Every advisory firm that outsources investment management must have a manager-selection and monitoring process that’s probably been fine-tuned over a long period of time. Chances are there these include a risk-adjusted return component, historical performance over favored time periods, consistent out-performance, and many other metrics. But are these the best predictors of future performance?
When it comes to predicting performance of investment managers–an investment manager’s “skill,” there are “only four decisions which matter,” according to Rick Di Mascio. For a long only portfolio it is these: to own or not own, to buy or sell.
Di Mascio, founder and chief executive of Inalytics Limited, with offices in the UK, U.S. and Australia, takes a fairly simple idea and uses it to deconstruct a manager’s actions in order to predict whether that manager will outperform in the future. Inalytics’ clients, institutions and pension funds, use this information to select and monitor investment managers.
Using data provided by a manager’s custodian, record keeper or from managers themselves, Inalytics looks at every position and trade, every day, going back varying numbers years depending on locale. With this data, Inalytics can see whether a manager has gotten into or out of stock positions at the optimum time and predicts their “hit rate” for being in or out of a stock at the right time. “The investment process is not relevant as an arbiter of success,” says Di Mascio. It’s “even simpler: either the stocks outperform or underperform; [you] want what you own to do well, and what you don’t [own] to do poorly.” A manager can “outperform the benchmark by not picking the losers as well as picking the winners.” And of course if a stock is excluded on a given day and outperforms, “then there’s missed opportunity.” The idea is so simple but until relatively recently there wasn’t enough available computing firepower to crunch the intraday data for all stocks against the manager’s purchases and sales every day that Inalytics uses to evaluate an individual manager’s “hit rates.”
It’s a way of predicting manager skill in a way that may be more reliable than historical performance is. Di Mascio believes that if a manager has been in the right place at the right time in terms of what they have selected or not, bought or not, sold or not, it’s a way to value their skills and a predictor of future success–that a manager will continue to be in the right place at the right time, whether buying or selling, picking the winners or avoiding the losers. At a time when the long-term outlook for the markets–even (or especially) with equities at new highs for the year–is still pretty uncertain, this may be another way to monitor the skills of managers that have already been selected, as well as looking ahead to new manager selection. For more information or to request white papers about use of these analyses, please go to Inalytics.
Comments? Please send them to email@example.com. Kate McBride is editor in chief of Wealth Manager and a member of The Committee for the Fiduciary Standard.