Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 29

Skilled managers do exist

John Authers of the Financial Times recently asserted that nobody can tell which “investors are more skilled than others” and that active fund managers are unaware of their skills. These assertions are wrong. I suggest – with statistics very much on my side – that Berkshire Hathaway’s Warren Buffett and Renaissance Technologies’ Jim Simons are more skilled than most and furthermore that there are others who with a little work can be identified. I also know that at Aberdeen we are keenly aware where we possess skill and – more pertinently – where we don’t.

Knowing where you possess skill however requires knowing what it is. Simply, investment skill involves identifying non-randomness (pattern) in financial markets then profiting from it. It is about knowing the difference between what is predictable (pattern) and what is not (randomness). It is about understanding where and when one has an edge then swooping in for the kill.

The sad fact is that the vast majority of investors waste their energies and capital guessing the equivalent of which side a coin will land, often supported by written and verbal justification that is both sincere and articulate.

Know when the odds are in your favour

The key to investing is knowing when the odds of a coin landing heads have increased to, say, 70 or 80%. And this is where serial mean reversion comes in. Occasionally, random walks take asset prices so far away from their mean or trend that they are pulled back towards it rather than continuing in a random fashion. If a coin lands heads ten times in a row, the odds of a tail on the next throw are still 50%. In the world of investing however, it may be 70 or 80%. Put another way, despite the ubiquitous disclaimer, past performance can sometimes be a guide to the future.

Identifying pattern is very much what the two aforementioned maestros do in their own different ways. Buffett’s edge, in my humble opinion, has been his remarkable understanding of human nature, both its strengths (what it takes to build a great company) and its weaknesses (propensity for humans to be greedy or to panic) combined with discipline, patience, honesty and a very good grasp of statistics. Jim Simons, on the other hand, is a brilliant mathematician and has smarter and faster computers than anyone else. While Buffett is the king of predicting share prices over 10 years, Simons is unrivalled over 10 minutes.

Buffett and Simons are rare birds yet many still believe themselves to be good investors when the facts may tell a blatantly different story. The reason for this is that we humans evolved a survival mechanism to believe that we are better than we actually are. A timid approach to facing down a sabre-toothed tiger or attracting a cave mate would have been disastrous. Furthermore, we have an asymmetrical ability to blame our failures on (bad) luck but to attribute our successes to skill, a bias termed the fundamental attribution error. Thus you only need a couple of successes amongst all the failures to think that you’re a skilful investor.

Need to use your edge

If you have correctly identified an edge, the next step is to know how to use it. Question: if you have a biased coin that you know has a 60% chance of landing heads and you are playing with someone who does not know the coin is biased, what percentage of your bankroll should you bet each round in order to increase your wealth over time?

If you bet nothing, you’re wasting your edge (you know, he doesn’t) and your wealth will remain the same. If you bet your entire purse, there’s a 40% chance the coin will come up tails, and you’ll lose everything and be out of the game (even with the bias, the chance of there being one tail in ten tosses is 99%.) So the optimal percentage must be somewhere between 0% and 100%. The answer, in fact, is 20%. Bet 21% or 19% and over time you’ll end up less wealthy than if you bet 20%. If you want to know the formula, look up the term ‘Kelly betting criterion’.

How does this apply to investing? In Buffett’s case, he of course understands that to put all one’s eggs in one basket is foolish, but also that being overloaded with baskets will wear you out. The efficient market hypothesis asserts that you should diversify as much as possible to eliminate stock specific risks. Buffett on the other hand actively seeks out stock specific ‘risk’ because he knows that’s where his edge lies. As he has noted, ‘Wide diversification is for people who don’t know what they’re doing.’

Does Buffett know precisely what his odds are? Of course not. What he does know is that he has a good feel for where a company will be in 10 or 20 years’ time, giving him the confidence to run a concentrated portfolio. There’s much we can learn from him, though I’ll admit I’m not the first to suggest that.

 

Peter Elston is Head of Asia Pacific Strategy & Asset Allocation at Aberdeen Standard Investments (formerly Aberdeen Asset Management).

 

RELATED ARTICLES

Unfortunately, all fund manager presentations are good

What game is your fund manager playing?

What types of people should manage your money?

banner

Most viewed in recent weeks

Which generation had it toughest?

Each generation believes its economic challenges were uniquely tough - but what does the data say? A closer look reveals a more nuanced, complex story behind the generational hardship debate. 

Maybe it’s time to consider taxing the family home

Australia could unlock smarter investment and greater equity by reforming housing tax concessions. Rethinking exemptions on the family home could benefit most Australians, especially renters and owners of modest homes.

100 Aussies: seven charts on who earns, pays, and owns

The Labor government is talking up tax reform to lift Australia’s ailing economic growth. Before any changes are made, it’s important to know who pays tax, who owns assets, and how much people have in their super for retirement.

The best way to get rich and retire early

This goes through the different options including shares, property and business ownership and declares a winner, as well as outlining the mindset needed to earn enough to never have to work again.

A perfect storm for housing affordability in Australia

Everyone has a theory as to why housing in Australia is so expensive. There are a lot of different factors at play, from skewed migration patterns to banking trends and housing's status as a national obsession.

Chinese steel - building a Sydney Harbour Bridge every 10 minutes

China's steel production, equivalent to building one Sydney Harbour Bridge every 10 minutes, has driven Australia's economic growth. With China's slowdown, what does this mean for Australia's economy and investments?

Latest Updates

Economy

Why we should follow Canada and cut migration

An explosion in low-skilled migration to Australia has depressed wages, killed productivity, and cut rental vacancy rates to near decades-lows. It’s time both sides of politics addressed the issue.

Investing

Simple maths says the AI investment boom ends badly

This AI cycle feels less like a revolution and more like a rerun. Just like fibre in 2000, shale in 2014, and cannabis in 2019, the technology or product is real but the capital cycle will be brutal. Investors beware.

Property

Australian house price speculators: What were you thinking?

Australian housing’s 50-year boom was driven by falling rates and rising borrowing power — not rent or yield. With those drivers exhausted, future returns must reconcile with economic fundamentals. Are we ready?

Shares

ASX reporting season: Room for optimism

Despite mixed ASX results, the market has shown surprising resilience. With rate cuts ahead and economic conditions improving, investors should look beyond short-term noise and position for a potential cyclical upswing.

Property

A Bunnings play without the hefty price tag

BWT Trust has moved to bring management in house. Meanwhile, many of the properties it leases to Bunnings have been repriced to materially higher rents. This has removed two of the key 'snags' holding back the stock.

Investment strategies

Replacing bank hybrids with something similar

With APRA phasing out bank hybrids from 2027, investors must reassess these complex instruments. A synthetic hybrid strategy may offer similar returns but with greater control and clearer understanding of risks.

Shares

Nvidia's CEO is selling. Here's why Aussie investors should care

The magnitude of founder Jensen Huang’s selldown may seem small, but the signal is hard to ignore. When the person with the clearest insight into the company’s future starts cashing out, it’s worth asking why.

Sponsors

Alliances

© 2025 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. To the extent any content is general advice, it has been prepared for clients of Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), without reference to your financial objectives, situation or needs. For more information refer to our Financial Services Guide. You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.