The problem that people don't understand is that active managers, almost by definition, have to be poorly diversified. Otherwise, they're not really active. They have to make bets. What that means is there's a huge dispersion of outcomes that are totally consistent with just chance. There's no skill involved it. It's just good luck or bad luck.
Interpretation
Active managers often take risks that lead to varying outcomes, which can be misinterpreted as skill.
Eugene Fama emphasizes that active managers in finance must concentrate their bets, leading to high variability in performance. This concentration is a defining characteristic of active management, and the wide range of outcomes can often be attributed to luck rather than skill, highlighting the inherent uncertainties in investment strategies.
In practice
A financial advisor might quote this when explaining the risks of active investment strategies at a seminar.
After costs, only the top 3% of managers produce a return that indicates they have sufficient skill to just cover their costs, which means that going forward, and despite extraordinary past returns, even the top performers are expected to be only as good as a low-cost passive index fund. The other 97% can be expected to do worse.
Market timing doesn't work. If all the bubbles and all this mispricing really exist, how come so few people see it before it turns out that way?
There's quite a bit of evidence that even professionals don't show any ability to pick stocks or to predict market rollbacks. Most of the people we identify as skilled based on returns have probably just been lucky.
There is nothing so disastrous as a rational investment policy in an irrational world.
The stock market really isn't a gamble, as long as you pick good companies that you think will do well, and not just because of the stock price.
The average investor's return is significantly lower than market indices due primarily to market timing.
The stock market is a wonderfully efficient mechanism for transferring wealth from the impatient to the patient.
When getting help with money, whether it is insurance, real estate or investments you should always look for a person with the heart of a teacher, not the heart of a salesman.
Just because a stock is down doesn't mean it's a great buy.
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