Life After Full-time Work Blog

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#39 Is There Investment Skill? If So, What Is It Worth?

If we make enough choices, some will work out and some won’t. How do we distinguish luck from skill? Is there skill? What is it worth? This post looks at those questions.


As I said in a previous post (…-separate-issues/), everyone who is involved in active management genuinely professes skill in being active. The thing is, skill here doesn’t just mean getting a good return (passive management can also get a high return); skill means getting a better result than the average of others who also profess the same skill. So it’s not just their skill you’re relying on, it’s also your own ability to find them. Is there such skill? If so, how do you locate it? And if so, is it worthwhile for you to pay more for it?

No need for suspense. Let me give you quick answers. Yes, there is investment skill. Locating it is very difficult. Typically it’s not worth paying for it. There, now you know; the rest of this post gives you my justification for those assertions.


Yes, there’s skill. I have said so on many occasions. At one stage of my career I ran a department that attempted to find superior investment managers, in many asset classes around the world. I published a paper in 1998 documenting my firm’s results.[1]  I engaged in a public debate with an Oxford professor at a conference on the issue in 2014,[2] rebutting his assertion that “It’s a waste of time listening to consultants [on the subject of finding good active managers]. It’s a service that’s useless.”[3] I pointed out that his definition of success was the ability to select the manager who finished at the top of the performance rankings, whereas all that a buyer of active management services requires is the ability to beat the passive benchmark – in other words, winning a silver or bronze medal or being an Olympic finalist is success, not just the gold medal – and his own paper actually demonstrated the existence of this level of selection skill. And at another stage in my “post-graduate” years I published a paper[4] providing insights for evaluating active management. So it’s something I have long studied.


But frankly, it’s not enough for there to be historical skill in finding managers who themselves have investment selection skill. This sort of skill tends to get gradually diluted with time. Investment markets become more efficient with the rapid dissemination of research and greater ease of trading. And so what happens is that persistent added value from skill becomes increasingly difficult to identify. What you always find is occasional added value, and of course it’s precisely after such a period that managers advertise their skill; nobody advertises: “We’ve been underperforming recently, but trust us, we’re really superior.” And yet advertising is persuasive. Flows into funds that have performed well in the recent past are invariably greater than into funds that have performed poorly.

What’s clear is that there is no simple way to identify future superior performance (which is all that counts – you get no credit for what happened before you became an investor in that fund). And it may surprise you to know that the traditional maxim in other areas of life, that “you get what you pay for,” is typically not supported in the investment field. Let me simply quote from the Investopedia website[5]: “Just about every study ever done has shown no correlation between high expense ratios [i.e. fees] and high returns. This is a fact. If you want more evidence, consider this quote from the [US] Securities and Exchange Commission’s website: ‘Higher expense funds do not, on average, perform better than lower expense funds.’”

You may think, therefore, that you’ve located skill when you find a fund that has recently outperformed the passive benchmark; but beware the selective presentation of information.[6]


What’s also important is to ask: if there really is skill, how much is it worth paying for that skill? You may find, for example, that over moving 5-year periods a manager (or a fund) has outperformed the passive benchmark 80% of the time. Wow, that’s great! But by how much? And after fees (both the fund’s active management fees for individual investors and your professional’s fees) how much is left for you? Is the amount that’s left for you worth the risk of future underperformance? Perhaps it is, perhaps it isn’t. My point is simply for you to ask the question.

Possibly most important of all is a question that isn’t often asked: Why do you care if your performance is slightly better than passive? If it’s bragging rights you’re after, then yes, you’ll get them. But if the ultimate goal isn’t investment bragging rights, if in fact your investment returns are just a way to get to the lifestyle you desire, then your goal is a lifestyle goal rather than investment bragging rights, and the question is whether active management success contributes much to the probability that you can achieve your lifestyle goals. Whether you’re willing to pay more for active management may ultimately come down to that perspective.

By coincidence, I just came across some comments on a study by Fidelity Investments. Madeline Farber, in Time magazine, summed it up with a great quote[7]:

“Women have long-term goals, and they stick with the plan,” Kathy Murphy, president of personal investing at Fidelity, told CNN. “They focus on saving and investing for retirement or a kid’s college fund, not on outsmarting the market [as men do].”

Good for women!  I’m sure this is a relative statement, in the sense that men tend to be taller than women, but not all men are taller than all women, or women tend to outlive men, but not all women outlive all men; so too the statement is a relative categorization of men and women: not all women and not all men behave according to the quote.  But this is the point I’m making: outsmarting the market is only a means to an end, not the end in itself.



Yes, there is investment skill, but locating it is very difficult, and typically it isn’t worth paying for.


[1] Ezra, Don (1998). “Adding value through active manager selection and structure: documenting Russell’s experience” (September 1998), Frank Russell Company UK Conversation Piece.

[2] Global ICON Conference, Boston, MA, July 2014.

