Way of the turtle

Lucky Genes
Another way to understand random effects is to look at their exis-
tence in nature. Intelligence, height, athletic ability, singing abil-
ity—all these qualities are the result of random effects. If you have
good genes for a particular trait (i.e., your parents both had a par-
ticular trait), you are much more likely than most people to have
that trait, though perhaps not to the same degree. If your father
and mother are both very tall, you probably will be very tall, but
the farther they drift from the norm, the more likely you are to be
shorter than they are. 
In genetics and in statistics this is known as reversion to the mean
or the regression effect. A person with very tall parents also has par-
ents with tall genes and a very lucky combination of those genes
from a height perspective. But a person with lucky genes is able to
pass on his genes but not his luck, and so a child born to those par-
ents is more likely to be closer to average since that child is not as
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Way of the Turtle

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likely to have the same “lucky” arrangement of the genes that the
parents did.
Bad News for Investors
When one starts to use performance measures to separate a group
of funds into the good ones and the underperforming ones, one is
very likely to encounter random effects. The reason for this is that
there are more lucky average traders than unlucky good traders.
Consider a universe of 1,000 traders in which perhaps 5 or 6 are
truly excellent traders. If 80 percent of the 1,000 are close to aver-
age traders, there are only 5 or 6 traders who have an opportunity to
get unlucky, but there are 800 with the opportunity to get lucky. If
2 percent of traders get lucky enough to have a good track record
for 10 years—and the test described above shows that the actual
number is probably even higher than that—this means that there is
a group of 21 traders with excellent performance, only one-quarter
of whom are actually excellent traders.