return from 1971 through December 2006 beat the market by over 4 per-
centage points per year. Close behind was Mutual Shares Z, run by
Franklin Templeton, with a return of 16.04 percent over the same pe-
riod. In a virtual tie in third and fourth places are the Columbia Acorn
Fund (previously known as the Liberty Acorn Fund), run by Charles
McQuaid and Robert Mohn, and the Sequoia Fund, run by the invest-
ment firm of Ruane, Cunniff, & Goldfarb that closely follows Warren
Buffett’s philosophy and has a large portion of its holdings in Berkshire
Hathaway. These two have enjoyed annual returns of 15.57 and 15.54
percent, respectively.
Despite these sparkling returns, chance may have played a large
role in these outperformers. The probability that a fund would beat the
Wilshire 5000 by 4 percentage points or more over this period by chance
alone is 1 in 12. That means out of the 138 funds examined, one would
expect 11 to have done this well.
Yet luck could not explain Magellan’s performance from 1977
through 1990. During that period, the legendary stock picker Peter
Lynch ran the Magellan Fund and outperformed the market by an in-
credible 13 percent per year. Magellan took somewhat greater risks in
achieving this return,^5 but the probability that Magellan would outper-
form the Wilshire 5000 by this margin over that 14-year period by luck
alone is only 1 in 500,000!
FINDING SKILLED MONEY MANAGERS
It is easy to determine that Magellan’s performance during the Lynch
years was due to his skill in picking stocks. But for more mortal portfo-
lio managers, it is extremely difficult to determine with any degree of
confidence whether the superior returns of money managers are due to
skill or luck. Table 20-2 computes the probability that managers with
better-than-average stock-picking ability will outperform the market.^6
The results are surprising. Even if money managers choose stocks
that have an expected return of 1 percent per year better than the mar-
ket, there is only a 61.9 percent probability that they will exceed the av-
erage market return after 10 years and only a 70.1 percent probability
346 PART 5 Building Wealth through Stocks
(^5) The standard deviation of the Magellan Fund over Lynch’s period was 21.38 percent, compared to
13.88 percent for the Wilshire 5000, while its correlation coefficient with the Wilshire was 0.86.
(^6) Money managers are assumed to expose their clients to the same risk as would the market, and the
money managers have a correlation coefficient of 0.88 with market returns, which has been typical
of equity mutual funds since 1971.