What skill?

Anthony Bolton's retirement as manager of Fidelity's special situations fund is inspiring many tributes like this (reg req). It's also inspiring some bad economics.
Jonathan Davis (who's usually excellent) says Bolton's great returns - his fund has turned £1000 into £130,000 over the last 27 years "defies the findings of a thousand academic research papers that no professional investor can beat the market by so much for so long."
Well, his performance might defy a thousand bad papers. But it's entirely consistent with this good one. Eugene Fama and Ken French say value stocks - those on low price-book ratios - have out-performed the market around the world because they compensate investors for taking distress risk. That is, the danger that such stocks will do badly in recessions.
Anthony Bolton has merely exploited this fact. My chart shows that the performance of Fidelity special situations, relative to the All-share, is closely correlated with consumer spending. In recessions, his fund under-performs. In buying "under-valued" stocks, Bolton has merely taken distress risk and been compensated in normal times. Just as French and Fama would expect.
Except for one thing. If we control for retail sales and market returns, Fidelity special situations has actually under-performed. A simple regression of annual returns since 1980 upon annual returns on the All-share and annual growth in retail sales gives us:
   Fidelity = -9.76 + 1.13 x All-share + 3.95 x retail sales.
R-squared = 67.7%.
The intercept of -9.76 implies that Bolton would actually lose almost 10% in a 12-month period when the All-share and retail sales volumes were flat.   Hardly a sign of skill.
Now, I'm not saying here that Fidelity's has been a bad fund. Quite the opposite. For many investors, it's entirely sensible to take cyclical risk. Personally, I'd take cyclical risk rather than trust someone's stock-picking "skill" every time.
I'm only saying that Bolton's performance is consistent with the efficient market theory, properly understood.

Comments

[dearieme]

Clinical, Mr S & M.

[dsquared]

Chris, it says "Annual % change" there; does it mean that, or does it mean annual returns? If Bolton's stocks have lower market/book ratios than the allshare, then they are likely to have higher dividend yields.

[chris]

D2 - sorry, I mean annual total returns, which include dividends.

[CJC]

And *someone* has to be the *best* fund manager, just as in a room of 1000 coin tossers someone will toss 10 heads in a row.

[dsquared]

And are Bolton's returns net or gross of fees (this makes a big difference, because they jacked up the front end fee to soft-close the Special Sits fund when it got big)

[Piyush]

I have never understood why people think that long term market outperformance somehow contradicts the Efficient Market hypothesis. If you take an arbitrarily long time period and measure average market performance over it, clearly some investors' records would be superior to that average ( as they can't all be the same). Looking back it is easy to identify many such patterns and instances and the fact that it happens has nothing to do with the EMT. This will happen simply due to the nature of averages and the fact that the sum total of all investors is the market.
This outperformance could well be explained simply by chance rather than any particular skill.

The more interesting question is whether you can predict outperformance in advance ( rather than by creative mining of past data). Could Bolton's performance have been predicted when he started out ? Even here it gets tricky as the number of holdings is also significant. Investors taking increased risk and holding a smaller number of stocks have a greater probability of long term outperformance ( effectively a reward for the increased risk) without contradicting the EMT. People like Buffett, Munger etc. fit into this bracket.