Nobel laureate Daniel Kahneman claims in his book Thinking, Fast And Slow that the stock picking industry is built largely on an “illusion of skill.”
Among the evidence he gives is a study he did of a group of investment advisers. Kahneman analysed their returns over eight years to see how consistently advisers performed over time. While he expected large variation in performance, he was surprised to see that the correlation was basically zero.
“The results resembled what you would expect from a dice-rolling contest, not a game of skill,” he writes.
How did the advisers respond to evidence of their uselessness? With the most awkward dinner party — and car ride — ever:
On the evening before the seminar, [colleague] Richard Thaler and I had dinner with some of the top executives of the firm, the people who decide on the size of bonuses …
Our message to the executives was that, at least when it came to building portfolios, the firm was rewarding luck as if it were skill. This should have been shocking news to them, but it was not. There was no sign that they disbelieved us. How could they? After all, we had analysed their own results, and they were sophisticated enough to see the implications, however we politely refrained from spelling out. We all went on calmly with our dinner, and I have no doubt that both our findings and their implications were quickly swept under the rug and that life in the firm went on just as before. The illusion of skill is not only an individual aberration; it is deeply ingrained in the culture of the industry. Facts that challenge such basic assumptions—and thereby threaten people’s livelihood and self-esteem—are simply not absorbed. The mind does not digest them. This is particularly true of statistical studies of performance, which provide base-rate information that people generally ignore when it clashes with their personal impressions from experience.
The next morning, we reported the findings to the advisers, and their response was equally bland. Their own experiences of exercising careful judgment on complex problems was far more compelling to them than an obscure statistical fact. When we were done, one of the executives I had dined with the previous evening drove me to the airport. He told me, with a trace of defensiveness, “I have done very well for the firm and no one can take that away from me.” I smiled and said nothing. But I thought, “Well, I took it away from you this morning. If your success was due mostly to chance, how much credit are you entitled to take for it?”
Excerpt from Thinking, Fast And Slow.
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