A few years ago I found a document put out by DrKW Macro Research called “The Seven Sins of Fund Management” (caution – PDF) – it is truly an awesome piece of work, and a brilliant critique of the mutual fund space (and active managers in general). I could not remember where I had found it – so I’m going to thank whoever originally posted it and then re-post it here for others. This paper really formed a lot of my thoughts on why I should either be using a quant strategy or just be passive in my investing approach.
The paper is full of great insights – but my favorite is the analysis they did of stock picking performance relative to confidence in the outcome. Here, they measured both students/lay people and professionals. The outcomes are truly eye-opening – in this first chart, you’ll see that the students bested the professional in accuracy, but did so while having a lower confidence rating. In other words, the professionals were both cocky and wrong.
This one is great as well – it shows what perfect calibration on stock picking accuracy is as confidence rises, and then it shows both lay people and professionals. While the lay people are static, the professional actually get worse as their confidence goes up.
Anyway – it’s a great read – hope you enjoy it as much as I did.
In a related continuing story, fund managers continue to underperform the market. Shocking! ;)