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By Mark Hulbert: The news media are drawing all the wrong lessons from Meredith Whitney’s decision this week to close down her hedge fund.
To be sure, the media are right to point out that Whitney, after a spectacularly correct forecast at the top of the bull market 2007 that banking stocks were due for a big drop, was spectacularly wrong several years later when she forecast massive municipal bond defaults. And, yes, performance at her hedge fund, Kenbelle Capital, has been disappointing.
But the real story here is why anyone is surprised.
That’s because most investment success — not just Whitney’s, but any adviser’s — is due overwhelmingly to luck rather than skill. So what truly would have been surprising is if Whitney’s fund had actually performed well.
UCLA finance professor Brad Cornell has proposed a simple formula for gauging the relative investment importance of skill and luck. Upon applying that formula to a large sample of mutual funds, he found that 92% of the differences in those funds’ annual returns was "attributable to random chance."
I reached a substantially similar conclusion when applying Cornell’s formula to the several hundred investment advisers monitored by the Hulbert Financial Digest.
What that means in practice: Top-ranked performance in a given year is rarely repeated the next year. If you’re an adviser lucky enough to have made a call as great as Whitney’s in 2007, the rational response is to market the heck out o...................... To view our full article Click here
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