Institutional Money Management: An Inside Look at Strategies, Players, and Practices, edited by David M. Smith and Hany A. Shawky (Wiley, 2012) is the most recent addition to the Kolb Series in Finance. As is the custom with books in this series, it includes contributions by both academics and practitioners and is designed for professionals in the field as well as those aspiring to enter the field. It is a well-edited volume that anyone with a modicum of market experience should have no difficulty reading.
The book has four main themes that are explored in 22 chapters: market regulation, performance evaluation, and reporting; key individuals to the investment process; major investment approaches; and types of institutional investors.
In this post, rather than attempting an overview, I’m going to zero in on a single point that I think is potentially important for the individual investor.
The editors, in their chapter “Investment Buy and Sell Decision Making,” analyze data from Informa’s plan sponsor network (PSN) database, which is updated quarterly through surveys of money managers. They examine 5,410 equity portfolios and 1,494 fixed income portfolios from 1979 to the November 2009 release.
What criteria, they ask, do portfolio managers use when buying equities? About 60% reported using a bottom-up method. The next most popular criteria were quantitative/research (14%), fundamental analysis (11%), computer screening/models (4%), and top-down/economic analysis (4%). Only 20 portfolios of the 5,410 relied on technical analysis although, as the authors note, “the criteria most closely related to technical analysis—quantitative analysis, computer screening, and momentum—also enjoy widespread usage by portfolio managers.” (p. 125)
As we know, the more important question is usually when to sell. The PSN database recognizes six sell-discipline criteria: down from cost, up from cost, target price, valuation level, fundamental deterioration overview, and opportunity cost. The most popular among managers was fundamental, followed by valuation level; target price came in third.
The authors analyze returns by equity class (and the overall average) for each of these sell-discipline criteria. The best-performing criterion was down from cost, followed by target price. The worst performance, by a large measure, was logged by those who used no sell-discipline criterion. Here are the overall average numbers for the arithmetic average benchmark-adjusted returns (percent annualized): fundamental 2.17%, valuation level 2.00%, target price 2.47%, opportunity cost 1.76%, down from cost 2.59%, and none 1.22%.
There’s a lesson here.