The best hedge fund managers tend to be skillful security selectors, strong at sizing positions, and have high win/loss ratios, according to analytics firm Novus.
Identifying these three skills would help asset owners weed out the merely lucky managers, the firm argued in a report, instead picking ones with “precisely the skill they can rely on for future performance.”
Instead of looking at past returns alone, investors may be able to gather richer intelligence from managers’ holdings disclosures. Simulating portfolio returns based on reported positions would help investors understand how the manager made money, Novus advised.
“Once you know what you’re looking for, skill sets are not hard to identify,” said Stan Altshuller, the firm’s co-founder and chief research officer.
The first skill—security selection—could be identified by isolating a sector of the market the manager participates in and comparing their performance versus a specific benchmark. Filter the search to only include managers with a significant exposure to the sector to find the top stock pickers, the firm advised.
A manager’s win/loss ratio, or the “ability to ride winners and cut losers,” was the second display of skill and indicator for future performance noted in the report.
“Some managers are masters at getting the most from their winning trades and cutting their losses in a timely manner,” Altshuller said. “The best managers in this category are outliers that exhibit huge win/loss ratios over time.”
And the most important skill of all, according to Novus’ research, is the ability to appropriately size security positions, which tend to significantly dictate over- or underperformance.
“This skill speaks to the conviction of the manager in their best ideas and an inherent understanding of relative value and risk control,” Altshuller said.
To spot managers skilled in position sizing, the report said investors can compare an actual weighted portfolio’s performance to an equally weighted model portfolio, leaving sizing as the only measurable difference between the two. (Except returns, of course.)
Novus added that while it is difficult to find hedge fund managers possessing all three skills, certain firms do stand out.
Between 2010 and 2014, Miura Global Management and Brenner West Capital—both based in New York City—came out on top in Novus’ analysis, with Boston-based PAR Capital Management following at third place.
Activist Carl Icahn’s firm Icahn Management also made the list at number nine.
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