When it comes to generating alpha, nothing matters more than picking the right stocks.
The average alpha derived from equity research is 319 basis points, according to the latest Inalytics study. By comparison, sizing, which involves deciding how much capital to deploy to specific stocks, produced a small alpha loss of 11 basis points.
The results mean that “elite managers are very adept at deciding what to own through the research process,” according to the study. But unfortunately, “every effort to decide how much to own” is not so effective in generating outsized returns.
Inalytics based the results on a study of 752 wallets with over three years of performance data. Eighty-four percent of the portfolios outperformed their respective benchmarks by an average of 397 basis points, while the rest underperformed by an average of 150 basis points. The average alpha for the entire universe was 308 basis points, according to the study.
Inalytics found that 88% of portfolio managers demonstrated excellent research skills with an average research alpha of 383 basis points. Low performers, however, had an average search alpha of minus 139 basis points, according to the study.
“Stock picking is the primary area in which managers demonstrate skill,” the study said. According to Rick Di Mascio, Founder and CEO of Inalytics, this means dispatchers need to spend more time trying to understand the manager search process while performing due diligence. “If the research process, for whatever reason, stops adding value, it’s abundantly clear that sizing decisions and portfolio construction won’t make a difference,” he said. Institutional investor.
The Inalytics study found that only 46% of participants provided a positive alpha from sizing. Over 400 portfolio managers generated an average sizing alpha of minus 93 basis points. According to the study, the implication for asset owners is that they should be skeptical of “written management materials on portfolio construction, risk budgeting and conviction levels.”
Inalytics added that it was also important for asset managers to “investigate why their sizing typically fails to add value.” According to Di Mascio, the sizing factor is more “idiosyncratic,” meaning that why it doesn’t work varies across different portfolio managers. On the research side, “there is a huge infrastructure in place to get the best of the ideas into the portfolio,” Di Mascio said. And that’s why most managers generated positive search alphas.
Di Mascio added that the results also indicate that there is a group of “elite managers” in the active management space. “Our figures show that there is an elite [group] and that fund management is a skill-based business,” he said. “And just like sports, there is a cohort of people who can [win] their game.”