But, But, What about Buffett and Lynch?

william bernsteinThis article was excerpted and modified from pages 70–76 of the second edition of The Four Pillars of Investing, with the kind permission of the publisher, McGraw-Hill Inc. You can purchase this book from the link on this page.

Skeptics of the efficient market hypothesis and passive investing are quick to point out three of its most prominent exceptions: Peter Lynch, Warren Buffett, and Jim Simons, obviously skilled money managers who convincingly outperformed the market over a long period.

Let’s start with Lynch. After serving as a summer intern at Fidelity in 1965, he hired on full-time in 1969 as a stock analyst, rose to director of research in 1974, and took the reins of the Magellan Fund in 1977. At the time, it was an “incubator fund,” open to the public for a few years following its 1963 founding, during which few investors purchased it, then open only to Fidelity employees until 1981, when the public was allowed back in.

At the time, the incubator fund tactic was a common ruse in the fund world: Establish a cohort of incubators, kill off or merge the laggards into the winner, then advertise the heck out of the best one’s prior performance. This is exactly what happened to the Fidelity Salem Fund, which was merged into Magellan just before it reopened. (This tactic recalls a common stockbroker scam: Mail out three different random buy recommendations to hundreds of prospects, then contact the one eighth of the prospects ([½]3) to whom the laws of probability gave all three of the winners.)