Not All Returns Are Created Equal

Why we don't take the fund manager's stellar performance at face value?

Every few months, someone shows us a fund that has been beating the market by 10 percentage points a year. The question is always the same: why are we not with them?

It is a fair question. But if we were just chasing the biggest number on a league table, we would be doing you a disservice. We are trying to build something that lasts. And that changes everything about how you read a performance record.

A great return tells you what happened. It tells you almost nothing about why it happened, or whether it will happen again.

Every return can roughly be broken into four buckets. The first is what the market hands to everyone. When conditions are favourable, almost every active manager looks like a genius. That is not skill. That is the tide coming in.

The second bucket is risk. Some managers produce extra returns by taking on extra risk, sometimes knowingly, sometimes not. Higher return and higher risk are two sides of the same coin. A fund that returned 10% more than the benchmark may have simply taken on 10% more risk to get there, in which case the client got exactly what they paid for and nothing more.

The third bucket, and the rarest, is genuine skill. Repeatable, disciplined, and durable across different market conditions. When a manager walks in with a stellar record, our job is to figure out which bucket their performance mostly came from. That takes work most people do not see.

And then there is the fourth ingredient. The one nobody in this industry wants to put on their slide deck. Luck. A manager may have owned the right stock at the right time for entirely the wrong reasons. A macro call may have come good not because of careful analysis but because of an event nobody could have predicted and nobody could repeat. Luck is real, it is more common than people admit, and it looks completely identical to skill in the short run. The only way to tell them apart is time, and even then it is not always clear. We think about this a great deal when we are sitting across the table from a manager who is very confident about why they did so well.

Our job is to figure out which of these four ingredients drove most of the result. That takes work most people do not see.

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We meet with fund managers almost every week. They all arrive with slide decks and impressive numbers. Every single one has outperformed. We have never once had a manager sit down and say, “We got lucky and we are not entirely sure what happened.”

That is not because they are dishonest. It is because the ones who show up are, by definition, the ones who survived.

For every manager in front of us, there were dozens of others who ran similar strategies with similar conviction. Many of them no longer exist. Their funds were quietly closed and their records folded into history. What we see is the small number who happened to be on the right side of enough decisions to still be standing. Survival alone is not evidence of skill.

We are not looking for the manager with the best story about their past. We are looking for the manager with the best process for the future.

We also watch for something called style drift. A manager says they run a quality focused, low turnover strategy. But then you look under the bonnet and find a portfolio full of speculative stocks trading at 60 times earnings. Something changed. And when a manager drifts from their stated strategy, they stop doing the job we hired them for, regardless of what their short-term numbers say.

When managers do well, they almost universally credit their own skill. When they do badly, it is always unusual conditions or factors outside their control. This is just human nature. But it matters enormously when you are deciding who to trust with money. We are looking for managers who are honest about uncertainty, humble about the role of luck, and highly specific about where their actual edge lies. Those managers are less common than you might think. When we find one, we hold on.

The funds we hold were selected because they passed a rigorous process, not because they topped a table in a good year. When the market hands a short-term advantage to a different strategy, our numbers will look unflattering by comparison. That is expected. That is fine. Because this portfolio is not designed to win every quarter. It is designed to protect and grow your wealth across years and decades, without taking on risks that could cause permanent damage.

We will not move money simply because a number on a page looks bigger. Anyone can do that. Our job is to understand what is behind the number.