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Researchers Find Investors Don’t Sufficiently Account For Volatility in Fund Selection

A recent study found that investors flock to volatile performance in the selection of fund managers. A group of academics performed three surveys, asking German “financially competent private investors” to review fund performance charts and assess the skill level of individual fund managers. According to the paper, Fooled by Randomness: Investor Perception of Fund Manager Skill, “investors chase large alphas and large returns without sufficiently accounting for volatility, which impairs the reliability of the past performance as an indicator of manager skill.” The researchers also found that participants did not account for “the likelihood of a fund reaching [a] level of return by pure luck.” The paper concludes that current warnings (e.g. that past performance does not guarantee future results) have little impact on investors and suggested that warnings instead address the issues found in the study to be more effective. The researchers posit that this view of investors’ behavior could “lead to a race for riskiness in the fund industry as the riskiest of all funds will, luck permitting, be attributed the highest likelihood of skill by investors.”

The article can be found here.