What are the common features of outperforming investment managers? Do market conditions play a role in long-term alpha delivery? To answer these questions we studied the universe of global equity managers from around the globe that had outperformed the MSCI benchmark after fees for the past 20-years ending December 2014. We found that 24 managers out of a total universe of 103 outperformed over this period. On average, these ‘successful’ managers outperformed the MSCI by 2.4% per annum after fees.
These successful managers displayed the types of qualities that Nedgroup Investments focuses on when selecting Best of Breed™ partners. These characteristics are:
We then analysed (using predominately Morningstar® reports) the proportion of successful managers and found that they displayed the characteristics listed above. Our results are illustrated below with a ‘hit-rate’ calculated as the percentage of successful managers for which we found evidence of each feature.
The lowest hit-rate of 71% relates to the number of successful managers that are independent, investment-focused firms. The exceptions here include asset managers that are owned by a bank or are only a sub-division of a much larger conglomerate. This result does not change our view of the great advantages of independence, but rather confirms the importance of digging deeper. In some cases, a sub-division or bank-owned investment team can also operate according to business structures that allow it to be successful.
The two observations for which we could not find the words ‘long-term’ in any of the reports, has an annual portfolio turnover of 37% and 42% respectively. This is a very reasonable level and is perfectly in line with the median of the successful managers of 37%. This finding confirms that there is often much more to a manager than what is included in marketing material, which you will only find thorough research.
We did not delve into the level of detail required to determine whether each of the successful managers possess that specific valuation mind-set we like, but we were pleased to find that the vast majority of successful managers do describe their process as bottom-up.
Lastly, we looked for the mention of diversification and risk management in the philosophy and process descriptions and followed up with the three-year volatility relative to peers quoted in each of the successful managers’ Morningstar© reports. The result was favourable across the board.
Alpha trends in bull and bear markets
Next we studied the proportion of managers that outperformed in different sub-sets of the 20-year period, and the extent of their average annualised alpha in each, and some interesting trends emerged.
The vast majority of the successful managers (green bars of chart below) outperformed in bear markets (orange bars of chart below), as opposed to less than half in bull markets. This result implies that for the successful managers bear markets were thus far more favourable conditions for generating alpha.
Compared to the full period’s average alpha of 2.4% per year, managers delivered four- to five times greater alpha in bear markets as opposed to just keeping up or even underperforming slightly in bull markets. This, again, suggests that bear markets were a key contributor to our narrowed universe’s long-term success.
Knowing for certain which managers will generate long-term alpha without the benefit of hindsight is an impossible task. There is no checklist or set recipe you can follow to guarantee success. There will always be some exceptions, but in-depth and detailed research, as well as special attention to a manager's ability to protect capital in poor market conditions, can greatly increase your chance of success.
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