Is Top Manager Performance A Random Walk?
Research Roundtable Publication
Many research papers and books have been written about the process that describes and models random movements or a Random Walk.
In the investment world, the most famous version of this may be Burton Malkiel’s seminal publication, A Random Walk Down Wall Street. First published in 1973, the book details how stock prices seem to follow a random walk, suggesting that a stock’s current price offers no predictive value that would allow investors to consistently beat the market.
This being the 50th anniversary of Malkiel’s Random Walk made us think again about studies that analyze the performance of top investment managers to see whether their results are persistent or random.
In 2017, we published our first piece on research by S&P Dow Jones that analyzes what fund performance data says about the ability of top managers to stay at the top. In what Dow Jones calls their Persistence Scorecard, they found this:
- No Large-Cap, Mid-Cap, or Small-Cap fund managed to remain in the top quartile at the end of a five-year period.
For those in the asset management business who work hard to outperform an index, this was hard to take, so we looked again at the data at the end of 2021.
Unfortunately, we found this similar finding in the S&P Dow Jones persistence research:
- No Small-Cap fund remained in the top quartile after five years.
Large-Cap and Mid-Cap funds did improve a little, with 3.5% and 1.5% respectively remaining in the top quartile after five years. These are still levels, however, that are just at or below random chance odds.
Based on this, we wrote a piece that asserted that active management has revealed itself to be a low probability bet with a big ante. Since hope is not a strategy, we considered the possibility that fiduciaries making allocations to active strategies might be in an uncomfortable position, as they aren’t supposed to be making low probability bets.
We continue to get some pushback on this, so to continue to test our thoughts, we just looked at the numbers again. This time, we reviewed analysis that encompasses large up markets and then a recent significant down market period ending June 30th 2022.
In looking at this most recent S&P Dow Jones Persistence Report, this is what we found – again:
- Not a single equity or fixed income manager remained in the top quartile of their respective category peer group over a five-year period.
Based the consistent lack of consistency among top ranked managers, which has been documented repeatedly in S&P Dow Jones Persistence Scorecards, one might say that manager performance can also be viewed as a random walk – except for these important differences:
- Unlike stock prices, top quartile performance does indeed have predictive value, and the prediction is that the manager will almost certainly underperform in the future.
- Unlike stocks, a manager charges a fee, whether they outperform or not, compounding the probability or potential fiduciary penalty of manager underperformance.
Studies like we mention are not perfect and one can imagine scenarios where an active management strategy could outperform the market and justify the fees.
After continuing to review the data, however, we appreciate even more the points made by Malkiel.
When recently questioned on CNBC about his index fund strategy recommendation from 50 years ago, Malkiel said this:
“I believe even more strongly than ever that index investing is an optimal strategy and that index funds should constitute the core of everyone’s portfolio.”
We continue to agree.
Related Reading:
Are Selectors Good At Selecting Top Managers?
The Road Less Traveled – Simple Alternatives Is Top Manager Performance A Random Walk? 
Smaller Is Better