In his keynote address at the 17th Annual Credit Suisse Asian Investment Conference, “The Success Equation – Untangling Skill and Luck In Business, Sports and Investing,” Michael Mauboussin presented startling information that showed how luck is playing an increasingly important role in complementing skills for the achievement of success.
The paradox of skills
“In an activity where both skills and luck contribute to the outcome, it is often the case that when skills improve, luck becomes more important.”
Baseball player Ted Williams was the last player in major league baseball to hit over .400, something he accomplished in 1941, and this feat has not been replicated in the 70 years since.
The reason for this is that the level of skill has become more uniform in professional sports, that is to say, the difference between the average player and the very best players is less today than it was a generation before, and therefore those high scores are no longer possible.
In another telling example, Mauboussin points out that the difference in the time to finish the Olympic Men’s Marathon between the first and the 20th athletes has diminished from 39 minutes to just five minutes in recent years, showing how uniform athletic skills are becoming.
“The same is true of investing in today’s world as we have the same technology, skills are more uniform, we have the same information and that means the standard deviation of excess returns has gone down,” says Mauboussin. Luck, therefore, makes the crucial difference between success and failure.
Luck has become more important in today’s world than it was in the past, he suggests.
Michael Mauboussin: Corporate fortunes and luck
Mauboussin also claimed that a number of corporate success stories, so often touted in various management literature, actually relied more on luck than on management skills, as concluded by a recent experiment.
He made the point that performance based on luck was more likely to “revert to the mean” than a skill-based performance.
He challenged the audience to go back and recheck the performance of these so-called examples of management success – more often than not the company’s performance would have turned down as the luck effect wore off.
How to cope with the newfound importance of luck
According to Mauboussin, you can’t change luck, but you can manage it.
He suggests that a stronger player can improve his chances of winning the game by simplifying it, whereas a weaker player should try to complicate the game in his effort to win.
Mauboussin earlier suggested this in his note titled Alpha and the Paradox of Skill, where he talks about Jim Rutt, CEO Network Solutions, who as a young man once worked hard at learning poker, but was advised by an uncle, “Jim, I wouldn’t spend my time getting better, I’d spend my time finding weak games.”
This episode out of Mauboussin’s treatise was also highlighted by Howard Marks in his January 2014 letter to Oaktree clients on “Getting Lucky:”
“Success in investing has two aspects. The first is skill, which requires you to be technically proficient. Technical skills include the ability to find mispriced securities (based on capabilities in modeling, financial statement analysis, competitive strategy analysis, and valuation all while sidestepping behavioral biases) and a good framework for portfolio construction. The second aspect is the game in which you choose to compete.” (Emphasis added)
Howard Marks extended this logic to the markets by saying that just as the easiest way to win at poker is by playing in easy games in which other players make mistakes, likewise the easiest way to win at investing is by sticking to inefficient markets.
Audience question on Bill Miller – skill or luck?
A member of the audience at the conference asked Mauboussin whether the legendary Bill Miller’s winning streak of 15 years was entirely skill.
Mauboussin response was categorical that that streak had elements of both hard work and good fortune, harking back to his remark earlier in the talk that an outlier’s performance was a combination of great skill and great luck.
It is interesting that Mauboussin mentioned in passing that it would be well-nigh impossible to repeat Miller’s feat in today’s markets since they have become so competitive.
Value investing – skill or luck?
Value investing was an example of a “diversity breakdown” and the sign of likely market inefficiency, said Mauboussin, in response to an audience question. “The key to value investing is to know the difference between fundamentals and expectations – you want to buy on low expectations,” he added.
Full video of the speech can be found below