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Money: Have you ever met a coin-flipping genius?

03 Jul 2018

Years ago, Goldman Sachs, an American investment banking organisation, had a brilliant idea, since copied many times. They knew that any new investment proposition they introduced to the public had to have big returns to attract new investors.

Investors had to be super-convinced that an investment manager was skilful, so much so that it would seem like a no-brainer to put their money with this particular manager.

If Goldman had such an investment manager, they could justifiably charge high fees. But how do they find such a manager in advance? They realised they couldn’t but that there was another way. They would ‘incubate’ managers. By this I mean they’d pick a hundred or so managers and give them some of Goldman’s own money to manage. After a set period they’d review the results. Then they would cull half the managers that had poor performance and transfer the money to the other half.

After another set period they did the same. They repeated this exercise till they were left with one manager who had all the money. Poker tournaments sort of work on this principle. Anyway, they would then market this newly dubbed “all star” manager by showing off his incredibly impressive track record. On cue the money would flow in at the justifiably high fees Goldman craved. There was only one problem. Just after the manager went live, his skill magically evaporated and the promised high investment returns for investors didn’t eventuate.

We have numerous stories of this sort of thing. It is the rule rather than the exception. But given human nature, we have quite a struggle trying to convince even the most skeptical investors that just because a manager has out-performed the market for the past ten years does not mean they are necessarily skillful and that it will last.

What Goldman had wittingly or unwittingly done is the equivalent of giving 1000 monkey’s a coin and asking them to flip. After 8 consecutive flips one monkey has flipped heads 8 times. They then anoint that monkey a ‘flipping’ genius.

Now the relevance of this story is that right now literally thousands of “monkeys” are picking shares on the stock exchange. A few will do phenomenally well. You and I will hear about them because they do well. If they had been average, no one would have made a noise about it and you’d go on with your day none the wiser. Unfortunately, none of us can go back in time and put our money with the winning monkey. Imagine trying to do that in a hall of 1000 monkeys!

So, when you hear of someone who has out-performed the market, he or she is simply the monkey that won the coin-flipping contest.

Keep asking great questions …

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