Hi Guys,
A few months ago, a mid-western woman was crushed when a storm wetted tree came crashing down on her car. The story attracted particular attention because of the unlikely events that led to the disaster. The storm had flooded some roads forcing the woman to drive to a store that she never used on a road that she never traveled. The tree failed at the precise moment that woman was stopped at an intersection controlled by a traffic light. How improbable is this series of events? How unlucky can a person be?
That coin has another side that is amply illustrated by the lucky winners of lotteries. In general, lotteries are loser’s games. The payoff matrix for these money making events typically only returns about one-half of the winners pot to the game’s players. Yet millions of players accept that negative expectation payoff and choose to participate. The unlikely excitement of an outsized payday overwhelms the statistical likelihood of death by a thousand small wounds. Millions welcome this risk; they surely are optimistic souls.
These two stories are examples of purely random outcomes; luck dominated to the exclusion of skill considerations. In many other scenarios, skill and luck do interact.
A great example of the luck-skill mix in the sports world is Joe DiMaggio’s 56-baseball game consecutive hitting streak in 1941. Within the steak, baseball experts concluded that 5 of those hits were extremely lucky happenings to extend the streak. Experts also observed that Jolting Joe was unlucky in the 57th game when the Cleveland Indians designed a scheme to end the streak. But skill helped to sustain this record performance. Superior skilled players have a higher probability to establish longer streaks. In these instances skill and luck mix to enhance results.
The same is true for mutual fund management. Mutual fund firms extol their excess returns over a reasonable benchmark yardstick, their positive Alpha. Statistical considerations conclude that some fraction of the huge mutual fund universe will necessarily demonstrate a positive Alpha – at least for a short period. The critical test is persistence over time. One of the acid tests for true skill is the persistence of superior outcomes. Joe DiMaggio passed that test. Legg Mason’s Bill Miller passed that test until he failed. One rigid rule in both the economic and the investment worlds is a “regression to the mean”. Trees do not grow to the sky.
I addressed the persistence issue in a recent MFO posting that I titled “Illusive Performance Persistence”. Here is the Link to my earlier submittal:
http://www.mutualfundobserver.com/discussions-3/#/discussion/3278/illusive-performance-persistenceSo luck happens and significantly can control success and failure. That’s true in life; that’s true in investing. Given that reality, is it possible to tilt the odds just a little towards the superior outcomes?
Initially, I was dubious about such endeavors. Why waste time on something that is totally unpredictable, totally unknowable? But some recent reading on the subject has given me pause to reevaluate. I am not sure I’m completely convinced of some of the prescribed luck enhancement techniques, but many are commonsense based. I suspect we all often apply them intuitively in many of our daily interactions.
I was surprised at how many research studies and formal reports exist on the luck topic. Although I am a relative neophyte on the matter, with a goal to sway luck more in my direction, I have discovered a few sources that you might find informative.
My short list includes works by Michael Mauboussin, Richard Wiseman, and Max Gunther (author of the Zurich Axioms). Both Wiseman and Gunther have written books with the same title, “The Luck Factor”. Mauboussin has contributed a long Legg Mason research paper appropriately called “Untangling Skill or Luck”.
To whet your appetite on the subject, I’ll summarize Wiseman’s four and Gunther’s five major categories of luck enhancement techniques.
Wiseman recommends: (1) enlarging your contact base, (2) trusting your intuition based on experience, (3) be an optimistic dreamer, and (4) be persistent in making lemonade out of lemons. Wiseman offers techniques to implement these generic guidelines.
Gunther recommends: (1) deploying a spider web structure that enhances contact potential, (2) developing a hunching (intuitive) skill set, (3) being bold and take measured risks, (4) using a ratchet concept to limit downside impacts, and (5) having guarded pessimism even when happy.
Note the essential similarity between the Wiseman and Gunther approaches to enhancing luck. The single obvious disagreement in the recommended methods is on the optimism/pessimism scale. Wiseman argues that optimism will augment your persistence in problem solving; Gunther emphasizes the safety net benefits that pessimism encourages. You get to choose. I’m in the optimistic camp.
The spider web concept is essentially what we are doing when we participate in the MFO member exchanges. We are increasing our connectivity, and hopefully our prospects for superior investment rewards by reducing the luck component in the skill-luck equation.
Professor Wiseman has provided simple access to his work with an abridged version of his book called “The Power of Luck”. It is an easy and breezy read. I encourage you to read it. You gain access to an ebooklet download by visiting the following address:
http://www.theluckfactor.com/docs/ebooklet.pdfMichael Mauboussin’s paper is a bit longer, but it too is an excellent summary of the luck versus skill debate that is somewhat directed at mutual fund performance. You gain access to that Legg Mason paper by going to the following address:
http://www.lmcm.com/868299.pdfPlease visit these websites. You might actually improve your luck quotient by a more knowledgeable application of the recommended techniques. The methods probably can do no harm; they might even give you a slight edge with respect to improving your luck score. We all need a little more luck.
I’m sure all MFO members have experiences and knowledge that can expand this discussion. Please share those insights. Your contributions are hardily welcomed.
Best Regards.
Comments
Please forgive me now for "hijacking" your thread, as you've left an opening here for me to link author Michael Lewis's recent Princeton Commencement Address in which he invokes the role luck has played in our lives to inspire us to "give-back" to society some of our blessings. Caught excepts on TV and was moved. The following provides additional links to the video as well as the transcript. Enjoy.
http://www.businessinsider.com/michael-lewis-commencement-remarks-2012-6
When you hear the so-called experts tell us that such-and-such is going to happen, just remember that their crystal ball is just as crappy as your own. Each of us, in the end, need to be in a position where we can sleep at night and not spend lost hours worrying about what will happen to our investments if "stuff" happens.
Yeah, there is a certain amount of luck involved in all of this. But investors need to be able to admit that it is impossible to plan for every what-if. The best we can hope for is that our own well-conceived plans will see us through the short-term calamities, but still allow us to make adjustments to reach our long-term goals. And remember that sometimes (maybe most of the time), it's best to do nothing at all. Change for the sake of change to "stuff" that happens is usually not the best way to go.
Thanks, MJG.