Like former king of equities Bill Miller, reigning bond ruler Bill Gross has tripped after years of what economists might call a "hot hand." Can he prove his success was more than a lucky streak?Previously on the Gettin' Lucky channel:
FORTUNE -- Pimco's founder "The Bond King" Bill Gross once quipped that "anyone can theoretically roll 12 sevens in a row." According to Barron's in early 2003, he was talking in passing about the then-reigning ruler of stocks, Legg Mason's Bill Miller, who at the time had beaten the S&P for the previous dozen years.
It was a powerful statement about luck versus skill from the formidable fixed income guru. Clients might ask if they could apply the same words to Gross, too.
Similar to Miller, Gross has outperformed his peers in the bond market for years. But as the market blinked, Gross's investments struggled. An ill-timed bet on U.S. Treasuries last year made the Pimco Total Return Fund post a loss. Investors pulled out some $40 billion. Most recently, some internal bickering with former CEO Mohamed El-Erian, aired in unseemly ways through press reports, has raised questions about Gross' ability to bounce back.
Gross wouldn't be the first person to draw parallels between hot hand streaks and investment success. Economists often use a coin toss analogy to discuss whether the world's most sophisticated risk takers are actually good at their trade, or if they've simply played the game too few times to tell.
"Essentially, the problem with assessing any individual manager is disentangling some luck," says Brad Barber, the Gallagher Professor of Finance at UC Davis and co-principal investigator for the CalPERS Sustainable Research Initiative. When academics look at coin tosses, "you'll always get streaks of tails or streaks of heads." When applying this to investing, "the question is whether this is more or less than you would expect by chance." Focus on the folks that have streaks, he said, and there is little evidence skill, rather than luck, helps them outperform.
Barber explains the odds like this: With four tosses, the odds of four heads is one in 16. If there are 2,000 mutual funds with 4-year track records, then 125 funds would "beat the market" by chance (one divided by 16 multiplied by 2,000). After 10 years, about two out of 2,000 funds would have 10-year winning streaks by chance. (At the end of last year, there were over 7,500 mutual funds.)
Several studies support Barber's assertions. An in-depth statistical analysis from the University of Chicago in 2010 found that few managers have enough skill to simply cover their costs. A 2009 study from several professors including Scott Stewart of Boston University found that institutional investors lost some $170 billion for clients between 1984 and 2007 because of bad decisions. "Much like individual investors, who seem to switch mutual funds at the wrong time, institutional investors do not appear to create value from their investment decisions," the study said....MORE
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