Managers ‘slipping on home turf’

©AP

Financial institutions are not achieving an edge when they invest in their own sector

Fund managers are unable to make money even by investing in the industry they know best – their own – according to “striking” academic research described by its authors as an “indictment of some gravity”.

Analysis of 30 years of Wall Street trades by fund managers working for banks, insurers and mutual fund companies found no evidence that these industry insiders were able to leverage that information advantage by investing successfully in their own industry segment.

“We would expect investors with first-hand experience in the same industry as their investments to reap the rewards from being well-informed about its future profitability. [But] there is no evidence of investment ability either at the individual stock or industry level, despite the fact these institutions are investing in their own backyard,” said Aneel Keswani of London’s Cass Business School, who authored the paper* alongside David Stolin of Toulouse Business School.

If anything, the research found managers were better able to time investments in completely unrelated industries than they could in their own.

“If financial institutions exhibit any investment skill at all, it should be particularly evident when they invest in stocks of companies that are involved in the same business as themselves,” added Mr Keswani. “Their failure to beat the competition on their home turf amounts to an indictment of some gravity.”

The research analysed every trade over $200,000 made in the US stock market between 1980 and 2009. The analysis found some evidence that fund managers favoured their own sectors, with bank and insurance company-run funds disproportionately exposed to their own industries.

Yet this confidence appears misplaced, with fund managers no better at making money in their own sectors than they are in unrelated ones, and perhaps slightly worse.

Mr Stolin said this was surprising given that “if you can observe demand within your own company you should be able to extrapolate to others in your sector”. In addition, a number of research papers have suggested that fund managers seem to be able to leverage their greater knowledge of companies geographically close to them in order to generate superior returns.

He speculated that fund managers’ apparent inability to benefit from sectoral proximity could be driven by “overconfidence” or simply an inability to “see the forest for the trees”.

The authors argued the results could be another nail in the coffin of expert networks, the specialist research services used by many asset managers, particularly in the US, which sell insights based on specific industry knowledge. These expert networks are already suffering in the wake of a series of insider trading scandals.

One buyside financial analyst said he was surprised by the findings. “If you work in financial services you would probably have a better understanding of how different banks fit together, how they work. I sit on various committees and have to understand regulation and that has helped me when I look at banks and insurance companies to understand the regulation they are facing,” he said.

However, he accepted this greater degree of comfort could make people more confident and opinionated about their own industry.

In contrast Will Low, head of global equities at Scottish Widows Investment Partnership, argued the existence of Chinese walls within organisations, allied to the sheer complexity of banks in particular, made it very hard for fund managers to gain meaningful insights into their employers that are not already known to the market. However, he believed expert networks could still be useful.

* Squandering home field advantage? Financial institutions’ investing in their own industries