One facet of advisor value is the ability to pick money managers that provide above-average returns. Choices are vast, which creates dispersion between top and bottom performers. High dispersion increases the opportunity for advisors to add or subtract value from manager selection.
Many advisors spend a great deal of time performing analysis and due diligence on the investment strategies and managers utilized in their clients’ portfolios. Since allocations to traditional long-only strategies typically represent the vast majority of a portfolio, the time and resources committed to their due diligence is commensurate. However, the dispersion between top and bottom performing long-only managers is normally much less than that witnessed in many alternative investment categories. This concept is not new to those who have experience with venture capital and private equity funds, but is still being discovered by advisors who are adopting liquid hedge fund strategies.
For example, for the five years ending March 31, the difference between top and bottom quartile large-cap growth mutual funds was 2.87% per year and 2.72% for intermediate bond funds, according to Morningstar. By contrast, the differences between top and bottom quartile long-short equity and managed futures mutual funds were 7.50% and 6.21% per year, respectively. As we all know, an extra few percentage points of performance over only a five-year period can add up to hundreds of thousands of dollars on a million-dollar portfolio.
While the five-year figures above are eye-opening, this dispersion anomaly is exacerbated when looking at the extremes, shorter time periods and institutional hedge fund managers. The latter point is important as more and more institutional hedge fund managers move into the mutual fund space.