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Is investing a luck or skill?

Over the last few years, many new investors have entered financial markets lulled by the promises of making “easy money”, “quick returns” etc. Investing involves both luck and skill and when you are on a roll, unfortunately most believe success to be a function of your skill. Is there a way to gauge if investment returns are more luck or skill?

Introducing a fictional character – Random! The tweet bio of Random describes it as “Stock Market Enthusiast, Follower of Buffet, Charts, Bhav Bhagwan Che, Elliott Wave , Quant, FnO, CoffeeCan, Crypto!”

Random has done the following every month since 2000. From a universe of stocks which are within 90% of the overall market cap of listed stocks (thus avoiding micro-caps and other illiquid securities), Random creates 1,000 random portfolios of equal-weighted 50 companies. Similarly, Random creates another 1,000 portfolios whose individual stock weights vary from 0.5% to 9.5%. Thus, running 1,000×1,000 simulations (million portfolios of random stocks and random weights) and holding these portfolios for one year, gives a wide range of distribution of returns of these portfolios. Alongside this distribution of returns, we place total returns of NSE500/Nifty and arrive at their percentile scores.

A percentile score closer to 50 for Nifty50/NSE500 will reflect broadly a market where random portfolio distribution has equal chances of returns above and below returns of Nifty50/NSE500. (And so, near equal measures of luck and skill). Similarly, a very low percentile of Nifty50TR/NSE500TR would mean almost all random portfolios have given much higher returns, giving a sense of luck or rising tide lifting all boats. Conversely, a very high percentile score of Nifty50TR/NSE500TR would mean a period of massive frustration, where most portfolios have under-performed Nifty50TR/NSE500TR.

In percentile score of NSE500/NIFTY50TR over the last 22 years. There have been phases of luck superseding skill – like 2010-11, 2014 to 2017 and recently post-Covid recovery till end of 2021.

And then there are phases like 2012-13, 2018-19 where investors’ ability to beat NSE500/Nifty50 have been sorely tested.

So the verdict – the 18 months (till end of 2021) have been one of best returns for any of Random’s portfolios – all the expertise of following Buffet, charts, FnO, Elliott Wave, Crypto, Coffee Can, Quant etc. have worked out beautifully, most portfolios outperforming NSE500TR/NiftyTR. Already, in the last 6-7 months, the “luck” factor has lost some sheen, as recent scores of NSE500/Nifty50 are at 53%/59%, respectively.

This is of course the story of Random’s million portfolios. In reality, most portfolios are built not by random, but by curating on any particular theme/style/factor etc. So clearly, there will be portfolios in the real world that will have distribution ranges significantly different from Random. However, the idea of this exercise is more to showcase that a rising tide of the market lifts most boats, and rather than confuse with skill, one would be wise to thank lady luck for Random’s fortunes. And such phases don’t last forever.

“Risk hai toh ishq hai” etc. sounds fun on TV, but quitting a job and joining full-time markets works out for very few, if at all. Enjoy the spoils of the market, but don’t let the giddy returns go up your head.

(Harish Krishnan is senior fund manager (equities) at Kotak Mutual Fund. Views are personal)