Thursday, January 03, 2008

Expert Coin Flippers

Many studies have shown that mutual fund managers with a history of superior performance usually fail to maintain it in subsequent periods--a result that does not surprise supporters of the efficient markets hypothesis. Today's Wall Street Journal gives an example of this phenomenon (although the paper seems to be promoting the funds, rather than drawing the logical inference from the numbers).
As shown above, the Journal reports that of the many thousands of mutual funds sold to the public, only 31 beat the Standard & Poor’s 500 index in each of the 8 years from 1999 to 2006. A skeptic of the efficient markets hypothesis might think that, subsequently, these funds would offer a better-than-average place to invest. In 2007, however, only 14 out of these 31 outperformed the index—about what would be expected from sheer chance. Exceptional past performance appears to give little reason to expect future success.
Let me venture a guess about how many of the remaining 14 will see their winning streak continue another year: 7.