I like it when I am on the same page as Jason Zweig.  In a post over at the new Total Return blog Zweig takes to task fund managers who are using the high correlation among sectors and stocks these days as an excuse for underperformance.  Zweig writes:

What matters is not whether stocks are all moving in the same direction but, instead, whether they are all moving to the same extent. If all stocks go up at once, but some go up more than others, then stockpickers with the skill (or luck) to hold the biggest movers will rack up the best returns. If all stocks go down at once, but some go down more than others, then managers with the skill (or luck) to avoid the worst losers will have the best records.

This was a topic I had touched on earlier in a post entitled “Correlation is not destiny” in which I wrote:

Let’s take the daily returns of the S&P 500 for the past year and simply add 1 basis point to each day’s returns.  $SPY over this time period returned 7.7%.  Our modified S&P 500 would have returned 10.4%.  However the correlation between these two return series is by definition 1.00!  Two highly correlated assets can see their returns diverge over time.

Active managers SHOULD be measured not over days, weeks or months but rather over a whole market cycle.  The problem is that portfolio managers want to have it both ways.  When they outperform they claim it is skill.  When they underperform it is due to ‘adverse market conditions.’  Admittedly skill and luck both play a role in the markets, but you can’t pick and choose among based upon convenience.

Maybe we shouldn’t be all that surprised by manager reactions to adverse outcomes.  Daniel Kahneman in an excerpt from his new book Thinking, Fast and Slow writes:

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 general facts that people will ignore if they conflict with their personal experience.

So while correlations may revert back to historical norms, don’t expect underperforming managers to “absorb” their past performance willingly.

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