Here’s how to do it.
By Clare Flynn Levy
Clare Flynn Levy is CEO & Founder of Essentia Analytics. Prior to setting up Essentia, she spent ten years as a fund manager, in both active equity (running over $1B of pension funds for Deutsche Asset Management), and hedge (as founder and CIO of Avocet Capital Management, a specialist tech fund manager).
Like baseball in the 2011 film Moneyball, decision attribution analysis is changing the game for professional investors. Using the Behavioral Alpha Benchmark, allocators and fund buyers now have an evidence-based way to factor decision-making skill into their public equity manager research; while portfolio managers can now clearly identify their own decision-making strengths and weaknesses, enabling much richer, more substantive conversations with investors.
Importantly, the financial reason to pursue better decision-making, while always intuitively clear, is now substantiated with data: the latest research finds that managers who have made good decisions over the past year are 1.5 times as likely to outperform their benchmark over the next year than those who have not. It’s in everybody’s interest to keep an eye on decision-making skill.
While the value of skill-based assessment is obvious, actually doing it, if you’re a fund manager – or asking managers to do it, if you’re an allocator – can be met with instinctive heel-dragging. The same thing happened in Moneyball. And it’s understandable: this is a new approach that most industry practitioners did not grow up with, and a fear of the unknown is, after all, innate to us all. What if this new thing puts us in danger?
This is an excellent opportunity to recognize our primitive brain for what it is, and deliberately engage our prefrontal cortex: Decision attribution analysis, like every other major quantitative development in our industry’s history, ultimately lifts all boats. The biggest risk is to those who fail to embrace it at all.
With that in mind, here are five good reasons you should be discussing decision attribution analysis with your investment team:
- It’s your fiduciary duty. Whether you’re picking stocks or picking managers, you have a duty of care to your investors: an obligation to make decisions on their behalf with competence, diligence, and thoroughness. If you have the ability to see data-driven feedback on the quality of decision-making in your portfolio, and you decide not to, you’d best start preparing your defense.
- It’s either a marketing opportunity or a retention opportunity, if you’re an investment manager. We’re all aware it’s a buyer’s market for active equity management, and that’s not likely to change anytime soon. Yet nobody actually wants to fire a manager. A manager who is doing decision attribution analysis as a means to performance improvement has a narrative that buys them time, at the very least. And a manager who’s doing it as a matter of best practice has a narrative that inspires ongoing confidence. Either way, decision attribution analysis enables far richer conversations between managers and investors, leading to longer, deeper, more productive relationships.
- It costs nothing to get the conversation started. The Behavioral Alpha Benchmark app (shown below) is a simple way to compare the decision-making skill of active equity managers – and it’s free. Adding or nominating a portfolio is simple – and managers who are referred by allocators get the $6,000 annual participation fee waived for the first year, no strings attached. Managers control who can see their scores at any given time – and can upgrade for deeper analysis whenever they’re ready.
- The data is already out there. Model delivery and active ETFs are the only notable growth areas in the active public equity space these days – and both of these involve sharing daily holdings data. It’s no longer acceptable to refuse to submit data to a manager research platform with an industrial-grade information security infrastructure and manager-controlled permissions if it’s part of investors’ due diligence process – unless you don’t want the investment.
- The upside is real. Decision attribution analysis offers managers a level of visibility into their own behavioral patterns they’ve never had before – and a baseline against which to measure continuous improvement. For the motivated, that unlocks quantifiably better performance: Essentia clients who engage with nudges (part of our premium Insight Advantage service) generate 160bps more alpha per annum than those who don’t.
The relationship between active fund managers and their investors is changing, and it’s for the better. Managers are increasingly open to prioritizing decision attribution analysis – particularly when there’s no cost involved – and they’re increasingly comfortable with sharing their stats with manager research teams. Allocators and fund buyers, it’s your duty to ask.
