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OPINION

The myth of expertise

The myth of expertise
October 20, 2014
The myth of expertise

Andriy Bodnaruk of the University of Notre Dame and Andrei Simonov at Michigan State University studied the personal investments of unit trust managers, and found that these do no better than the portfolios of wealthy and educated but non-specialist investors. "Wealthy investors appear to be as good individual investors as professional asset managers" they conclude.

This isn’t an isolated finding. Dutch researchers have found that investors who buy deferred annuities get worse deals if they take financial advice than they get if they act alone. German economists have found that financial advisors push investors into excessively risky investments. And US economists show that during the financial crisis banks in which CEOs had big personal stakes did as badly as those in which CEOs had invested less, suggesting that bankers were as lousy at looking after their own money as they were at looking after other people’s.

You might think all this is iconoclastic stuff. In one sense, though, it’s not. It’s wholly consistent with orthodox economic theory. The efficient market hypothesis says that all information about shares is already embedded in prices, and so expertise about future price moves is useless.

However, there’s a big caveat here. Professors Bodnaruk and Simonov found that shares which fund managers own both personally and in their funds did out-perform. This is consistent with a finding by Christopher Polk at the London School of Economics, that even average fund managers have a few good stock ideas. However, in their funds the need to diversify risk means that these few good ideas are diluted by other, worse, shares. And in their personal portfolios, shares which they buy on their own account offset the performance of their best professional ideas.

There might be a reason why managers’ professional stock picks out-perform their private ones. It’s that their stockpicking ability – in the sense of having a few good ideas – isn’t theirs alone but is in fact owned partly (or perhaps entirely) by their employers. Working for a big fund management company gives even someone of average ability advantages over the private investor: access to big data, to knowledgeable colleagues and greater access to companies. It’s this organizational capital that gives fund managers’ a small edge, rather than personal skill. This is consistent with research by Harvard Business School’s Boris Groysberg which shows that so-called star equity analysts see their performance deteriorate when they switch employer. And it helps explain a longstanding puzzle – of why fund managers keep going into work, with all the hassle that entails, rather than invest on their own account.