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Alpha Theory Blog - News and Insights

« June 2018 | Main

1 posts from July 2018

July 05, 2018

More Evidence of Manager Skill – Concentration Manifesto Continued

In preparation for a webinar we hosted about the Concentration Manifesto on June 21st we had a client question using batting average (win percentage) as a way of measuring skill. Their contention was that high batting averages do not always result in great returns, because a low hit rate with high asymmetry (lots of upside with little downside) can be even more profitable than predictable low returners.

 

Screen Shot 2018-07-05 at 12.25.30 PM

 

To analyze that point, we looked at the Return on Invested Capital (ROIC) by the same buckets we analyzed batting average.

 

Chart2

 

You can see that there is a similar correlation. Assets that are sized the largest had the highest return on invested capital. Said another way, the Top 5 positions went up an average of 12.1% while the portfolio as a whole went up 8.4% (for shorts, went down 8.4%).  That’s 50% better!

Chart3

 

We then analyzed the distribution of returns by bucket.

 

Again, you can see a predictive quality in manager position sizing. Stocks that have smaller positions have a wider distribution of returns (and more downside). The smallest positions had the most upside, but what we see in the data is that managers can forecast more volatile positions and size accordingly.

 

To finish the point, I’ll pull up a chart from the original Concentration Manifesto where we use our clients’ forecasted returns (Expected Return) and created two portfolios. One with the 20 best forecasted returns and then the rest. In the graph below, you can see that managers can forecast which assets will have the best returns. This shows skill not associated just with positions sizing, but on forecasting price return.

Chart4

 

There is very little question that our clients demonstrate skill. There is also very little question that they have mitigated a substantial portion of their skill by having too many positions.