The importance of luck (and recognising it)

By: Stephen Bennie, Founder, Castle Point Funds

At the time, I found this strange advice, as she was clearly an experienced and highly skilled investor. I struggled to see the luck in how she generated great returns. But if I heard her say that once, I literally heard her say it a hundred times while I worked with her. In the fullness of time I have come to better understand the importance of her advice.

Primarily she was saying to avoid the arrogance that often creeps into successful professionals. The reality is that all good outcomes in life are a mix of skill and luck, but we tend to be poor at recognising it. Interestingly, as people we are exceptional at recognising where bad luck has led to bad outcomes. For example, think of all the superstitions that we have adopted to ward off the spectre of bad luck. We touch wood, we don’t break mirrors, we avoid black cats, we don’t walk under ladders, actors won’t say “Macbeth” and countless other examples. So, while we know the effect of bad luck and seek to avoid it whichever way we can; we are less good at acknowledging the role of good luck and this can all too easily lead to arrogance.

The problem with arrogance is that it is the fraternal twin of over confidence, one of James Montier’s “Seven Sins of Fund Management”. In his 2005 paper on this topic he delved into the behavioural heuristics that litter the world of investing. It’s fair to say that the seven sins combined are the reason most investors, both retail and professional, struggle to deliver returns greater than the general market. Montier believed that overconfidence by fund managers in their forecasts was a fundamental sin that led to poor performance. 

He identified several problems with overconfidence in forecasting earnings. The prime reason being that virtually all forecasts are incorrect. So, overconfidence in your ability to forecast makes you poor at recognising when your forecasts are turning out wrong, which will inevitably be most of the time.