Thursday, 19 February 2009

Fund manager stock-picking and inefficient markets

There's an interesting paper here, one of those put out as part of the activities of the Paul Woolley Centre for the Study of Capital Market Dysfunctionality.

Here's the abstract:
This paper provides powerful evidence that mutual fund managers can pick stocks that outperform the market. Many have argued that the inability of mutual fund managers to outperform benchmarks is the most persuasive evidence in favor of capital market efficiency. Berk and Green (2004) argue that this is not necessarily the case, because factors related to the structure of the money management industry will cause even good stock pickers not to outperform. We circumvent this problem by examining the performance of stocks that represent managers' "Best Ideas." We find that the stock that active managers display the most conviction towards ex-ante, outperforms the market, as well as the other stocks in those managers' portfolios, by approximately 39 to 127 basis points per month depending on the benchmark employed. This leads us to two conclusions. First, the U.S. stock market does not appear to be efficiently priced, since even the typical active mutual fund manager is able to identify a stock that outperforms. Second, consistent with the view of Berk and Green, the organization of the money management industry appears to make it optimal for managers to introduce stocks into their portfolio that are not outperformers, even though they are able to pick good stocks.


CharlieMcMenamin said...

Fascinating: but you can't leave it like this. You have to explain why.

Why should money managers know how to identity potentially high performing stocks but not actually buy them?

Tom P said...

This is what they say (more evidence that the fund management business itself is inherently inefficient?):

"The poor overall performance of mutual fund managers in the past is not due to a lack of stock-picking
ability, but rather to institutional factors that encourage them to overdiversify, i.e. pick more stocks than their best alpha-generating ideas. We point out that these factors may include not only the desire to have a very large fund and therefore collect more fees [as detailed in Berk and Green (2004)] but also the desire by both managers and investors to minimize idiosyncratic volatility: Though of course managers are risk averse, investors appear to judge funds irrationally by measures such as Sharpe Ratio or Morningstar rating. Both of these measures penalize idiosyncratic volatility, which is not truly appropriate in a portfolio context."

CharlieMcMenamin said...

"...institutional factors that encourage them to overdiversify.."

So it's the risk management control techniques which reins in their ability to go for broke? How's the industry standard approach on that front shaping up in your view Tom....:)