This is my favourite time of year from a sporting point of view and the summer so far, has been very exciting. Watching the Open Championship this weekend brought to mind the paradox of skill that I recently read about in Larry Swedroe’s excellent book ‘The Incredible Shrinking Alpha.’
The tournament was beset with poor weather and high winds, with Zach Johnson finally lifting the claret jug after a play off. In all the time I have watched the Open I cannot recall so many golfers in with a chance of winning on the last day. Even several amateurs were in contention; and this was a tournament without Rory McIlroy, Tiger Woods or Phil Mickelson playing a leading role.
The paradox of skill in sport is influenced by two key factors. Firstly, there are now competitors in a growing number of countries as more nations now have a larger middle class. This creates a much greater pool of talent to draw from and this gives huge strength in depth.
Today’s players in all sports are also clearly superior athletes. They are bigger, faster and stronger. They have better nutrition, equipment, training techniques and full time coaches. They have everything on their side to break the records of yesteryear. However, all players have these advantages available to them nowadays. Very rarely can an athlete in any endeavour have an ‘edge’ over the competition, due to a breakthrough that no one has access to. The result is that this raises the skill level of all competitors and it therefore becomes very difficult for any athlete to out perform by large margins.The paradox of skill means that whilst some of todays golfers may be just as skilful as the legends of the game, they are very unlikely to dominate the sport like Jack Nicklaus did, due to these factors.
Similar conclusions can be drawn in the active fund management industry. Fund management groups can now attract the brightest minds due to the attractive salaries that can be earned. These individuals also have access to the best technology available, super-fast trading platforms, teams of analysts and a huge amount of information from the internet. Yet, as with sports, as the average relative level of skill rises, so it becomes more difficult to out-perform their peers. As the pool of talent in sports has grown, so too has the growth in the number of funds, which makes it more difficult for even the brightest managers to do better, despite improving skill.
As ever, we endorse the principle that the best investment strategy is to accept the market return at low cost in a globally diversified portfolio of passively managed funds in line with your financial planning goals and risk profile. We choose not to play the game of active management, which due to the paradox of skill has the odds stacked against it.