What’s the best way to achieve superior, long-term, risk-adjusted returns?

On one side of the argument are the efficient market devotees. They argue cost and turnover are the prime factors of fund performance. Nothing else matters since it isn’t possible to ‘beat the market.’

On the other side of the argument are those with functional brains. Ha! They argue incentives DO matter. Don’t believe so? Think about it next time you’re in line at the post office. Union wage scales and guaranteed COLA adjustments provide NO incentive for good service.

If anecdotal evidence won’t convince you then how about the empirical kind? The authors of a recent paper – three professors in as many continents (North America, Asia, Europe) – find that fund managers who are paid bonuses based on their funds’ returns “exhibit superior subsequent fund performance, especially when [their pay is linked] to performance over a longer time period. In contrast, alternative compensation arrangements such as fixed salary…are not associated with superior performance.”