The Doctor is 0.43% More Right (Even If I Do Say So Myself)

A friend of mine sent me a recent news article on BloombergViewIt talks about an academic paper that has the following abstract (summary):

Several hundred individuals who hold a Ph.D. in economics, finance, or others fields work for institutional money management companies. The gross performance of domestic equity investment products managed by individuals with a Ph.D. (Ph.D. products) is superior to the performance of non-Ph.D. products matched by objective, size, and past performance for one-year returns, Sharpe Ratios, alphas, information ratios, and the manipulation-proof measure MPPM. Fees for Ph.D. products are lower than those for non-Ph.D. products. Investment flows to Ph.D. products substantially exceed the flows to the matched non-Ph.D. products. Ph.D.s’ publications in leading economics and finance journals further enhance the performance gap. [link]

The efficient market hypothesis — something that is ingrained into every PhD student’s mind — says that markets move randomly. Success at timing the market is merely luck. The only way to make money is the invest in a fully diversified portfolio and watch it grow. There’s a grain of truth to that. After all, the S&P 500 Index has returned an approximate 8% compounded average over the last century or so. However, as the Bloomberg article points out:

…you can predict a money manager’s future performance based on her educational credentials. That is a big deal. Most anomalies identified in the literature require a fair amount of capital and computing power to exploit: Hedge funds might put them into operation, but the average individual can’t.

This, though, is news you can use: Just make sure your broker has a Ph.D.! I mean, not really, but it does suggest that you’d do well to pick mutual funds and other products managed by Ph.D.s over those that aren’t. More broadly, it suggests that investment-management ability is more rationally predictable than is often assumed: It’s not just luck and mojo and intangibles; it’s teachable in a degree program and deducible from a resume. [link]

The author goes on to talk about being skeptical about the study’s results. I agree. It is somewhat unorthodox (is that the right word?) to talk about finance and religion in the same sentence, but as the Buddha said: doubt everything. Or something along those lines, at any rate. Basically, be skeptical about everything. As my PhD adviser (a famous mathematician) used to say when he introduced me to someone: “Here is Mr. So-and-so, he’s a great friend of mine. Don’t believe a word of anything he says!”

So the study touts using a PhD as your money manager, but from my experience, the degree does very little to improve your intelligence. It improves your knowledge, certainly. But what you do with that knowledge still depends on who you are. So while yes, you might have some advantage with this knowledge that a PhD makes a better money manager, that still does not mean that they are all better money managers.

Note: The statistical advantages of having a PhD are still slight — only 43 basis points above non-PhDs. Read the news article for more details.

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