The yield of a financial portfolio can be influenced not only by the performance of individual securities or financial instruments that comprise it, even the style of management adopted by the manager or professional investor do-it-yourself: it is possible to distinguish between management active and passive management.
The scientific evidence shows that in the short and medium term the activity of a specialized operator can, by varying the asset allocation and repeatedly picking and market timing stock, bring added value to the management, influencing the performance; on the contrary, it is evident that, in part because of frequent behavioral bias, the performance of a portfolio managed independently by the individual investor may suffer a little shrewd management and inconstant over time.
The active management
The construction and professional management of a portfolio of financial
Active management is an investment strategy in which the manager takes a variety of investment decisions over time, aiming to obtain a performance superior to that of a benchmark index, called benchmark.
The concept behind this strategy is as follows: the manager exposes the portfolio to a higher risk than the benchmark; whether the increased risk generates a higher return, the strategy is successful.
But how often this strategy is successful? This question is not possible to give a clear answer: it depends on the manager’s ability and the conditions of the markets in which it operates. However, it is possible to draw interesting conclusions with a historical analysis of the returns of active management, both by professional managers, both on the part of individual investors.
The main tools available to the manager to implement this strategy are:
– Asset allocation: change over time, the portfolio’s exposure to different markets in order to take advantage of – ideally – the positive trends in some of these, leaving those who show negative trends;
– Stock picking: select financial assets in order to create a portfolio in which activities are prevalent underestimated by the market (and therefore with a greater potential for growth) than overestimated;
– Market timing: increase or decrease the portfolio’s exposure to different markets based on forecasts of future price.
Investment decisions, however, are constrained by the fact that, by identifying a benchmark index, and the nature of delegation of the management contract, it implicitly identifies a risk / return profile from which the manager can not deviate too much.
Bring out clearly how this strategy is based:
– On the implicit assumption that financial markets are not efficient, or does not incorporate all available information into the price at any moment;
– The consequent belief that ability, experience, intuition and technologies can allow the operator to take decisions more effective in terms of yield.
The passive management
The construction of a portaglio investment as a replica of one or more market indices
The management is a passive investment strategy in which the manager of a portfolio (often, but not necessarily, a mutual fund, a pension fund or other collective body of savings) minimizes their portfolio decisions in order to minimize transaction costs and the taxation of capital gains.
In this strategy, it is common to resort to the method to replicate the performance of a market index (said benchmark) or of a composition of market indices. This approach is more common in the management of equity portfolios, through the creation of so-called index funds that replicate the performance of an equity index.
The concept of passive management is based on two fundamental elements of the theory of finance:
– The efficient market hypothesis, according to which the market price reflects fully and perfectly balance the information available and, therefore, according to the most common interpretation, it is impossible to “beat the market”, ie to achieve a better performance that of the market as a whole;
-the problem agent / principal, that arises from information asymmetry and the skills gap, which allows the investor (principal) adequately monitor the activities of the operator to which it entrusts its assets (agent).
A portfolio that replicates the performance of an index is achieved by acquiring financial assets in the same proportion as the index chosen. This poses a major constraint to the effectiveness of this strategy: given that the financial assets are not infinitely divisible, to replicate the composition of the index is necessary to have a heritage very high, so that the different granularity of financial assets requiring a replica not perfect portfolio, generating a deviation from the performance of the index in question.
One of the main advantages of passive management is linked to fewer sales and purchases of financial assets carried out by the operator per unit time. This reduces transaction costs and, in the case of mutual funds, pension funds and other collective savings, minimizes the fees charged to subscribers. In consequence, for the same yield of the management, the minor commissions allows to have a higher net performance.
A second advantage is related to the fact that the lower frequency of trades permits, in some cases, and in some tax systems, to defer the taxation of capital gains, which are recognized when the financial assets are sold, the difference between the purchase price and sale price.
The yield of active management of professional managers
The empirical evidence about the performance offered by professional asset management
When choosing between active management and passive management of the portfolio, the empirical data is crucial for performance evaluation and comparison. But the data – or, rather, their interpretation – at least fifteen years has sparked a debate involving academics, finance professionals and specialized press.
Two studies, conducted by Brinson, Hood and Beebower seem to show that the two fundamental elements of active portfolio management, the selection of financial assets and market timing, have a limited influence on the performance of management. Most of it, in fact, would be attributable to the choice of fund portfolio diversification among different asset classes: the so-called asset allocation.
On the other hand, we should not delude ourselves that it is possible to determine rationally and correctly the asset allocation of a portfolio and allow the selection of individual securities and the time of each transaction is assigned to the case, or anyone.
In general terms, the activities of the operator affects the performance in the short and medium term: the long and very long term, the quality of active management seems to have less impact on performance, which tends to dominate the influence of the major strategic decisions of diversification.
