Study finds traders are useless, top research drives returns
Investment research is the defining factor by which fund managers produce strong returns, a new study has found, underscoring the role of stockpickers as investors increasingly shift to passive portfolio strategies.
An analysis of 752 equity investment strategies run by fund managers on behalf of large institutional investors, such as pension funds, found that research – the rigour behind stockpicking – was the overwhelming driver of excess returns.
The findings, from data analysis group Inalytics, may appear intuitive, but the implications for fund managers and their clients are significant. Fund managers rely on a varied list of research sources, from analysts at brokerages, boutique research firms, to in-house teams that drive portfolio management.
The findings show that strong, differentiated research helps investment managers outperform their benchmarks to add alpha to portfolios. Additional means of squeezing outperformance, such as astute trading, are largely insignificant.
“If you’re an active equity manager, the core skill they need to display to create ongoing alpha for customers is the ability to identify the stocks to own in the portfolio – that is where the value is created,” said David Goodman, managing director, Asia Pacific, for Inalytics.
The study casts a poor view on the trading function, which large asset managers for years have built out to compete in an increasingly complex market structure to try and boost returns.
“Trading, at least in the wealth of data we’ve seen in this study, and previous work we’ve done, is not a part of the process that creates alpha for clients in a sustainable way,” Mr Goodman said.
“If you had a conversation with traders at an investment bank, their edge is knowing where liquidity is and that’s where they can create value, but the edge [of] an asset owner or asset manager is to create a research process that identifies stocks that will outperform,” he said.
“If that core capacity is not their strongest, it will be hard for them to outperform.”
Data analytics
The study carved the portfolios analysed into those with demonstrable research skills, and those with poor research capabilities. The former group delivered 3.83 per cent in excess returns above their benchmarks, while the latter group suffered negative drag on portfolios of 1.39 per cent.
The findings offer a note of support for the practice of stockpicking at a time when it has come under pressure as investors shift to low-cost alternatives, such as exchange traded funds.
The data also shows the uses of high-powered analytics that can inform investment management operations.
Fund managers are increasingly turning to data science, machine learning and artificial intelligence to sharpen their research and operations in the hope of achieving even small gains in performance.
“Asset managers increasingly use data analytics to have a microscopic lens on their investment process to see the things they do well, what they’re not doing enough of, or even behavioural biases that are introduced in the process," Mr Goodman said.
“Elite fund managers have a passion to get better and that’s where data helps.”
US-based Dimensional is one fund manager that has tapped the growing array of data science tools to help bolster portfolio returns. The company’s research team sports around 20 doctorate graduates to help refine its investment approach.
“If you’re an investment manager and you’re not looking at your processes using data analytics, you’re not keeping up with your peers,” Mr Goodman said. “All the leading investment managers have invested in data analytics to better understand their processes.”