It seeks to identify the conditions in which a fund manager makes his/her best and worst decisions, enabling fund management companies to create the most productive environment.
This system – Essentia Analytics – has been devised by former hedge fund manager Clare Flynn Levy. It enables fund managers to enter information about their mood – angry, miserable, bullish – or physical condition – tired, flu-ridden, plus the time of day and environment in which the trade was made. They can then judge the success or otherwise of those trades and draw conclusions on the type of conditions that lead to the best decisions.
If the system is a success, it could bring additional predictability to fund manager selection. This could be a powerful tool in the hands of advisers, who could invest where they saw the circumstances were ripe for managers to make the best decisions and sell out when they saw circumstances change.
Boost for active managers?
It could also improve the whole active fund management industry, and improve its competitiveness versus passive funds. If fund management groups could create a better environment for their fund managers to perform, it may improve the active industry overall.
Man Group and one other major fund manager has signed up to use the site, lending it some significant credibility. It plays into a long-running desire among multi-managers to find the right circumstances for top performance.
For example, some, such as the team at F&C Investments, believe the boutique structure, where fund managers have a significant stake in the business, and an environment free of bureaucratic constraints, tends to create the right incentives for fund managers to perform well. John Chatfeild-Roberts, head of the fund of funds team at Jupiter, has also been honest about the extent to which he examines a fund manager’s circumstances when investing.
However, there are clearly limitations to the system. It appears to rely on a fund manager honestly recording his or her emotions at the time of making a trade. This is, at best, subjective, and relies on a self-awareness that not all fund managers will possess. It also relies on a clear definition of what constitutes a ‘good decision’. It cannot simply be that a stock goes up – it must be over a certain time frame, and factor in market movements. It must truly be a decision that added ‘alpha’.
Whistle while you work
Also, for some time it has been clear the kind of circumstances in which a fund manager performs. Most companies are aware a boutique structure works well, with short reporting lines and light-touch management, but many still do not implement it. This may be because of the demands of shareholders or a dominant boss, but it may be too soon to call a broader improvement in the active management industry.
There is a danger that the system throws up a set of circumstances in which fund managers do well and fund management groups neglect firstly, that people are different, and secondly, that it cannot control all parts of a fund managers’ decision-making.
So if the research declares those managers who work from their sheds do well, should all managers retire to their sheds, when some prefer an office environment? It would undoubtedly be useful for identifying trends, but if – as Richard Buxton, head of equities at Old Mutual Asset Management recently suggested – fund management is prone to attract “loners, weirdos and fruitcakes”, and some of them are the great managers, it may bring investors no closer to understanding what truly makes a manager succeed.
A good understanding of human nature is undoubtedly vital to successful fund management: It is, after all, what drives markets. If the new system can impose some science on human behaviour, then it will have some purpose for investors.
However, it is unlikely to be revolutionary for the industry as a whole: it has long been clear the type of circumstances that fund managers favour and yet fund management groups have still fought shy of implementing them. Greater nuance to the understanding of good decision-making is unlikely to change that.