Fat Bottomed Girls and Finance
Earlier this month marked what would have been the 65th birthday of Freddy Mercury. The music channels tend to play a marathon of the artists at these times and so there I was sitting on the couch watching Freddy and Queen belt out Fat Bottomed girls while I happened to be reading a chart and some analysis about active managers and fat tailed distributions. This led me to believe that Freddy was telling me in his own way that I needed to write about it......the distributions that is, not the girls!
Active management is an interesting conundrum, on the one hand you have a manager or broker advising you on what stocks you should purchase and what stocks you shouldn't on the basis that they believe they have correctly selected only the ones that will rise and have excluded the ones that will fall. It's a pretty simple concept and herin lies the conundrum, if they have the ability to accurately and consistently do this, why would they tell you?
Let's look at this a different way. Let's say that tomorrow you wake up and discover that you have the unique ability to correctly predict which stocks will rise and which stocks will fall on any given day. Now with this ability is your first reaction 'I gotta tell everyone I know about this, or better yet set up a fund or become a broker'! Or would your reaction likely be to keep it to yourself, at least until you had profited from it?
So where does Freddy and the fat tails fit into this I hear you ask?, Well going back a number of years a gentleman by the name of Mark Carhart published a study on 'Persistence in Mutual Fund Performance' (Journal of Finance March 1997). This study looked at the performance of 1,302 active managers over a 23 year period. The results can be seen in the chart below and were alarming.Continued on the next page