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Chapter 3. Patterns and Predictions > Foresight and Hindsight

Foresight and Hindsight

A similar problem to quantifying randomness with high-tech models is the problem of trying to evaluate investor performance. Those mutual fund managers that beat the return on the stock market are written about in the media and appear on investment TV shows. These investors are advertised as highly skilled, and enormous amounts of money flow into their mutual funds. I will argue later that the randomness in stock returns will cause some mutual funds to beat the market by sheer luck. So, is an investor who beats the market highly skilled, or just lucky? How can we tell?

Peter Lynch has been purported as one of the greatest investors. At the helm of Fidelity's Magellan Fund, Peter Lynch beat the Standard & Poor's 500 Index in 11 of 13 years, ending in 1989. If the chance of beating the S&P 500 in any one year is 50% (like flipping a coin), the odds of beating the S&P 500 in eleven out of thirteen years is only 1 chance in 105 (or 0.95%). It certainly looks like the Magellan Fund was managed with superb skill. However, this is looking at the performance in hindsight. That is, we know the Magellan Fund was a winner over the period, which is why Peter Lynch receives the accolades.


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