August 2016: Telling the Difference Between Skill and Luck

It’s unclear who or where the aphorism “a rising tide lifts all boats” comes from, given that there are instances of its existence dating back to 1915. But it is often attributed to John F. Kennedy, who used it in a speech in 1963 to deflect criticism that a dam he was inaugurating was considered by his political rivals to be a “pork barrel project”—a public work or project whose primary beneficiaries are a politician’s constituents, who will return the favor by way of future political support. 

Warren Buffett used it when referring to the equities markets on both sides of the Atlantic in the mid-2000s, explaining, inter alia, that a booming economy and a healthy capital markets sector ensure that investment returns are good, irrespective of who or how those investments are being managed. The notion that asset managers could produce double-digit returns at the time “without getting out of bed” led many to question how investors could discern skill from luck. It’s a question that lingers to this day across the buy side.    

In a similar vein, I remember speaking to Catherine Doherty, CEO and principal at Investit, as the global equity markets cooled in the prelude to the global financial crisis of 2008. During that conversation, she explained that the research her firm had done indicated that investors were far more patient and willing to retain asset allocations with buy-side firms if they felt the asset manager was able to provide clear and logical evidence that it had made the best possible investment decisions in line with their mandates, regardless of whether those decisions had produced any material return or not. The key, she said, is transparency. 

The point of these anecdotes is that technology now, more so than ever, plays a crucial role in not only complying with increasingly restrictive and stringent regulations, but it’s also a means—the only means—by which money managers are able to provide investors with auditable, unbiased evidence that they are indeed providing the levels of services commensurate with what was agreed when mandates were awarded. This notion permeates every business process where a service is provided to an investor or a client. It’s also one of the reasons why BISAM’s March 2016 acquisition of market risk specialist FinAnalytica makes so much sense: It provides BISAM’s asset management clients with the means to not only provide transparency around performance and attribution, but also shed light on the level and types of risk consumed when chasing that performance. The risk component might not directly affect the outcome, but it does provide investors with an added level of transparency into how their assets are being managed. And that can only be a good thing.