If you’ve got money invested, you probably have an investment manager looking after it. But what makes them good at their job?
Investment skill isn’t luck, and neither is it simply providing the market return.
How can you tell if your investment is giving you the market return? Look at your investment manager’s returns alongside their chosen market index.
If the returns are broadly similar to the index, meaning they go up and down at roughly the same time and by a similar amount, the manager is just trying to provide the market return.
When the results of your investment are often noticeably better than the index, it means the returns are partly driven by skill, or luck. Not just the market.
If the results of your investment are often worse than the index, it’s likely skill, luck, or both are missing.
How can you tell if a good result is due to skill – or if it’s a matter of luck? The best way to separate skill from luck is time.
Luck is random, and usually won’t last, but theoretically, skill means a good outcome can be repeated.
A good definition of investment skill is being able to consistently outperform your market index.
Where does skill come from?
Most research suggests investment skill is a combination of:
- Great process
The exact combination depends on who’s doing the investing, what they’re investing in, where in the world they’re investing, and how they’re investing.
The key to success
To outperform the markets, a skilled manager must have a little more information, a slightly better take on the information, or just use it more wisely when selecting and managing their investments. This is a difficult edge to maintain.
Some markets can be richer hunting grounds than others for skill, because it takes effort to get information about how the market works and how companies in it behave.
Take Australasian ‘small cap’ companies, those worth AU$1 billion and less. In many cases, not a lot of information is available about those smaller companies. So, in this market, an investment manager’s effort to uncover information to gain insight, and make intelligent bets, can help them consistently outperform.
Not all markets have these factors.
How do you find out if your investment manager has skill?
Look for three things:
- How do they talk about their investment processes, especially how they manage risk? Is it convincing, does it make sense, do they support their views with good evidence and theory? If they write or talk about it in different places, is it consistent?
- What evidence can they show that they’ve stuck to their philosophy and processes, especially when markets were choppy. If they strayed from them, you can’t be sure that good results weren’t entirely due to good luck.
- And third, if they did stick to their investment processes and philosophy – how did they do? Did they beat their benchmark? Did their members benefit? Did they do better than other managers claiming to have the same approach? More than once or twice?
Finally, even if you’re confident you’ve found genuine skill, you might find that the benefits you get can be seriously reduced – or erased – by fees.
It’s okay to pay more fees for skill if you’re confident it’ll give you better returns over time. But it’s not okay to pay so much that the manager is getting more than their fair share.
Remember, it’s your money that’s at risk.
Published October 2018
Story by Paul Gregory, Pie Funds
We aim to make investment with KiwiSaver easy to understand. To help us make this article reader friendly, we used The Write Plain Language Standard.
Paul Gregory is the Chief Operating Officer at Pie Funds Management Limited. Pie Funds Management Limited is the issuer of the JUNO KiwiSaver Scheme. You can read our Product Disclosure Statement. This article is general in nature only and has not taken into account any particular person’s objectives or circumstances. We recommend you speak with a financial adviser. All content is correct at time of publication date.