Suppose we were to run a contest in which a group of 30 individuals were asked to predict the outcomes (heads or tails) on a series of coin flips. After each coin flip, some of the players would drop out because they made the wrong selection. If we continue the experiment until there is one person left, the winner, would he be skillful or simply lucky? In any contest, there are winners and losers. In sporting events, we attribute winning performances to skill. Does this make sense in other endeavors? If markets are completely efficient, there should be no reward for skill, so ex post abnormal performance can only be attributed to luck.

Another interpretation is that the market prices managerial skill at fair value. So, an exceptional manager who generates an alpha of 2% earns that 2% in the form of a management fee. After fees, that manager’s performance looks identical to the average manager who generates an alpha of 0.25% and earns a 0.25% management fee.10 The lack of variation in CDO manager-fee structures suggests that the marketplace does not currently price skill differences across managers.