Since the emergence of “Modern Portfolio Theory” and the “Capital Asset Pricing Model” in the late 1960s, institutional investors have taken a quantitatively driven approach to portfolio construction, looking to create portfolio diversification and obtain better risk-adjusted returns by balancing their asset-class exposures. This journey has seen several important advancements in thinking about how to optimally achieve desired results.
Funds that want to take the total portfolio approach first need to get the total portfolio view. To do that they not only need data – and lots of it – but a rock-solid understanding of exactly how they’re going to use it.
Inalytics helping sort the wheat from the chaff
(Pictured: Amanda Field)
A benefit of a low-return environment is that investors tend to put a lot more emphasis on analyzing the efficiency of their implementation actions and assessing their decision-making processes. They should do this in good times too.
One of the tools which is increasingly being used in Australia and elsewhere is the Inalytics system of analyzing trades every which way to determine a manager’s level of skill. Inalytics, a privately owned UK-based research firm which has had a Melbourne office for several years, provides a different sort of performance measurement to the ubiquitous Mercer and eVestment surveys. It studies every stock selection decision from its managers and assesses its value add to a portfolio. The firm believes it can identify a skillful manager where otherwise using traditional measurement procedures may take years to sort the wheat from the chaff.
Amanda Field, who set up Inalytics’ Australian office in 2006, says there are a lot of similarities between the Inalytics research and the way elite athletes are analysed.
An interesting analogy is to compare the performance of tennis player Andy Murray with investor Warren Buffet. While the analysts know that Murray won at last year’s Wimbledon, 72 per cent of points when his first serve went in, and only 42 per cent when he had to go to a second serve, there is little similar analysis of Buffett’s decisions except at the general level of annual returns.
The Inalytics universe consists of about 800 managers, of whom 80 are Australian, including hedge fund managers. The firm not only assesses whether a buy or sell decision worked out but also how it recycled the capital from a sale.
“We can see that managers tend to tinker a lot,” Field says. “And often times that does not add value.”
On the other hand, Inalytics research shows that concentrated portfolios do, indeed, tend to outperform more diversified portfolios. A study of 599 equities portfolios showed that those in the lowest quartile for number of stock holdings outperformed the highest quartile (most stocks) by almost 400bps a year.
From a behavioral finance perspective, the researchers say that the lower the number of holdings in a portfolio, the more attention each stock gets by the managers.
Inalytics is currently working on a study to see correlations between corporate governance and performance.
