November 6, 2013

Paging Dr. Alpha: Advisors With Ph.D.s Add 0.5% to Portfolio Profits

Study finds money managers with doctorates outperform less educated peers across a variety of investment criteria

Financial professionals ever seeking that elusive screening tool that yields a meaningful investment edge may be interested in a new study that purports to find one that is easily identifiable: Does the manager have a Ph.D.?

The hypothesis is pretty simple, and probably a natural for the four doctorate holders who conducted the study: “…substantial effort and knowledge acquisition is necessary to complete the advanced coursework and execute unique research required to obtain a Ph.D. degree. Thus, individuals holding these degrees will have unusual characteristics relative to the baseline population,” write the four authors of “What a Difference a Ph.D. Makes: More than Three Little Letters,” each a professor at a Midwestern university.

For good measure they also look at managers who publish papers in leading academic journals as another factor evincing superior value beyond just the possession of a Ph.D.

And what they find when comparing domestic equity products within the institutional money management world — taking care to match those investment products by objective, size and other factors — is that Ph.D.s add 42.7 basis points, or nearly half a percent, to annual returns.

Ph.D. products — defined as those in which Ph.D.s perform key executive roles such as CEO, portfolio manager, strategist, director of research and others — also beat non-Ph.D. products in terms of Sharpe ratios, 4-factor alphas and other performance measures.

The researchers also confirmed that Ph.D. products outperformed net of fees. However, they found that including fees enhanced Ph.D. performance since Ph.D. products were significantly less pricey than non-Ph.D. products.

Moreover, after taking care to match products in terms of size, past performance and other factors, the researchers found that Ph.D. products attracted statistically meaningful investment flow 18.2% higher than non-Ph.D. products — so it would seem that hiring Ph.D. holders is good for business.

Finally, the researchers tested their secondary hypothesis about publication of research, finding that the placement by Ph.D. managers of their research in journals of finance and economics was positively related to investment performance.

Previous studies in the mutual fund space have shown superior performance by money managers with higher versus lower SAT scores, but have not established a similar advantage for MBAs versus non-MBAs. The authors of the current study conclude that attainment of the highest academic degree does add significant value to investment products’ risk-adjusted return and other investment criteria.

On the basis of their research, the authors find “a clear economic justification for the aggressive recruitment [of] individuals holding a Ph.D. to serve in key positions in money management companies.”

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