Equity managers
buy well but sell badly
Research shows that managers are good at
EXECUTIVE SUMMARY spotting winning and losing shares, but their
• Fund managers are skillful stockpickers.
returns are hit hard because they sell the
• Their performance is hit by poor timing.
winners at the wrong time and hold on to the
• Behavioural fi nance explains their
decisions.
losers, by Malcolm Smith, ASIP
BY: MALCOLM SMITH, ASIP
© ULTRA.F
or as long as most of us can by favourable buying skills which We then analysed how the stocks in
F
remember, debate has raged contribute 47 basis points a year. Th is is each band contributed to relative
about whether equity managers explained as the Disposition Eff ect, performance. Th ose which are
have skill. To fi nd the answer, which shows that investors tend to lose overweight (whether heavily or not)
Inalytics has carried out an analysis of more money when selling than by contribute by outperforming the
all the decisions taken across the range chance alone. benchmark, those which are
of clients in its database. Th e answer is underweight by underperforming.
yes, and emphatically so. Th e THE ENDOWMENT EFFECT We found that the average
overwhelming majority of managers’ Th e Endowment Eff ect is considered contribution was roughly 36 basis
skill at buying typically adds among the most robust phenomena in points a year for each heavily
signifi cantly to return. However, these the fi eld of behavioural fi nance. It is the overweight position, and 15 basis point
skills are dissipated by well-known tendency of people to value assets that a year for each overweight position. Th is
eff ects in the behavioural fi nance they own more highly than assets they do is clear evidence of skill.
literature, particularly the ‘Endowment not own. In the context of institutional However, an equally interesting
Eff ect’ and the ‘Disposition Eff ect’. investment portfolios, this is manifested result arose when the underweight
Fund managers choose stocks that by investors paying more attention to stocks were examined. Th e average
typically add value, providing real their long (or overweight) positions than heavily underweight stock contributed
evidence of manager skill and even they do to their short (or underweight) -24 basis points a year and the
underperforming managers show evidence positions. Th is is not to suggest that the underweight stocks about -3 basis
of having the skill to identify in advance underweights are ignored, but our results points a year. Th is represents a huge
shares that subsequently outperform. indicate that the focus is just not the haemorrhaging of performance, and
Unfortunately, most managers lose same. It should be noted that the shows that increased focus and research
value from their material underweights. underweights are typically those stocks on what stocks to heavily underweight
Th is is explained as the Endowment that are part of the benchmark, but not is one of the key opportunities for
Eff ect. part of the portfolio. improving investment returns.
Contrary to conventional wisdom, We analysed 41 portfolios, covering a
fund managers do not run their winners wide range of equity mandates. We THE DISPOSITION EFFECT
and cut their losers. In fact, they do the allocated each holding within the Th e Disposition Eff ect relates to the
opposite and it hurts performance. We portfolio in the following bands of propensity of investors to lose more
have found that poor selling negatively active weight: heavily overweight, money when selling than would be
impacts returns on average by 94 basis overweight, (broadly) neutral, expected by chance alone. Th is is
points a year, which is only partly off set underweight and heavily underweight. explained in terms of ‘prospect theory’
28 WINTER 2008/09
28-2928-29 equities.indd 28equities.indd 28 27/11/0827/11/08 15:53:3215:53:32
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