Research and data interviews.
Why the top performers disappoint
The question
A fund's best traders this year are usually worse next year. Does that mean the firm is failing to develop them?
Have a go before you open the solution. If you are stuck after a few minutes, the first paragraph below is usually enough of a nudge.
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The answer
No. Most of it is regression to the mean.
Observed performance is skill plus noise. Selecting the top performers selects for both high skill and favourable noise.
Noise does not persist, so next period the same people show their skill plus fresh noise, which averages to less than before.
The effect is strongest when the noise-to-skill ratio is high, which is exactly the case for short samples of trading results.
The practical consequence is that any evaluation based on a single strong period will systematically overrate its winners, which is why interviewers ask this.
What it is testing
Whether you can separate selection effects from causal ones.
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