Only 18% of fund managers make the correct decision a majority of the time, according to a new research paper by Essentia Analytics.
The Essentia Behavioral Alpha Benchmark, which launched today (15 September), uses propriety analysis to attempt to assess portfolio managers on their decision making skills, rather than their recent past performance, which is "highly subject to the random effects of luck".
This tool incorporates seven key metrics to assess fund managers: stock picking, entry timing, sizing, scaling in, size adjusting, scaling out and exit timing.
The paper found that most managers got their decisions wrong most of the time. Only 18% made decisions that added value a majority of the time, and the best manager made the right decision just 55% of the time.
Nevertheless, 82% of managers had ‘positive payoffs', meaning their good picks outperformed their bad ones, all else being equal.
This is largely because when managers did get it right, they benefitted more than the negative impact of a wrong decision. Just over two-thirds of managers added more value when they got a decision right than they lost when they got it wrong.
The research paper assessed 76 anonymised active equity portfolio managers over 36 months of activity, up to 30 March 2022.
Managers were scored on a metric that considers the hit rate (percentage of decisions that added value) and payoff (net amount of value added) for each decision type.
Most managers excelled at selecting stocks for their portfolios, with 58% adding value through their stock picking decisions.
By contrast, managers typically destroyed value through their decisions on sizing a position, with only 38% adding value in this area.
Clare Flynn Levy, founder and CEO of Essentia Analytics, said: "The ability to prove the extent to which an active fund manager is skilled has been a sort of holy grail for investors."
She added that the tool "represents a sea-change in the industry - one that will 'raise all boats' for investors and managers alike".
Levy said: "Highly-skilled active fund managers can finally demonstrate their value over passive index funds, and managers who have not yet achieved a high skill level have clarity on what they can do to continuously improve."