2008 has been a disappointing year for many investors, putting fund managers under increasing pressure to justify their existence.  Adding fuel to the fire is new research into fund manager skill by Inalytics, which suggests that even the most successful managers only make correct investment calls in just over half of all decisions.

Inalytics examined 215 long-only portfolios with a combined market value of $152 billion, focusing on two measurements of manager skill.  The first of these, called the hit rate, was defined as the number of correct decisions as a percentage of the total.  The second measure, win-loss ratio, compared the alpha generated from good decisions to the alpha lost from poor decisions.

In the research Inalytics found the fund managers’ average hit rate – or ability to identify winners and losers – was 49.6 per cent.

This hit rate statistic is however only part of the story when assessing fund manager skill, and it should be remembered that such averages are not necessarily the most meaningful of statistics. 

Typically, managers compensate for a mediocre hit rate and offset losing investments by generating significant gains from winners.  Inalytics’ research bears out this trend with an average win-loss ratio of 102 per cent, meaning that the alpha derived from good decisions is 2 per cent more than that lost from poorer ones.

Inalytics’ research follows the launch of its Monthly Transparency Report in October.  The report, which was a response to recent market turmoil, is designed to give pension funds a better understanding of how their assets are being managed.

Rick Di Mascio, chief executive and founder of Inalytics, said: “Our research is a further step toward transparency within the fund management industry. The measurement of hit rates and win-loss ratios highlights how a manager generates alpha and whether the track record can be relied upon as a useful indicator of skill. It reinforces our attempt to steer investors' focus away from the track record towards an analysis of individual investment decisions."

"The real point is that track records may come and go but a manager's tendencies are more persistent. In general, managers are good at buying and going overweight but poor at selling and going underweight. Hit rates and win-loss ratios are a very effective way of identifying these tendencies," he said.

Inalytics is a specialist firm that assists pension funds with the selection and monitoring of equity managers.  The firm, which was launched in 1998, currently works with over 40 clients including large pension funds and asset managers.