Improving Your Golf Game and Curing Underperformance


Readers of this blog know full well that the investment research business has been impacted by a number of factors over the past decade which has pressured the active management business.  One of the most obvious issues (though one that is often not discussed) is the consistent underperformance of the investment management industry.  Unfortunately, few ever discuss how buy-side investors might improve their investment performance.  The following article starts an important discussion on this topic.

The Problem

More than 80% of actively managed funds underperform each year, and it has been this way for decades. In response several trillion dollars of capital has been reallocated away from active management and into passive products like index funds and ETFs with no end to this trend in sight. If this weren’t enough, fees for active management are continuing to drop like a rock. All told, the future for active management is very challenging especially if the current dynamics continue.

And that’s where a new book called “Managing Equity Portfolios: A Behavioral Approach to Improving Skills and Investment Processes” by industry veteran Michael Ervolini offers hope to the industry. Recently published by MIT Press, Mike’s book challenges active equity managers to improve their performance before it is too late and then provides practical ideas for how to begin improving their skills using an intuitive but rigorous method he lays out in a straightforward style.

Michael Ervolini has over 27 years of experience in institutional investment management and software development.  Prior to co-founding behavioral finance firm Cabot Research, Mike was a founder and CEO of Charter Research Corporation. Previously Mike was a Portfolio Manager and Chief Information Officer with AEW Capital Management where he first started using information technology as a strategic tool to run institutional portfolios. He was also a Vice President with Legg Mason Real Estate Institutional Advisors (Philadelphia, PA). Mike holds a B.A. in economics from Rutgers University and an M.S. from the University of Pennsylvania.

How To Start Solving The Issue…

The following quotes from Mike’s new book get to the heart of how asset managers might be able to start identifying and practicing the skills they need to improve their performance.

“One reason that so many equity managers can’t improve is poor feedback. Here is what I mean. Traditional portfolio analytics like relative return, information ratios, alpha hit rates and attribution are useful to a point  … but what they all share in common is that they are merely scorecards.  They measure how the manager did over a period of time and that’s it. They say nothing directly about skill and that is a huge problem. It is as if a golfer is only told the scores of her games and had no idea of where she had the most skill: Is it her drives off the tee? Her irons in the fairway? Or her putts? Armed with only the scores she would have no chance of becoming self aware or improving. This is precisely the bind that equity managers are in today. It’s why they can’t improve.”

Mr. Ervolini continues his explanation, “For example, all managers should know whether they generate more excess return from their buying or their selling. But they don’t. They have a gut feel or an intuition but they really don’t know. And not knowing your personal strengths and shortcomings makes it impossible to improve. I have this very conversation regularly with managers around the globe and they all agree that they would like to improve but they are not sure of which of their skills are strongest and which need retooling.”

Mike expands on his golfing analogy, saying “Unlike portfolio managers, golfers benefit from rigorous and granular feedback about their skills and sub-skills. It is the quality of the feedback that enables them to improve even when they are at the pinnacle of their ability. My book provides a new analytic framework that enables equity managers and analysts to get on par with golfers when it comes to feedback. Each page contains practical information for becoming more self aware and a better investor. The book describes a new analytic framework that enables professional investors to quantify how much skill they have at buying, selling and sizing positions. The book also shows how to use this information to improve deliberately. Hundreds of managers and analysts are using these techniques today and they are seeing terrific results. Put simply, if you want to survive as an equity manager you need to do better and my book offers you the roadmap to stronger skills, investment processes and eliminating behavioral tendencies.”

Two Key Findings

The following summarizes a few of the key findings of the research that Mr. Ervolini lays out in his new book.   “I’ll end on this note. At Cabot we’ve analyzed hundreds of professionally managed equity portfolios and here are just two of our findings. First, virtually all managers, even those that have been above their benchmarks for years, have at least one skill that is negative and it is draining performance from the portfolio. Second, over eighty-five percent of managers exhibit at least one behavioral tendency that is very persistent and costs the portfolio in excess of 100 bps of return year-after-year. The question then is: What behaviors are hurting your performance and isn’t it time to find out?”

Mike’s book and the need to help active management are the topics of an event being hosted by Bloomberg LP on Tuesday, November 11, 2014 starting at 4:00 PM, in NYC. Contact if you’d like to attend this industry-wide conversation about the future of the asset management business.  You can learn more about Mike’s new book, and purchase it directly by clicking on the following link


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