Fund management: A game of luck?

Fund management: A game of luck?

A large part of the active versus passive debate has always revolved around whether an active manager's returns are through luck or judgement.

Last Updated: 8:14AM BST 08 Apr 2009

The debate was reignited at the end of last year when Inalytics, a specialist firm that helps pension funds to select and monitor equity managers, published research which showed managers typically get only half of their decisions correct.

The research, based on an examination of 215 long-only funds worth a combined £99 billion, found that the average manager's ability to identify winners and losers was no better than 50-50. Put simply, they would do no worse tossing a coin.

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The research looked at two measurements of fund manager skill: what it termed the hit rate and the win/loss ratio. The hit rate shows the number of correct decisions as a percentage of the total number of decisions. The win/loss ratio is a comparison of the alpha generated from good decisions with the alpha lost from the poor decisions. To judge these, Inalytics daily analysed every purchase/sale, underweight and overweight made by the fund managers.

Rick di Mascio, the chief executive and founder of Inalytics, says: "The industry maxim suggests that six correct decisions out of 10 would constitute good performance. However, we did not find one manager who got six out of 10. The average was five out of 10 (49.6pc) and the really good managers only managed to get a 53pc hit rate, which was a surprise as we expected the best manager to be a lot higher."

To compensate for this, di Mascio says the average manager is able to generate good gains from "winners" to offset the losses from "losers". According to the research, the average win/loss ratio was 102pc, which means the alpha gained from good decisions was 2pc higher than that lost from the poor decisions.

"The good managers had a win/loss ratio of 120pc, with the best getting up to 130-140pc," says di Mascio. "This is where the skill comes in, running your winners and cutting out the losers. It's what differentiates the also-rans from the best. There is nowhere to hide with these numbers."

http://www.telegraph.co.uk/finance/personalfinance/investing/5093111/Fund-management-A-game-of-luck.html