Positive skew & the near impossibility of consistent alpha
Posted by Robin Powell on April 11, 2017
If you read nothing else today, read this. It’s an article by Oliver Renick for Bloomberg Markets on positive skew, which might just be the single biggest reason why only around 1% of active fund managers consistently beat the market over the long term.
To quote Renick, “The distribution of returns in the stock market is bizarrely lopsided. Often, equity benchmarks are so reliant on gigantic gains in just a handful of stocks that missing them — as most managers do — consigns the majority to futility.”
Or, as JB Heaton, joint author of a 2015 paper called Why Indexing Works, puts it: “Your intuition is that you can randomly pick stocks and start at zero. But the empirical fact is if you randomly pick, you are starting behind zero.”
The interesting thing is, the theory is based on an academic paper written nearly 20 years which attracted very little attention at the time. I sometimes wonder whether financial professionals would be better off tuning out the financial media altogether and confining their reading to a resource such as SSRN instead.
You can read the article here: