In his book “Thinking, Fast and Slow”, Nobel Prize winner Daniel Kahneman tells a story about a flight instructor.[1] The instructor said that after he praises a cadet for a great aerobatic manoeuvre the cadet normally does worse next time. The opposite also works. A cadet normally does better after the instructor screamed at him/her following an extremely bad execution of an exercise. This is regression to the mean in action. In Kahneman’s view, success = talent + luck. Luck fluctuates. Its impact is especially visible in great success or great failure. Any impact of good or bad luck is not sustainable.

It looks like Norges Bank Investment Management applies Kahneman’s view about talent/skill and luck on a portfolio manager’s excess return. Norges Bank Investment Management manages the largest sovereign wealth fund in the world with assets of more than USD 1 trillion. Part has been managed by various external managers for more than 20 years. The average annual excess return external managers generated over 1999-2018 was 1.8% net of fees. Excess return was positive in 16 out of 20 years. In a recent white paper about their experience with external managers, it writes: “We often assumed that returns would recover after periods of underperformance and so increased funding – and reduced funding after periods with a better performance than expected”.[2]

We think that talent[3] and luck are in play in the portfolio management sphere on the Russian equity market. It requires talent to estimate whether a particular stock is mispriced, to figure out the factors that are crucial for a company’s business and to understand what has not been priced in by the market. Good luck can help an investment idea to be realised sooner and better than expected. Bad luck can push stock prices in a different direction from the expected one. By good/bad luck, we mean events with a very low probability or completely unpredictable events.

The position in Luxoft at the beginning of 2018 is an example of when good luck helped an investment idea to be realised very quickly. At that time, the BNP Paribas Russia Equity fund[4] held a position in off-benchmark software developer Luxoft. We saw around 70% upside to a fair price for this stock and liked its business prospects, the level of corporate governance and the alignment of majority and minority shareholder interests. In January 2019, US company DXC Technology bought Luxoft, paying an 86% premium over the price at which the stock was trading on the day of the announcement. As a result, the stock surged by 80% in US dollar terms.

The position in Unipro in 2016 is an example of when bad luck resulted in underperformance of a fundamentally strong investment case. At that time, the BNP Paribas Russia Equity fund held a position in the off-benchmark stock of this large power generator. We saw an upside of around 20% and potential for a sustainable double-digit dividend yield. In February, there was a fire at one of its newly built power-generating units Berezovskaya-GRES-3. As a result of the accident and the subsequent uncertainty over possible insurance compensation, Unipro underperformed the market in 2016.

(Please see the full version of the article with graphs in the attached pdf file.)

The impact of talent and luck can been seen in the cyclicality of the excess return of the largest Russian equity fund, BNP Paribas Russia Equity. Regression to the mean can be seen in action as it was in the flight instructor story. Extreme underperformance over the past 12 months normally increases chances of outperformance as well as the size of outperformance in the subsequent 12 months and vice versa.

The impact of talent and luck can be seen in the average performance of Russian equity funds. It is far less material compared to the impact on BNP Paribas Equity Russia. A particular event can mean good luck for one fund and bad luck for another. The more funds we have in the sample the lower the impact of luck fluctuation will be on their average excess return. No wonder that we do not see any material difference in probability to outperform depending on prior excess return. However, there is a slightly higher average excess return after periods of extreme underperformance compared with periods after extreme outperformance.

Consequently, it probably makes sense:

  • To have two funds with exposure to the Russian equity market
  • The funds should be the ones for which: 1) you have a high level of conviction in the investment team’s skills and in the efficiency of their investment processes 2) and which normally have quite different portfolios
  • To rebalance the allocation across the funds in the case that one of them demonstrates extreme underperformance or outperformance over a particular 12-month period.


Authors: Egor Kiselev, Head of International Business & Investment Marketing; Gennady Sukhanov, Deputy Head of Equities & Head of Research

[1] Page 175

[2] From “Investing with external managers” Page 33

[3] We use ‘talent’ as a combination of an investment team’s natural qualities coupled with their level of skills, including the organisation of investment process

[4] TKB Investment Partners’ investment team has been advising the BNP Paribas Russia Equity fund since its inception in February 2007

Cyclicality of excess return for Russian equity funds October 2020

The investments in the above funds are subject to market fluctuations and the risks inherent in investments in securities. The value of investments and the income they generate may go down as well as up and it is possible that investors will not recover their initial outlay, the funds described being in risk of capital loss. For a complete description and definition of risks, please consult the last available prospectus and KIID of the funds.

Categories: Research