While Paul Samuelson concedes that “perhaps there are managers who can outperform the market consistently,” he questions why academic investigators have been unable to find any evidence of their existence. Professor Grubel suggests that the answer may lie in the Peter Principle.

When a portfolio manager has investment success with a particular portfolio, it often presents him with opportunities to manage different and larger portfolios. So long as he continues to succeed, he will continue moving from one portfolio to another, larger portfolio. Ultimately, he will confront a portfolio so large that his talents are taxed to the limit; having reached his level of “incompetence,” he will no longer be able to achieve above-average returns.

In a world in which recognition for success comes rapidly, portfolio managers rapidly reach their levels of incompetence and tend to remain there for some time. Thus, at any given moment, only a small proportion of all portfolio managers will be earning consistently above-average returns. And they will move through the successful portfolios of their careers so quickly that their existence will not really be visible to the tests of academics.

If this hypothesis is correct, a successful portfolio manager should produce longer runs of above-average returns if he persists in managing small portfolios than if he moves on to larger portfolios. More generally, because the successful portfolio manager tends to change jobs frequently, any proper test of his existence requires analysis of the performance history of the manager, rather than the performance history of the portfolio.