This consideration seems to be confirmed by a study conducted by SEI Investments, a major American financial company, the data relating to the performance of mutual funds Americans throughout the course of the 90s. This research shows that the best managers are not the same in different periods: only slightly more than half of the managers ranked in the first quartile in the period 1994-1996 (ie those who have obtained a performance that placed them in the first quarter of the list) were among the best in the next period (1997-1999). Similarly, just under half of the worst managers (fourth quartile) during the period 1994-1996 has been placed in the top positions of the ranking in the subsequent period.
On the other hand, these data and these studies have been challenged from many quarters and the current state of the debate, you cannot take an unequivocal position in favor or against active management, in terms of quality of performance generated.
The yield of active management of retail investors
The empirical evidence with respect to the performance achieved by the management realized by individual investors
Until the mid-nineties very little was known as to the performance of active management on the part of retail investors, contrary to what happened to the mutual funds, one of the compartments most studied throughout the empirical finance.
Many results have, however, been developed in recent years, especially with the ability to use large databases of operations undertaken by thousands of individuals. The databases have been made available by some discount broker Americans.
Barber and Odean are the most active researchers in the analysis of these databases. They try to interpret the investment operations carried out by individuals in the light of behavioral bias identified by the analysis of behavioral finance, with particular reference to the tendency of individuals to be too confident in themselves. In some analyzes, Barber and Odean analyzed the relationship between the amount of turnover (e.g. the frequency of purchases and sales of equity securities in a certain period of time) and the return achieved by the investor. They find that the returns before transaction costs are independent of the turnover, but that the returns net of transaction costs have a strong inverse relationship with turnover. One possible interpretation is that individuals in the sample (more than 66 thousand people) do not have a special ability to selection of securities and therefore do not tend to earn more by doing a lot of transactions. In contrast, the increase in transaction costs associated with the greatest turnover is not compensated by higher average returns, leaving an inverse relationship between transactions and returns. In other analyzes Barber and Odean found that the securities that are typically sold by individuals have a future change in prices (for a period up to two years after the operation) broader securities that are purchased: over a two-year differential in yield between the securities sold and securities purchased is slightly higher than 3.5%. In addition, studies reveal the tendency of investors to hold securities at a loss too long, almost as if the continued availability of the portfolio represented the refusal to recognize the error made when purchasing a security whose price is then dropped.
Also in the field of social security wealth accumulation are found some worrying trends. Benartzi example shows that about a third of contributions to occupational pension schemes in the United States are invested in securities of the same company at which you work, a behavior that is contrary to basic principles of portfolio diversification. There is also a strong trend on the part of individuals to follow the directions of the company that provides the pension plan, both as regards the annual amount of contribution both as regards the investment in various classes of financial assets.
The behavior of Italian investors
The result of the analysis on the financial behavior of Italian investors
Until a few years ago, little was known about the behavior of individual investors, but by the mid-nineties were carried out various analyzes on the behavior of small investors Americans, especially thanks to scholars such as Barber and Odean, who were able to use a dataset granted by a discount broker on the choices made by individual customers.
In the case of Italy, various evidences have been made since the late nineties thanks to various studies, among which we can remember those contained in the Annual Report on saving the Einaudi Center and BNL.
The results are consistent in indicating the existence of irrational behavior by investors (individual, not institutional). In the case of the United States for example, has shown that investors:
– Hold too long the securities at a loss, probably being reluctant to admit the mistakes made in the choice and ignoring the characteristics of the securities to study the future prospects of prices;
– Making too many changes to the portfolio: it is possible to identify a large differential between the yield earned on who handles both the portfolio and that of those little handles the portfolio in favor of the latter;
– Systematically favor stocks that have lackluster performance in the future at the expense of the securities instead are likely to rise;
– Are affected by the channel negotiation (bargaining move from “traditional” to the Internet is increasing the frequency of the transactions);
– In the case of selection of mutual funds, investors are highly (negatively) affected by the presence of entry fees but relatively insensitive to the level of management fees. They also tend to buy and sell mutual funds that have achieved positive returns in the past, holding too long in the portfolio of mutual funds that have received negative returns;
– Insufficiently diversified portfolio from the international point of view, even prefer securities issued by companies located near the place of residence.
Even in Italy, investors seem to be plagued by similar problems of irrationality. For example, holders of Italian equity securities often hold a portfolio consisting of very few titles; but above reveals several problems related to the lack of information and lack of knowledge of financial markets. An analysis performed relatively known in the Report of the Einaudi Center and BNL for example, shows that Italians are informed on financial matters very little. Out of 100 Italian respondents, 66 do not know how much time each week devoted to financial information, and half of the remaining 33 well spend less than half an hour a week to this issue.