Industry Updates

Specialist manager evaluation firm Inalytics’ research highlights the fallacy of track records

Tuesday, May 24, 2011

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At a time when fund manager performance is scrutinised more closely than ever, research from Inalytics, the specialist manager evaluation firm, has found that fund managers with no significant skill in stock-picking have still been able to outperform the market. The research stems from the mistaken industry belief that Australian fund manager skill levels, and therefore track records, are superior to their global industry peers. Carried out on a sample of 62 Australian long only portfolios, representing over half of the industry, the study saw 42 managers (67%) outperform 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 the underweight stocks; a highly unusual situation and one commonly associated with luck rather than that of skill. Of the managers that outperformed, 11 saw a greater gain from the underweights than their actual stock picking.

The Hit Rate (the percentage of decisions that a manager gets right) for Australian managers was 49.9%, marginally above the 49.5% recorded for their global peers, suggesting that although their performance track records are clearly superior to the rest of the world, skill levels are comparable between the two. The data also revealed a Win-Loss Ratio (whether good decisions generate enough return to offset poor ones) of 104.9% for Australian managers, as opposed to 109.6% for the global peer group. Seven managers even outperformed despite showing no skill in stock-picking. Further analysis of the 42 Australian managers that outperformed revealed that:

39 managers had positive contributions from the underweights;
In 11 portfolios, the contributions from the underweights exceeded the overweights;
In 7 portfolios, the contributions from the overweights were negative.

A high level of the outperformance contained within the findings was generated from positive performance from underweight stocks. Furthermore, a significant reason for this outperformance was discovered to result from the extraordinary coincidence of view in one sector, that of real estate investment trusts (REITs), an asset class that underperformed over the period. Out of the 62 manager sample, all except two were underweight in REITs through the period under review.

Commenting on the results, Rick Di Mascio, CEO and founder of Inalytics, said: “These results show that there is a marked difference between the track record of a manager and their level of skill; this research separates the two for the first time. 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.

“Two-thirds of Australian managers outperforming their benchmark is a good result by any standard. However, performance is not quite at the level that anecdotal evidence and even the initial numbers suggest. Our study found that both decisions on overweighted and underweighted stocks have 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. Our conclusions from this research would suggest that while there is skill, it is not nearly as unique or strong as tracks records initially suggest. The level of skill is in fact broadly in line with their global peers.”

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