What Characteristics Indicate Skill in Equity Management

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What Characteristics Indicate Skill in Equity Management

The most important question facing the active investment management community as a whole is whether skill exists and whether it can be identified. Much research has shown that skill at selecting assets that can be expected to outperform the market is not easily identified.1 Nonetheless, active managers are regularly selected. There is a well-established procedure whereby equity managers are judged on the three Ps: People, Philosophy, and Process. Yet it is unclear how a third party can make the link between these three Ps and a fourth P, Performance. The link suggested in this paper is analyzing the decisions. The explicit decisions are buy and sell decisions. The paper consists of an overview of current methods of identifying skill, followed by an outline of a novel approach to identifying skill by detailed analysis of buying and selling decisions. This paper asserts that skill does exist, although it is rare. However, identifying skill requires the analyst to encompass an extension to the current attribution orthodoxy and analyze the gains and losses arising from the decisions enacted by the portfolio manager.