When it comes to successful active management, the secret to generating alpha isn’t portfolio construction, nor is conviction the path to outsized returns. When it comes down to it, it’s all about picking the right stocks.
New research from Inalytics shows that if the money manager isn’t choosing the right stocks, nothing else will help. Per the study, the average alpha derived from stock research is 319 basis points. In contrast, sizing, which refers to deciding how much capital to deploy to specific stocks, resulted in an alpha loss of 11 basis points.
“Stock picking is the primary area in which managers demonstrate skill,” the study says.
Inalytics founder and CEO Rick Di Mascio told Institutional Investor that the results of the study show that allocators should focus on understanding their money managers’ research process while conducting due diligence.
“If the research process, for whatever reason, stops adding value, then it is quite clear that the sizing decisions and portfolio construction is not going to make up the difference,” Di Mascio added.
Of the 752 portfolios with more than three years of performance data that Inalytics studied, 84% outperformed their benchmarks by an average of 397 basis points, while the rest underperformed by an average of 150 basis points. Average alpha for the whole universe was 308 basis points.
The study found that 88% of portfolio managers showed strong research skills with an average research alpha of 383 basis points. Meanwhile, the underperformers had an average research alpha of negative 139 basis points.
Only 46% of participants delivered positive alpha from sizing. More than 400 portfolio managers generated an average sizing alpha of negative 93 basis points, suggesting that investors should be skeptical of “manager material written on portfolio construction, risk budgeting, and conviction levels,” the study says.
T. Rowe Price offers a suite of actively managed ETFs and has been in the investing business for over 80 years through conducting field research firsthand with companies, utilizing risk management, and employing a bevy of experienced portfolio managers carrying an average of 22 years of experience.
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