In his 2016 Berkshire Hathaway Annual Letter, Warren Buffett discusses the role of luck in investing, suggesting that among a large group of managers making predictions, some are bound to occasionally succeed purely by chance, much like a randomly successful monkey. However, unlike the monkey, successful managers might attract investors, even if their success is not based on skill but on luck. This underscores the difficulty in discerning truly skilled managers from those who are merely fortunate. Here’s an excerpt from the letter:
There are no doubt many hundreds of people — perhaps thousands — whom I have never met and whose abilities would equal those of the people I’ve identified. The job, after all, is not impossible. The problem simply is that the great majority of managers who attempt to over-perform will fail.
The probability is also very high that the person soliciting your funds will not be the exception who does well.
Bill Ruane — a truly wonderful human being and a man whom I identified 60 years ago as almost certain to deliver superior investment returns over the long haul — said it well: “In investment management, the progression is from the innovators to the imitators to the swarming incompetents.”
Further complicating the search for the rare high-fee manager who is worth his or her pay is the fact that some investment professionals, just as some amateurs, will be lucky over short periods.
If 1,000 managers make a market prediction at the beginning of a year, it’s very likely that the calls of at least one will be correct for nine consecutive years. Of course, 1,000 monkeys would be just as likely to produce a seemingly all-wise prophet.
But there would remain a difference: The lucky monkey would not find people standing in line to invest with him.
You can read the entire letter here:
Berkshire Hathaway 2016 Annual Letter
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