[3] Sorkin, Andrew Ross (2013). “Doubts raised on value of investment consultants to pensions” in DealBook (September 30, 2013). Retrieved on May 20, 2016.

[4] Ezra, Don (2011). “Insights for evaluating active management” (December 2011) Russell Investments US Viewpoint.

[5] Retrieved on May 20, 2016.

[6] Ezra (2011, op. cit.).

[7], viewed March 18, 2018



I have written about retirement planning before and some of that material also relates to topics or issues that are being discussed here. Where relevant I draw on material from three sources: The Retirement Plan Solution (co-authored with Bob Collie and Matt Smith, published by John Wiley & Sons, Inc., 2009), my foreword to Someday Rich (by Timothy Noonan and Matt Smith, also published by Wiley, 2012), and my occasional column The Art of Investment in the FT Money supplement of The Financial Times, published in the UK. I am grateful to the other authors and to The Financial Times for permission to use the material here.

4 Responses to “#39 Is There Investment Skill? If So, What Is It Worth?”

  1. Ted Harris says:

    Don, I think there’s a valid argument for using ETFs which are prudently selected to meet one’s long term investment objectives. This exercise has now become more elaborate with the evolution of every type of ETF imaginable, including actively managed ETFs ! So the first challenge is getting reliable advice on an appropriate objective and then developing a benchmark suitable to one’s objective.

    For those in the accumulation phase, who do not want to add to their risk through market timing, a passive approach should work over the long haul.

    For those who are retired, and deriving any income from their portfolio, market volatility is a bigger issue. For them maximizing returns represents more risk than optimizing returns, insofar as optimization entails achieving an acceptable comparative rate of return against a benchmark suitable to their realistic investment expectations, their propensity for risk and their capacity for return variability. A shorter time frame and the need for income, without having to sell depreciated assets, will likely require a portfolio with less volatility than a market-based benchmark, so optimization will not always mean exceeding the benchmark. In the worst case, one would strive to satisfice one’s objectives. (Your word, not mine!)

    In this case one would be trying to identify a manager or fund which does not perform as badly as the market benchmark in down markets and, as a result of less volatility, does not reach the same highs as the benchmark. Indeed, their volatility year-over-year should be less than the benchmark and their competitors. The fee paid is partly insurance against volatility. Over the long haul it’s better to be consistently in the second quartile.

    I remember one study – there are probably several – that tracked the investment returns achieved by it’s investors versus that of the fund itself. The investors underperformed – trying to market time their participation in the fund.

    One last thought. Sometimes underperformance is a good thing. I once won a mandate during a period of underperformance against the manager universe. Why? We were competing for a position in a multi-manager style offset portfolio. The manager we replaced generated good performance, but at the wrong time – they were out of sync with the style they were hired to execute (style drift).

    • Don Ezra says:

      Thanks, Ted, so many good points here! There are many situations where an index doesn’t fit one’s objectives — I’ll mention this in the next post — and so departure from the index is good. Your example of something less volatile than the index, in decumulation, is one such situation. Yet the traditional definition of active is simply any departure from an index. I think that’s too broad. It should be narrower: attempting to outperform the index, with no long-term tilt in any direction. Your example of underperformance is similar: what was important there was the style tilt, not performance relative to the broad index. I think you’ll enjoy the next post!

  2. Ralph Loader says:

    So here’s what I say to that. I agree that there is skill, although often luck looks a lot like skill and investment skill reveals itself less in terms of excess return than it does in terms of capturing the long-term return characteristics of the benchmark with fewer securities and lower volatility. If what I have said is true, then determining whether the said “skill” is worth it rests in the eye of the beholder. If I sleep better knowing that my portfolio manager has, to the best of his/her ability, selected 40 or 50 stocks that will probably give me benchmark returns but that will lose only 10% when the market drops 20%, then manager fees (50 bps) may be worth it to me. Of course, if I can find a low vol ETF that will do the same for me at 30 bps, and I don’t mind reviewing my portfolio regularly to adhere to sensible re-balancing rules, then the fully active alternative looks less interesting to me.

    On a more philosophical note, we must not forget to assign some value to HOPE. We know that “hope springs eternal” and for most folks hope is all bound up in their search for meaning in life. So, why not invest some portion of your assets in an active management alternative that affords you hope that you may rise, at least a little, above the rat-race? The hoped-for reward may elude you, and you may be left holding the “regret” bag, but in the interim you will enjoy the benefit of the inspiration that hope delivers. And if you choose your active manager carefully, you will also enjoy the benefit of a less stressful journey (i.e., less downside capture) on the way through.

    Thanks for your articles Don . . . good food for thought, always.

    • Don Ezra says:

      Thanks for these very deep and useful thoughts.

      On the first one: Absolutely! If you trust the manager’s selection/timing skills, go for it. All I’m advocating is that you go for it consciously.

      And on the second one: Without hope, we’d all be severely depressed, so hope is a good thing! Again, all I’m saying is that your hope should be well-founded; otherwise it’s fodder for exploitation. As always, I advocate informed judgment.

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