A mutual fund prospectus says its manager has more than ten years of experience. The manager has achieved a 10% average annual return, it also says.

Impressive, yes? The manager has talent, more such successful years lie ahead.

Maybe not.

Luck seems to have a lot to do with a fund manager's success and experience may not be a good indicator of anything, according to an academic paper published by professors Gary Porter and Jack Trifts titled "The Best Mutual Fund Managers: Testing the Impact of Experience Using a Survivorship-bias Free Dataset".

"What is interesting to me, fund companies continue to promote this idea that experience matters, and that you should join their fund based on their most recent performance," says Porter, an associate professor of finance at the Boler School of Business at John Carroll University.

"If hard work, expertise and resources-if that is what drove great returns, then we probably wouldn't know or care who [former Fidelity Investments fund manager] Peter Lynch was. There'd be hundreds of managers with his kind of performance," he adds.

In the paper, Porter and Trifts, who is professor of finance at Bryant University, studied historical performance data on the 289 solo managers of 355 actively-managed funds (some managed more than one fund) who managed funds for more than ten years.

In the study, the average annual performance for all the managers during the first three years was 1.18%, but in subsequent years this performance dropped to 0.46% per year.

The best 50 managers in the study saw average annual returns of 8.27% during the first three years, and then performance dropped to 5.96% afterward.

These statistics led the academics to the following conclusions:

* The longer the best solo mutual fund managers managed a fund, the poorer their average annual performance. In fact, managers with tenure of ten or more years are likely to have significantly poorer performance the longer they manage

* A period of high returns by chance (luck) is followed by lower returns in a process of mean reversion.

* Fund managers outperformed their peers because their strategies worked well early in their careers and were branded as having superior skills or ability.

* Managers with the best long-run performance earned impressive returns very early in their solo careers.

* The attrition rate for under-performing managers is high, particularly early in their careers.

* While the evidence supports the notion that there may be a very small group of managers who can outperform the market over a period of 10 to 15 years, results tend to decline. Three-fifths of the best 25 managers generated poorer returns after the first three years.

Many managers declined comment on the paper, but one manager, Robert Gay, applauded it. Gay, director of research at Buford, Dickson, Harper and Sparrow and a manager of three funds via his company Global Equity Analytics and Research Services LLC (GEARS), said it "illustrates the reality of the asset management business model."

"To attract interest and build early assets under management you must have an eye-catching premium return. Most often that is the result of right place at the right time-just luck," he said. "Many managers do such a poor job of attribution analysis that they have no idea where that premium return comes from so they are like a deer in the headlights when the investing environment changes."

Porter insists that the study is "not an indictment of active managers." In fact, he said, the best managers with 10 years tenure in the study still outperformed the market following initial success.

"We simply point out that their performance did not, on average, improve with experience," he said.

Why doesn't experience count? The Efficient Market Hypothesis of course, says Porter. Because the markets are information efficient, everybody has access to the same information. It's not impossible to outperform the market consistently or for a long run, it's just very unlikely.

Porter says that firms can make their luck to some degree, like creating solid research. Also helpful: the flexibility to move in and out of securities or styles quickly, to take advantage of opportunities.

Success, he says, usually comes down to anticipating the next trend or the next valuable, but unexpected, nugget of news. Harder than that, though, is the ability to recognize when one's strategy stops working.

"Like they say, no one rings a bell at the bottom. The market is constantly evolving and managers are always playing catch up," he says. "Despite all the mathematical models and equations, investing is not rocket science-literally."

Consequently, he says, it's getting harder for managers to demonstrate their relevance-hence growing movement towards index and exchange-traded funds. Since active fund managers are likely to perform at or below the market, investors are trying to gain an edge by seeking out the lowest cost funds.

Patrick Morris, chief executive of the quant shop Hagin Investment Management, says that investment talent comes in these forms: purely return-based (i.e. did you beat the benchmark in some time period) and keyed to preservation of capital.

The ability to generate above-market returns, he says, is a difficult thing to measure if the real goal is to raise assets, since this changes the overall style and risk that a manager takes in the portfolio.

"The key metric that has been used to determine skill is return, but without much consideration for risk and with no consideration for various other influences on the manager," he says.

Morris attributed long-term performance declines, first, to the constraints placed on managers by mandate gatekeepers, and, second, to growing assets under management. Money flows into a fund generally after a run-up in performance.

"If all of the money comes in after the effect has been fully exploited and you, the manager, need to be fully invested, the timing of the fund flows may not line up well with the timing of the market," he said.

The lesson, Morris said, is to give money to managers that are smaller with short track records of some success.


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