How Skillful Is Your Hedge Fund Manager? | Chief Investment Officer

The best hedge fund managers tend to be skillful security selectors, strong at sizing positions, and have high win/loss ratios, according to analytics firm Novus.

Identifying these three skills would help asset owners weed out the merely lucky managers, the firm argued in a report, instead picking ones with “precisely the skill they can rely on for future performance.”

Instead of looking at past returns alone, investors may be able to gather richer intelligence from managers’ holdings disclosures. Simulating portfolio returns based on reported positions would help investors understand how the manager made money, Novus advised.

“Once you know what you’re looking for, skill sets are not hard to identify,” said Stan Altshuller, the firm’s co-founder and chief research officer.

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The first skill—security selection—could be identified by isolating a sector of the market the manager participates in and comparing their performance versus a specific benchmark. Filter the search to only include managers with a significant exposure to the sector to find the top stock pickers, the firm advised.

A manager’s win/loss ratio, or the “ability to ride winners and cut losers,” was the second display of skill and indicator for future performance noted in the report.

“Some managers are masters at getting the most from their winning trades and cutting their losses in a timely manner,” Altshuller said. “The best managers in this category are outliers that exhibit huge win/loss ratios over time.”

And the most important skill of all, according to Novus’ research, is the ability to appropriately size security positions, which tend to significantly dictate over- or underperformance.

“This skill speaks to the conviction of the manager in their best ideas and an inherent understanding of relative value and risk control,” Altshuller said.

To spot managers skilled in position sizing, the report said investors can compare an actual weighted portfolio’s performance to an equally weighted model portfolio, leaving sizing as the only measurable difference between the two. (Except returns, of course.)

Novus added that while it is difficult to find hedge fund managers possessing all three skills, certain firms do stand out.

Between 2010 and 2014, Miura Global Management and Brenner West Capital—both based in New York City—came out on top in Novus’ analysis, with Boston-based PAR Capital Management following at third place.

Activist Carl Icahn’s firm Icahn Management also made the list at number nine.

Investors are paying lip service to long-term investing and there is room for significant improvement across the board, say two influential consultants.

Pension funds and other major investors are failing to act sufficiently to promote good governance and long-term investing, according to a new study.

KPA Advisory co-founders Keith Ambachtsheer and John McLaughlin this month published two reports in tandem, using data from a survey conducted in June 2014. They found there had been some improvement in governance of pension funds and other major investment institutions, but many “major concerns” still remain.

“Despite evidence that board effectiveness is marginally improving, much work still needs to be done.” —Keith Ambachtsheer and John McLaughlinThe authors also reported a significant gap between the long-term investment aspirations of asset owners and the reality of their strategies’ implementation. The two areas are very likely linked, they added, as there were “statistically positive relationships between the governance quality rankings and the long-horizon investment quality rankings.”

Ambachtsheer and McLaughlin’s studies followed a “Focusing Capital on the Long Term” initiative launched in 2013 by Dominic Barton, global managing director at McKinsey, and Mark Wiseman, CEO of the Canada Pension Plan Investment Board.

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Barton and Wiseman’s initiative was aimed at promoting long-term investing and identified governance as key to its success.

Ambachtsheer and McLaughlin updated previous governance surveys to add force to the initiative, quizzing 81 major pension funds with total assets in excess of $5 trillion.

“Despite evidence that board effectiveness is marginally improving, our survey-based study conducted in 2014 finds that much work still needs to be done,” the authors wrote.

Among their governance concerns, Ambachtsheer and McLaughlin listed “flawed” board selection processes, unclear board oversight functions, and uncompetitive pay packages hampering recruitment and retention of talent.

“It will require a concerted, ongoing joint effort by pension plan stakeholders, pension organization boards, regulators, and legislators to change the current situation,” the pair said.

On long-term investment, the authors said there was “broad consensus” among respondents to the survey that a longer investment timescale was “a valuable activity for both society, and for their own fund.”

“A concerted effort—both inside pension organizations and among them—will be required to break down these barriers.”“However, there is a significant gap between aspiration and reality to be bridged,” Ambachtsheer and McLaughlin added.

“Here too a concerted effort—both inside pension organizations and among them—will be required to break down these barriers.”

The authors listed the barriers to long-termism: some areas of regulation, a “short-term, peer-sensitive environment”, a lack of clear investment processes and performance metrics, and difficulties in aligning interests with outsourcing providers.

The full paper can be accessed here.