Research – stock picking – is the dominant source of alpha in almost 90% of institutional portfolios, new analysis from Inalytics, the leading experts in identifying investment skill, has found.
Based on analysis of more than 750 equity mandates managed on behalf of pension schemes and institutional investors globally1, Inalytics found that 88% of portfolios generated positive alpha from research – the process of investigating stock opportunities and adding winning positions.
With the analysis also showing that research is the overwhelming source of excess returns, the study suggests that asset owners conducting due diligence on fund managers should subject their research capabilities to much closer scrutiny.
Inalytics found that managers with demonstrable research skills generated 383 basis points alpha per annum, dwarfing all other sources of alpha. In contrast, the analysis found that other key elements of investment processes, like portfolio construction and trading, generated little or no positive alpha.
For instance, position sizing – how much of a stock to own – caused the majority of portfolios to lose value. Of the 752 portfolios analysed, the process of sizing positions generated a drag on performance of -11 basis points on average, meaning weighting decisions added marginally negative alpha.
Trading also contributed little to no performance overall. The alpha being added through buying decisions was shown to be offset by poor selling, leaving the balance close to zero.2
In total, the average annualised alpha of portfolios analysed – including outperforming and underperforming portfolios – was 308 basis points.
The analysis was informed by Inalytics’ new analytical methodology that attributes and quantifies investment skill. The framework, DECSIS, is designed to pinpoint empirically the sources of alpha being generated by active equity managers.
Commenting on the analysis, Rick Di Mascio, CEO and founder of Inalytics, says: “Our analysis shows that the research process, stock picking, is by far the single most important source of alpha that active managers generate. That strongly implies that asset owners conducting due diligence on asset managers should focus primarily on understanding the research process – how stock ideas are generated, how they are investigated, and how they make their way into a portfolio – rather than on other disciplines like portfolio construction and trading.
|1||The research is based on analysis of portfolios in the Inalytics database with more than three years of data|
This observation is consistent with the academic paper Selling Fast Buying Slow, co-authored by Inalytics CEO Rick Di Mascio (see notes to editors)
“The analysis and screening of managers has evolved significantly in recent times and we are now at a tipping point. Asset owners are increasingly turning to data science to inform the due diligence process and this research empirically demonstrates exactly where they need to focus their attention to find managers able to consistently add significant alpha to portfolios.”
Chris Duncan 07717 782 997
Helena Jones 075 0364 5612
Inalytics has been providing objective empirical measures of investment skill for more than 20 years. Its clients include some of the world’s largest global institutional investors, both asset owners and asset managers: pension funds, sovereign wealth funds, endowments, foundations, multi-managers, family offices, fund and portfolio managers. It has more than 50 clients in 13 countries.
Inalytics was founded in 1998 by Rick Di Mascio, the former CIO and CEO of the British Coal Pension Fund, one of the UK’s largest occupational pension schemes. He has also been a portfolio manager at Goldman Sachs Asset Management and Olympus Capital.