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There is plenty of room for fund managers to improve their performance as evidence suggests they buy winners but sell even bigger winners.
Zhe Chen CMCRC PhD Candidate Macquarie Graduate School of Management Professor David Gallagher CMCRC Project Leader Macquarie Graduate School of Management Keywords: Investment management
Active Fund managers are highly compensated for their presumed ability to gen- erate excess returns relative to the benchmark index but academic evidence in sup- port of this skill is, at best, mixed. A recent study, Buying Winners and Selling Even Bigger Winners: Evidence from Active Australian Equity Managers by CMCRC PhD stu- dent Zhe Chen looks at fund manager performance and comes up with some very surprising findings that lead to the conclusion that there is significant potential for funds to do a lot better. Chen’s study was conducted with data from 59 funds over a 15 year period from 1995 to 2010. This comprehensive data set of daily fund manager trades and monthly holdings, which was not publically available in the academic space, was used to examine literally hundreds of thousands of share trades. Chen’s analysis of investment returns over the period that funds typically hold a stock (230 trading days on average) finds that actively managed funds overall outperform the bench- mark index. However, when the performance of the shares that the funds have recently sold are examined (over a period of 120 trading days post-trade) he finds that these recently sold shares outperform not only the index but also the stocks that they had newly purchased. In other words, fund managers tend to buy stocks that generate excess returns after purchase but they also sell stocks that accumulate even greater excess returns after sale. Actively managed funds fall into five basic categories based on self-declared in- vestment philosophies: Growth, Growth at a Reasonable Price (GARP), Value, Style Neutral and Enhanced/Active Managers. Chen’s research findings were particularly pertinent for Growth, GARP and Enhanced/Active fund managers but less impor- tant for Value and Style Neutral funds. The research also finds that the more concen- trated funds, which hold a smaller number of stocks, are less affected by this than the funds that hold many stocks. It was also noted that for smaller capitalisation stocks the excess returns generated by the sold shares, compared to the shares bought and sold by the funds, was even greater. The study provides evidence to suggest that Growth, GARP and Enhanced Ac- tive fund managers buy stocks that generate alpha (beat the index) but tend to sell stocks that subsequently perform even better, especially in small-cap stocks. This suggests that for these types of funds there are actions that can be taken to simply and effectively improve performance.
Author(s): Zhe Chen, David Gallagher