Brad Neuman: The Hidden Driver of Outperformance
Why do most people consider Ted Williams the best batter of the past 75 years? It is likely because he was the last person to bat over .400 — in fact, he hit .406 in 1941. But was he really so much more skilled than every other batter who has come since?​

Williams managed to hit an amazing four standard deviations over the league average, a statistical feat with a probability of occurring in 1 in nearly 16,000 times. However, with better and more pervasive knowledge and training over the years, the dispersion in batting averages has trended down over time (batting average has not).i This means that today the same achievement of hitting four standard deviations over the average would necessitate hitting only about .370—something that has been done several times in the post-War era.

​​The takeaway is that the level of outperformance is driven by both skill and opportunity, or expressed as a formula:​

​Here skill is the number of standard deviations that a batter hits above the average, while opportunity is the dispersion of potential outcomes or the size of the standard deviation. This means that while there have been a handful of baseball players who have hit with as much statistical skill as Williams in modern times (i.e., four standard deviations better than average), they are not as famous because they did not break the 0.400 barrier as a result of less opportunity (i.e., a smaller dispersion or standard deviation in results). 

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Most investors focus almost exclusively on the important task of identifying a skilled investment manager. But how do we maximize opportunity? How do we pick securities like we are batting in the 1940s rather than the 2000s, in an effort to generate the most outperformance?

An effective approach may be to actively seek out opportunity directly or managers who are particularly aware of it. That could be by looking to asset classes or areas of asset classes with considerable dispersion. One example of the latter is software stocks, where winning in an industry may produce very large outperformance as compared to losing. We might compare software stocks with regulated utility stocks, where being a skilled analyst is unlikely to produce large absolute outperformance given a small dispersion in potential outcomes.

When pursuing outperformance, remember that skill and opportunity are inextricably linked. Skill without opportunity may produce an exceptional result relative to the dataset but a less than impressive absolute result. On the other hand, a lot of opportunity with little skill could produce large underperformance. Opportunity and skill both contribute to the ability to generate strong returns because manager skill leverages return dispersion.

For more on this topic, read our white paper Understanding how Skill and Opportunity Drive Outperformance.
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​​​​Stephen Jay Gould, “Triumph and Tragedy in Mudville: A Lifelong Passion for Baseball,” W.W. Norton & Company, New York, 2004, pp. 151-171.​



​​The views expressed are the views of Fred Alger Management, Inc. as of March 2019. These views are subject to change at any time and they do not guarantee the future performance of the markets, any security or any funds managed by Fred Alger Management, Inc. These views are not meant to provide investment advice and should not be considered a recommendation to purchase or sell securities.​

This material must be accompanied by th​e most recent fund fa​ct sheet(s) if used in connection with the sale of mutual fund shares. 
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Risk Disclosure: Investing in the stock market involves gains and losses and may not be suitable for all investors. Investment return and principal value of an investment will fluctuate so that an investor's shares, when redeemed, may be worth more or less than their original cost. Many technology companies have limited operating histories and prices of these companies' securities have historically been more volatile than other securities, especially over the short term. Technology companies may also face increased competition, government regulation, and risk of obsolescence due to progress in technological developments.​​


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