How can you tell whether a money manager is lucky or smart? A recent study by research firm Inalytics together with asset manager GLG Partners claims to have come up with an accurate way of figuring this out. They explain that the link between past performance and future returns is "imagined" and dismiss track record as a useful way in which to measure a manager’s skill.
Their report takes an evidence-based approach that analyzes every decision a manager makes. They claim this will identify real strengths and weaknesses. This involves measuring two things, which the authors describe as "basic yet profound": does a manager get more decisions right than wrong (hit rate) and do the good decisions offset the poor ones (win-loss ratio).
The bad news for investors is that the average hit rate for the portfolios in the Inalytics database was only 49.6%. Yes folks, those people to whom you entrust your hard-earned money get fewer than half of their investment decisions right. But fear not, the win-loss ratio of the portfolios was 102% – meaning that good decisions offset poor ones – although if it were by a slightly larger margin it would be nice.
So far from underpinning the industry’s own sense of self-importance, the study concludes that the generally accepted wisdom that managers get six out of 10 decisions right is wildly optimistic. But it does claim that "extensive evidence" from the Inalytics database of managers shows that in the world of money management skill "does in fact exist". That is a relief – it would be awful if all of that fee income had been paid to a bunch of upstarts with no discernible skill whatsoever.