Lady Fortuna

Beating the Market—What's Luck Got to Do with It?

Lady Fortuna

The answer to that question is quite a bit actually, at least according to Nobel Laureate Eugene Fama1 and Ken French. Contrary to the protestations of Robert Olstein as featured in this New York Times article, Fama and French demonstrated that luck plays a very large role in the distribution of returns received by active managers, and as a group, they don’t deliver any more alpha than what we would see if luck were the only factor at play. Like all active managers, Mr. Olstein is bothered by the arguments in favor of indexing:

“It’s saying a guy like me can’t beat the market—that he shouldn’t even bother trying. That’s wrong! It really ticks me off. I can beat the market. I have beaten the market”

Naturally, we decided to put Mr. Olstein’s claim to the test—a statistical test. We compared the annual calendar year returns of the Olstein All Cap Value C (OFALX) to its Morningstar analyst-assigned benchmark of the Russell 1,000 Index. The bar chart of the differences in returns is shown below.

 

The characteristic that jumps out is the high returns in the three years from 1999 to 2001. Aside from those three years, it is a mixed bag, at best. This leads us to conclude that Mr. Olstein had a few very good years which most of his investors did not capture, as shown in the difference between the fund’s 15-year annualized return of 8.61% as of 11/30/2013 vs. its investor return of 5.31%, according to Morningstar. This is a pattern that we commonly see with active managers—a few good years towards the beginning of their tenure followed by mediocrity. As expected, a statistical analysis of these returns differences does not allow us to rule out luck as the explanation. In fact, we would need an additional 44 years of similar returns before we could say that there is significant alpha. This is what Professor Fama was referring to when he said, “It could be an anomaly—life isn’t long enough to be able to tell for sure.”

Any investors who are thinking about taking a chance with Mr. Olstein should give careful consideration to OFALX’s expense ratio—2.38% of which 1% is a 12b-1 fee (a fee paid to the broker for marketing the fund). It also has a 1% back-end load.  If Mr. Olstein, can indeed deliver alpha going forward, he needs to deliver enough of it to both cover the 2.38% and beat his benchmark by a wide enough margin to make his investors happy. Call us skeptics, but we will not be holding our breath.

 


1Fama, Eugene F., and Kenneth R. French. 2010. “Luck Versus Skill in the Cross-Section of Mutual Fund Returns.” The Journal of Finance, vol. 55, no 5 (October):1915-1947.