The Dog Ate My Alpha: Why Research Might Matter More in 2015


We have all heard that most active investment managers tend to under-perform their relevant market benchmarks.  And while this trend seems to have continued in 2014, there are some studies which suggest that investment research aimed at helping portfolio managers pick stocks could be a big driver of performance in 2015 and beyond.

Poor Asset Manager Performance Continues

According to Standard & Poor’s regular report cards, actively managed domestic mutual funds have a rather dismal record when compared with investing in passive indexes.  In 2010 58% of all domestic mutual funds underperformed when matched against the S&P 1500, in 2011 84% lagged behind the market, and in 2012 66% did worse than the averages.

For this three year period, each of the thirteen mutual fund categories tracked by S&P, on average posted returns worse than their respective benchmarks.  During this period, only Large Cap Value mutual funds beat their benchmark once — in 2010 when 65% of this class of funds exceeded the S&P 500 Value Index.  Unfortunately, in 2012 Large Cap Value funds gave back most of their outperformance when 85% of these funds underperformed their benchmark.

According to a recent article published by Bloomberg Business Week, Bank of America Corp. strategist Savita Subramanian recently calculated that the number of mutual funds which have outperformed their respective indices during the first ten months of 2014 was a mere 18% — the lowest success rate in 10 years.

Buy-Side Excuses Proliferate

Of course, most investment managers have come up with numerous excuses for why their mutual funds have under-performed the market in 2014 for anyone who will listen.  The Bloomberg article highlights a few of these excuses.

Some managers argue that their underperformance was based primarily on the fact that they did not invest in one or two stocks, including Apple or Microsoft.  Apple rose 41% in 2014 while Microsoft rallied 33% during the year – counting for a significant portion of the S&P 500’s 30% rally.

Other managers contend that the Federal Reserve continued monetary easing led to tighter correlations and less dispersion between different industry groups, making it difficult to identify potential outperformers as all sectors were propelled higher.  Some argue that the boom in ETFs have created a similar circumstance.

Some Changes in the Offing

However, this rather difficult market for stock-pickers could be about to change says the Bloomberg article.  In a recent report titled, ‘‘Era of Active Investing Upon Us,” BMO Capital Markets chief investment strategist Brian Belski concluded that intra-stock correlations, or the tendency of stocks to rise or fall together, have dropped in recent months and are now at below-average levels after being above average for many years.

Tom Lee of FundStrat Global Advisors also argues that the narrow dispersion of returns among industry groups seen in recent years is actually cyclical and that this dispersion is likely to revert back to the long-term average – a development which would provide a boost to the performance of actively managed funds.

Consequences for Research Industry

If these analysts are right, then investment managers who are skilled at stock-picking should be rewarded.  The good news for participants in the research industry is that research that can help investors accurately identify winners and losers could have a greater impact on the alpha of their funds, thereby making this type of research more valuable.

In our minds, this could be a boon for fundamental sector specialists, short ideas providers, and other investment research providers that have deep industry expertise or a good track record providing specific long or short stock recommendations.  Clearly this would be a welcome development after the last few years where many buy-side firms have trimmed their expenditures on sell-side and independent research.


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