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.
Pzena, Invesco managers top new investment skill benchmark
Fund managers that made good investment decisions in the past are likely to continue making them in the future, according to research from Essentia Analytics, providing a new metric for measuring their skill beyond the often messy metric of beating the benchmark.
“That makes common sense: it is reasonable to expect someone who has exhibited true skill at any activity — investment-related or otherwise — in the recent past to continue to do so into the near future,” said Essentia Analytics CEO Clare Flynn Levy. “But it’s also a very big deal: measures of investment skill that actually persist are rare indeed.”
Using its Behavioural Alpha Benchmark, Essentia scores managers on hit rate (percentage of decisions that added value) and payoff (net amount of value added) across stock picking, entry timing, sizing, scaling in, size adjusting, scaling out and exit timing. Managers that exhibit good decision-making in the recent past – six months for the median manager – are likely to keep making good decisions “into the foreseeable future”.
Essentia’s Q3 analysis encompassed 90 portfolio managers, of which more than half added value through their decision-making compared to their benchmarks. The top three teams in the ranking hailed from Harbor (specifically its Mid Cap Value Fund and Small Cap Fund) and Pzena’s International Focused Value Fund. Invesco’s UK Opportunities Fund came in fourth, while its Euro Equity Fund appeared in the top five for the first time. The leading four managers also scored in the top five of Essentia’s Q1 and Q2 rankings.
And while Essentia doesn’t think its Behavioural Alpha score should form the sole basis for making manager selection decisions, it does provide “a powerful additional lens” through which to analyse managers once due diligence has been done.
“Focusing on decision-making (which is, after all, what the fund manager actually does day-to-day) — rather than on portfolio performance (which is often heavily influenced by exogenous forces the manager cannot control) — we are able to provide both the manager and the investor with previously unavailable insight into whether that manager is likely to make good, value-additive decisions (which, over time, can be expected to lead to good performance.”
Essentia was established in 2013, with Northern Trust taking an equity stake in the business in 2021 as part of its “Whole Office” strategy to provide clients access to new technologies, services and solutions from across the investment lifecycle.
