Alpha Boils Down To One Thing In Active Management

Alpha Boils Down To One Thing In Active Management

Picking the right stocks is the single most important thing to generate alpha, contends an article in Institutional Investor. According to a recent study from Inalytics that is cited in the article, the average alpha generated from stock research is 319 basis points, versus sizing, which generated a loss of 11 basis points.

Those results indicate that experienced managers are very skilled at researching which stocks to pick, but perhaps not as adept at then allocating how much capital to put behind those stocks to produce outsized returns, the article continues. Out of the 752 portfolios studied by Analytics, 84% have surpassed their benchmarks by an average of 397 basis points, but the other 16% fell behind their benchmarks by 150 basis points on average.  88% of the managers in the study had an average research alpha of 383 basis points, indicating considerable research skills, but the managers of those portfolios that underperformed showed an average research alpha of negative 139 basis points.

The study shows that allocators should get a better understanding of portfolio managers’ research process, says Rick Di Mascio, the founder and CEO of Analytics. He told Institutional Investor that if the research process becomes less valuable, “then it is quite clear that the sizing decisions and portfolio construction is not going to make up the difference.”

In contrast to stock picking, only 46% of the study’s participants generated positive alpha from sizing, and over 400 managers delivered an average sizing alpha of negative 93 basis points. Di Mascio considers sizing to be “idiosyncratic,” with the reasons for why it doesn’t always work varying widely from portfolio to portfolio. But on the research side, there are many more protocols and systems in place that managers can utilize, facilitating a better process for delivering positive alpha.

The bottom line, Di Mascio shared with Institutional Investor, is “that fund management is a skill-based activity,” and there is a select group of managers in the active management space who are highly skilled at picking the right stocks and generating profit for their clients.