“Results Reflect Your Skill and the Game You Are Playing”

There are two aspects to success in investing: proficiency and choosing an attractive game. The key to an attractive game is dispersion in skill, where more skillful participants can benefit at the expense of less skillful ones.

The paradox of skill says that in activities where results combine luck and skill, luck is often more important in shaping outcomes even as skill improves. In many competitive interactions it is the relative level of skill that matters, not the absolute level of skill. In many fields, including investing, the dispersion of skill is shrinking, which leaves more to luck. There is a positive correlation between the breadth of opportunities and the dispersion of fund returns.

Pockets of inefficiency persist. These include diversity breakdowns, institutions competing with individuals, and trading with distressed counterparties.

Two drivers of out-performance:

• Your skill (proficiency)

• The attractiveness of the game (how wide the skill gap is among players)

Paradox of Skill:

• As average skill rises, the spread of skill narrows → luck dominates outcomes even for experts.

Relative > Absolute:

• Winning depends on being better than rivals, not on being absolutely good; when everyone improves, luck decides the winner.

Investment implication:

• Dispersion of fund returns shrinks as the industry becomes more skilled → alpha is harder to generate.

Where alpha still lives (inefficiency pockets):

• Diversity breakdowns

• Institutions vs. individuals

• Distressed-counterparty trades

• Breadth of opportunity correlates positively with return dispersion.

Source: Michael J. Mauboussin & Dan Callahan, “Alpha and the Paradox of Skill” (Credit Suisse, 2013)

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