Skill is very difficult to determine, much less to recognize in advance.
Star fund managers come and go. This year Jeff Gundlach is the hot hand while Bill Gross has lost his Midas touch. If we look back at the hot fund managers we see a pattern that emerges, they are usually aligned with the asset class that is outperforming the market.
The distinction between skill and luck is of more consequence when grapeshot is whizzing overhead than when trying to beat an index. But the difficulty of distinguishing the two is at the heart of money management, and the distortions it creates in the market.
In the early 90’s Peter Lynch invested in growth stocks, in the late 90’s it was the tech stock gurus like Kevin Landis that were the stars, and in the years since the 2008 crisis it is the bond fund managers like Gross and Gundlach that are getting all the accolades.
How much of the performance attribution is from the asset class and how much is from the skill of the manager. According to a study of 2,076 actively managed US open-end domestic equity funds between 1975 and 2006, 75.4% are zero alpha funds (funds that have managers with some stock picking ability, but extract all the alpha generated through fees) 24.0% of the funds generate no excess return, and only .6% generate any alpha after fees. (Barrras,Lauren Scaillet, Oliver and Wermers, Russ “False Discoveries in Mutual Fund Performance: Measuring Luck in Estimated Alphas” Journal of Finance February 2010 pp. 179-210)
Out of 2,076 funds, that means only 12 are generating any excess return. What are the odds that you are going to know in advance which 12 those will be?