Eighty-eight per cent of institutional investor portfolios generate positive alpha from research – the process of investigating stock opportunities and adding winning positions, according to Inalytics.

Based on analysis of more than 750 equity mandates managed on behalf of pension schemes and institutional investors globally, Inalytics found that research is the overwhelming source of excess returns. The study suggests that asset owners conducting due diligence on fund managers should subject their research capabilities to much closer scrutiny.

Inalytics found that managers with demonstrable research skills generated 383 basis points of alpha per annum, dwarfing all other sources of alpha. In contrast, the analysis found that other key elements of investment processes, like portfolio construction and trading, generated little or no positive alpha.

For instance, position sizing – how much of a stock to own – caused the majority of portfolios to lose value. Of the 752 portfolios analysed, the process of sizing positions generated a drag on performance of -11 basis points on average, meaning weighting decisions added marginally negative alpha.

Trading also contributed little to no performance overall. The alpha being added through buying decisions was shown to be offset by poor selling, leaving the balance close to zero.

In total, the average annualised alpha of portfolios analysed – including outperforming and underperforming portfolios – was 308 basis points.

Commenting, Inalytics CEO and founder, Rick Di Mascio, said: “Our analysis shows that the research process, stock picking, is by far the single most important source of alpha that active managers generate. That strongly implies that asset owners conducting due diligence on asset managers should focus primarily on understanding the research process – how stock ideas are generated, how they are investigated, and how they make their way into a portfolio – rather than on other disciplines like portfolio construction and trading.

“The analysis and screening of managers has evolved significantly in recent times and we are now at a tipping point. Asset owners are increasingly turning to data science to inform the due diligence process and this research empirically demonstrates exactly where they need to focus their attention to find managers able to consistently add significant alpha to portfolios.”

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