Most positive investment performance is due to luck, not skill. Do you agree?
A senior stockbroker once told us that the financial markets were a vast knowledge machine that knew everything about business. He cited as proof the interception of bad news from a company's Malaysian branch before the headquarters of the company in question had registered it.
We came away with the uneasy feeling that our contact knew a huge amount about certain kinds of matters, but was completely blind to many factors that vitally affect the performance of businesses. Furthermore, he was also blind to what he didn't know, and thus was unlikely ever to learn about the 'softer' aspects of business - how the quality of people, leadership, learning and special skills would affect future performance - what effects motivation, skill, culture, organisational design and performance would have on a company's results.
Our feelings were confirmed by reading Broker's Analysts' reports - these reports on companies are used by Investment managers to help them make judgments about which companies to invest in.
These are mainly spreadsheet analyses of past financial results, together with industry-level forecasts and a little very crude stuff about governance and top people. We (and some colleagues who had previously thought we were exaggerating) were amazed by the complete lack of awareness of how the qualities of organisations would affect future performance.
Then we studied the research by Sir John Cass Business School, which is referred to in more length in the Investment and the Financial Markets section - Good investment performance - a matter of luck or skill - new research
The bottom line of this comprehensive and careful study, building on similar ones performed in the U.S was that a lot of better-than-average performance by fund managers is due more to luck than skill - and the large tail of under-performance is emphatically due to a lack of skill.
Then the penny dropped - when it comes to deep and sophisticated understanding of how companies actually function, what actually differentiates good companies from also-rans, and what factors might be most useful in predicting how individual companies might perform in the longer-term future - most investment managers and analysts haven't a clue! They are almost entirely dependent on historic financial data and a little tittle-tattle.
Worse still, they are often aggressively unaware of how little they know.
These are the people who can support or dispose of our most powerful companies and sit in judgment on their top managers. Truly alarming!