Fantasy sports: it’s harder than picking stocks

Skill is the ability to do something well. For example, to carry out a task timely and effectively to achieve a positive outcome. Skill involves someone’s knowledge, expertise and actions. Luck, on the other hand, is what happens independent of the person’s knowledge and actions. Luck can produce both positive and negative outcomes and those outcomes are totally arbitrary.

According to the authors of the study 'Is It Luck or Skill', luck plays a bigger role in the success of a mutual fund manager compared to that of a fantasy sports player. To arrive at this finding, the research quantified the degree to which fantasy sports and mutual funds relatively exhibit a predominance of skill.

The research conclusively demonstrated that more skill is required in fantasy sports than funds management. The data showed that fantasy cricket data indicates a skill predominance by a factor of 10, while the managed fund data indicates skill predominance by a factor of three. What this means is that it is more unlikely for someone without skill to win at fantasy sports than win at picking stocks. Therefore luck can play more of a role for stock pickers than players of fantasy sports.

The challenge for investors is to identify and distinguish between which fund managers are skilful and those who have had a lucky streak.

Persistence

In investing, skill can be identified by persistent performance. The performance of a manager is measured by comparing their returns to a benchmark index. For an Australian equity manager this is the S&P/ASX 200. A skilful manager will persistently outperform this benchmark and their peers.

Every six months, S&P Dow Jones Indices releases its SPIVA Australia Scorecard which reports on the performance of Australian active funds against their respective benchmark indices over different time periods. It has been well documented that the SPIVA scorecard makes poor reading for active managers. And the most recent scorecard released last week is not different.

According to the scorecard, for the period ending 30 June 2020, almost 60% of active Australian equity managers were outperformed by the S&P/ASX 200 over the previous twelve months.

Over longer time periods it was worse, with more than 75% of active managers being outperformed by the benchmark over 3-, 5-, 10- and 15-year periods. Picking a skilful manager, one that persistently outperforms, is extremely challenging.

According to S&P Dow Jones’ Persistence of Australian Funds research, out of the 76 Australian equity funds in the top quartile in calendar year 2017, only seven held onto their top quartile position in 2018 and 2019.

Out of the 145 Australian equity funds that beat the S&P/ASX 200 in 2017, only 16 outperformed again the two following years.

So the overwhelming majority of active fund managers in the last three years are not achieving persistent outperformance. Finding a manager worth their fees (who outperforms their benchmark) has proven to be harder than winning a fantasy league.

Investors are seeking alternatives. One of these alternatives is smart beta and its use is on the rise in Australia.

Now in its fifth year, VanEck's Australian Smart Beta Survey was conducted in August 2020 among Australian financial professionals. Over 500 investment professionals took part. The survey showed the majority of financial advisers (57%) use smart beta strategies to replace actively managed funds and most (67%) are very or extremely satisfied with their investments. This highlights that the movement towards smart beta ETFs - which deliver targeted investment outcomes through rules-based investing – is taking hold in the Australian investment market and becoming mainstream.

Australian investors no longer want to pay their active managers for luck. Only the truly skilful will survive.

A summary of the smart beta survey results can be found here.