Identifying talent is only easy in retrospect

Jonah Lehrer writing at the great Frontal Cortex blog examine the phenomenon of “Linsanity” or how it is that a seeming NBA star was riding the bench.  Lehrer writes:

(N)obody thought [Jeremy] Lin could make it in the NBA. He was too short and too weak, with a mediocre jump shot. And that’s why, if I were an NBA coach or scout or GM, his remarkable success would keep me up at night. Professional sports, after all, are supposed to be a pure meritocracy, in which those with the most talent are carefully vetted and tested. Those who make it in the NBA are supposed to be a pure distillate of athletic potential: the players are richly rewarded because they really are the very best.

Lehrer goes onto look at the validity of the metrics NFL teams use to grade prospects at the annual NFL combine.  Research shows that the presumably hard data NFL teams use is actually pretty worthless when it comes to picking players that will excel.  Lehrer concludes:

Jeremy Lin is a reminder that similar problems almost certainly apply to the NBA, which is why we shouldn’t be so surprised that a benchwarmer cut from multiple teams is quickly becoming a star. There is talent everywhere. We just don’t know how to find it.

The same problem of identifying talent ex-ante is also endemic to active investment management as well.  Not only is it difficult to identify those portfolio managers who will outperform the market it is also difficult to say with any great deal of certainty that those managers who do outperform are actually skilled.  Michael Mauboussin has written extensively on the challenge of “untangling skill from luck.”

Brett Arends has a fine article up at SmartMoney about a below-the-radar investor, Allan Mecham who has put up some stunning performance numbers.  Over a 12 year period ending in 20011 Mechan’s fund has generated a 400% return.  Arends notes that Mecham, who from a Wall Street perspective, is not exactly what the vast majority of investors are looking for.  Mecham is a college dropout living in Utah who rarely if ever trades.  Arends writes about the aftermath of Mecham meeting with potential investors:

Mecham has faced this kind of befuddlement before — which is one reason he meets only rarely with potential investors. It’s tough to sell his product to an industry that’s used to something very different. After all, according to their rules, he shouldn’t even be in the business to begin with.

One investor, Brendan O’Brien of Gold Coast Wealth Management, even uses a sports analogy to describe the opportunity to invest with Mecham when he says it was “one of the rare few times when a star free agent becomes available in the beginning of his prime.”  The challenge for investors thinking of investing with Mecham today is whether he can continue this torrid pace.

We can’t know whether Jeremy Lin or Allan Mecham will continue to outperform, especially against what now seem to be very high expectations.  The fact is that no one saw either of these guys coming.  Can’t miss prospects, whether they be number one draft picks or hedge fund managers able to raise $500 million at the outset fail all the time.  The iron fact is that only in retrospect can we say with any degree of confidence whether any individual’s performance is more skill than luck.

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