None Dare Call it Skill

Have you ever reflected upon what people say about skill?

There seems to be a special category. Whatever is in that category is different. It has nothing to do with skill. Whatever it outside of that category, we are told, does not work. It cannot possibly work. It has been proved that it can never work. If it worked, there would be such a thing as skill. That would be ridiculous. Skill does not exist.

What about asset allocation and rebalancing? For sake of argument, assume that it works. Isn't this skill?

How about the Fama-French three factor model? If you identify the market, relative size (capitalization) and relative value, you can calculate the return (statistically). Once again, for the sake of argument, assume that it works. Isn't this skill?

How about buy-and-hold stocks (preferably, a broad-based index fund) for a very long time, of the order of three or more decades? For sake of argument, assume that it works. Isn't this skill?

Proponents of each of these approaches claim to have identified a way to maintain a consistent advantage. They have collected evidence that supports their claims. If so, they have skill.

The fact is that, if you can gain a consistent advantage, you have skill.

Skill does NOT mean that you have to trade often. Skill does NOT mean that you have to be able to measure valuations more accurately than others. Skill can be as simple as knowing how well you evaluate companies and markets. If you are accurate in your self-assessment and if you act upon that knowledge, you are displaying skill EVEN IF you decide to invest passively.

Too often, people quote a conclusion without considering the qualifiers behind the conclusion. It is one thing to reject a sales pitch claiming to return 20%+ year in and year out. Very few investors have ever done that well. It is quite different to reject a claim of an advantage of 1% or 2% annualized over a couple of decades. That could be a result of skill.

Have fun.

John Walter Russell
September 27, 2005