ESSAYS
Insights from the application of Behavioral Finance.
SMART THINKING & BEHAVIORAL MATTERS ARE ESSAY SERIES WRITTEN SPECIFICALLY FOR PROFESSIONAL INVESTORS AND PORTFOLIO MANAGERS.
FEATURED ESSAYS
Scorecard Receives Poor Grade
Investors in actively managed funds rely upon creditable guide posts to understand the market and how their allocations are performing. New research questions key assumptions underpinning the SPIVA Scorecard and its value to investors. Read more about this surprising investigation...
What Billy Beane Can Teach Us About Active Management
Even those who are not sports enthusiasts are likely familiar with the 2002 best seller Moneyball by Michael Lewis.[1] The book explains how Billy Beane, manager of the Washington Mariners, used new and rigorous analytics to build a highly competitive baseball team despite limited financial resources. When Bean took over the Mariners’ salary total was half that of their division’s average and one-third of that spent by the New York Yankees. Bean’s innovation was to challenge the conventional thinking regarding the measurement of player skill.
Size Really Does Matter
Position Sizing is a crucial fund manager skill. It determines if the alpha from great buys is effectively harvested and if questionable purchases are restricted in the damage they inflict. Alternatively, chronically underweighting the strongest positions and overweighting the weakest holdings is a headwind if not a surefire path to underperformance.
Going Beyond Hunches To Identify Skill
The absence of an industry-wide definition of skill is a serious problem. It makes the identification of skilled managers nearly impossible. It makes equity allocation decisions much riskier. It undermines the confidence of those working hard to identify top equity managers. It causes angst, fear, and avoidance that is unnecessary, which further fuels the reallocation of capital to passive equity products. Formulating meaningful ways to discuss skill is long overdue. So, let’s get started right now.
Where To Look For Skilled Equity Managers
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.
Assessing Manager Skill – Shifting from Guessing To Knowing
Sorting out which equity fund managers are skilled is arduous and expensive. Untold hours and huge budgets are expended each year in assessing the manager skill across existing allocations as well as the vetting of potential new opportunities. Even more concerning, however, is that skill assessment is an extremely uncertain undertaking. Consequently, the risks inherent to fund assessment as it is currently conducted are likely underappreciated by the majority of decision-makers. Results can include overconfidence and faulty allocation choices.
Active Share Is No Indicator of Manager Skill
Active share is used regularly to assess manager skill. It’s based on the belief that high active share is correlated with a fund’s ability to generate excess returns consistently. This understanding, in turn, has led to the inference that high active share funds are led by skilled managers. This has placed active share on many equity fund search checklists. It has also contributed to its presence within the marketing materials of numerous equity funds.
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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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