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Blind squirrels, nuts and investing

June 19, 2009

lake wobegonRocky often vacations at Lake Wobegon, where “all the women are strong, all the men are good looking, and all the children are above average.” For tax deductibility, he spends a portion of his trip recruiting young traders from the shores. Last year, he recruited Sue, a man who sadly lost an eye and a leg in a golfing accident, but whose eye for investment value remained intact.

This morning, Sue hobbled across the office, tripped on an empty Coke can, and handed Rocky a new paper from Eugene Fama, a father of the Random Walk theory of stock prices. The paper posits that NO investors have skill that enhances expected returns. It’s all about luck, and the fact that even blind squirrels find nuts.

Rocky thanked Sue for bringing Fama’s article to his attention, and noted that he’d rather be lucky than smart. (And as the saying goes, “the harder you work, the luckier you get.)

Click [here] to read the full paper.

Here is the abstract:
The aggregate portfolio of U.S. equity mutual funds is close to the market portfolio, but the high costs of active management show up intact as lower returns to investors. Bootstrap simulations produce no evidence that any managers have enough skill to cover the costs they impose on investors. If we add back costs, there is some evidence of inferior and superior performance (non-zero true alpha) in the extreme tails of the cross section of mutual fund alpha estimates. The evidence for performance is, however, weak, especially for successful funds, and we cannot reject the hypothesis that NO fund managers have skill that enhances expected returns.

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