skill are insufficient, advocating instead the use of Strategy Based Investing (SBI), a methodology that his firm has commercialized.  Loeper questions Howard’s conclusion, asserting that Howard’s analysis didn’t compare funds to a benchmark appropriate to measure all domestic equity funds.  Loeper believes skillful managers exist, but argues that that luck does as well and the conclusion Howard drew was based on analysis that presumed luck does not exist.

But that central disagreement just scratches the surface.  The comprehensive discourse of the debate is available through links to each installment appearing at the end of this article.

The debate has revolved around several issues:

1. Does historical data support the claim that alpha is increasing over time?
2. If alpha has been increasing, does this mean skill is increasing?
3. Is there statistical evidence that skillful managers can be separated from those that are merely lucky?

Howard has provided the following data primarily regarding the first question:

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