Where To Look For Skilled Equity Managers
Behavioral Matters: Insights from the application of Behavioral Finance | Issue 6
Written by Michael A. Ervolini
Where To Look For Skilled Equity Managers
INTRODUCTION
Skepticism regarding the existence of skilled equity fund managers is understandable. In most years the majority of actively managed equity funds underperform.[1] Among those that do outperform few manage to do so for 3, 5, or 10 years in a row.[2] Then there is the direct experience that most asset owners and allocators share: conducting a search for a new equity manager, performing rigorous due diligence, establishing a short list, selecting the final candidate, and making an allocation. Then watching with a mixture of surprise and dismay as the once high expectation fund delivers quarter after quarter of underperformance. It is no wonder why so many institutional investors have grown timid about allocations to actively managed equities.
However, not all asset owners and allocators are frustrated by their active equity programs. In fact, many capture meaningful alpha from their actively managed equity investments. They do it by more fully understanding the skill of their fund managers. This added knowledge enables them to sharpen their fund assessment processes and make better allocation decisions. This translates into the majority of their allocations outperforming in any given year. The managers of their funds are not perfect or super stars. They are what Inalytics LTD refers to as elite managers. Working with elite managers can tilt the odds in favor of earning alpha more frequently than not.
WHAT INALYTICS UNCOVERED
In their 2022 research paper Inalytics evaluated a group of 752 actively managed equity funds.[3] Among this group 630 or 84% outperformed their benchmarks for the prior three years. Whereas 122 or 16% underperformed. Clearly this group is not representative of the overall active equity industry. It consists of funds chosen to be analyzed by clients of Inalytics. Each fund had already gone through the gauntlet of traditional fund due diligence. Therefore, it is not surprising that the majority of these funds were generating excess returns. What is impressive is that the outperformers provided an average 397 basis points (bps) of after-cost alpha over the analysis period. Moreover, the Inalytics investigation showed that strong buying, or what they term the “research process”, drove fund results. Skilled buying , they computed, provided 319 bps of fund excess returns. This equates to 104 percent of the average excess returns for the outperforming group. Inalytics also observed that the sizing skill slightly impaired results, contributing (11) bps of alpha. Neither rebalancing position weights (adds and trims) or selling skills seemed to have a material impacts on fund returns according to their study.
It is worth pointing out that the skill or skills that most contributed to excess returns might vary when analyzed by the other decision-based analytics.[4] The potential for differing skill measures stems from the varying methods used in computing skills across the providers.[5]
CONCLUSION
The Inalytics research makes clear that quantifiable skills are responsible for fund excess returns in many instances. Subsequent analyses by Inalytics and other decision-based skill analytics providers confirms this observation. The analysis also underscores why a growing number of asset owners and allocators are incorporating decision-based analytics into their fund assessment processes.
By using these newer analytics investors know much more about the true skill of their equity managers (external and internal). They can also assess the consistency of skills that are most responsible for benchmark-beating results. Which means these investors have deeper insight into which managers are more likely to deliver positive alpha going forward. Now that sounds like smart investing.
ENDNOTES
- “SPIVA® Year-End 2025,” reports for U.S. and globally. https://www.spglobal.com
- “S. Persistence Scorecard Year-End 2024 – SPIVA. https://www.spglobal.com
- “Investment Skill: Does It Exist and What Does It Look Like?”, Inalytics LTD, Spring 2022.
- Michael A. Ervolini, Skill Versus Luck – Taking The Guessing Out Of Equity Fund Selection, MIT Press, February 2026.
- Ibid.
The ideas expressed on this website are developed and/or curated by Michael Ervolini. Mike has spent his entire 35 year + career leading efforts to improve and strengthen active management.
The multi-trillion dollar active management industry is predicated on the idea that managers have skill – yet little is known about it – Who has skill? How is it measured? This website is dedicated to finding answers to the questions surrounding skill.
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