Track records are a misleading skills indicator says research
Fund managers with no significant skill in stock-picking can outperform the market and it is a mistake to confuse track record and skills, according to research from Inalytics, a management evaluation consultancy.
The research was carried out on a sample of 62 Australian long only portfolios, representing over half of the local industry. According to the results, 42 managers, 67% of the total, outperformed the standard Australian equity benchmark, the ASX 300, between 30 April 2006 and 31 December 2010.
A significant proportion of the outperformance was generated from underweight stocks. “[This is] a highly unusual situation and one commonly associated with luck rather than skill,” Inalytics said. Of the managers that outperformed, 11 saw greater gains from the underweights than from their actual stock picking.
The percentage of decisions that a manager gets right was 49.9% for Australian managers, marginally above the 49.5% recorded for their global peers, suggesting that skill levels are comparable between the two.
Seven managers outperformed despite showing no skill in stock-picking. Further analysis of the 42 outperforming managers showed that 39 had positive contributions from the underweight stocks, that in 11 portfolios, the contributions from underweights exceeded the overweights, and in 7 portfolios, the contributions from the overweights were negative.
A high proportion of the outperformance came from a positive performance by underweight stocks, the research said. A significant reason for the outperformance came from a coincidence of views about one sector, real estate investment trusts (REITs), an asset class that underperformed over the period. Of the managers sampled, all except two were underweight in REITs throughout the period under review.
The research shows that there is a big difference between the track record of a manager and their level of skill, separating the two for the first time, said Rick Di Mascio, CEO and founder of Inalytics.
“The skill of a manager is inherent while track records really can come and go. As a result, skilled managers can underperform and less skilled managers can outperform. To confuse track record and skill would be a mistake for asset owners.”
The study also found that decisions on overweighted and underweighted stocks both added value to portfolios.
“This is interesting as many fund managers will charge significant performance fees relative to the index, yet their outperformance is coming from a decision to be underweight in a particular sector, rather than good stock selection. [This] would suggest that while there is skill, it is not nearly as unique or strong as track records initially suggest,” Di Mascio said.