Happy New Year, and happy birthday if you were born in January. For that 8% of the population, however, there is also bad news: You’re probably not a top portfolio manager.
But don’t worry too much: You’re likely to be a better investor than anyone born in February and you will always be able to look down on the unfortunate summer babies.
Such is a very rough interpretation of a new study by the University of Alabama’s Kevin Mullally, Boston College’s David Solomon and Northeastern University’s John Bai and Linlin Ma.
They categorized more than 4,000 US equity fund managers by their birth month, focusing on their relative age in their school year. A child born in October will therefore be ‘older’ than one born in March.
The researchers found that funds run by managers who were in the top quartile by relative age – those born in the first three months of the school year – outperformed those in the lowest quartile by 0.48% per year on a four-factor alpha basis.
The kids aren’t alright
The authors linked this trend to the greater confidence fostered by being among the oldest in a school cohort. They also identified other ways in which these relatively older managers ran portfolios more boldly than their younger peers.
For example, relatively older managers deviated more from their benchmarks, had a higher active share, and typically had more concentrated holdings.
‘Taken together, these results point to a novel conclusion: in contrast to the large literature on managerial overconfidence, greater confidence among fund managers is associated with superior performance,’ Bai, Ma, Mullally and Solomon noted.
‘If being insufficiently sure of one’s own abilities or overly pessimistic about the precision of one’s knowledge leads a manager to herd or be a closet indexer, this will be detrimental to the fund’s performance. Broadly, the problem is not confidence per se, but confidence relative to how much one actually knows.’
If that seems to be a very qualitative approach to fund selection – somehow picking confident portfolio managers, perhaps by using their birth month as a proxy – another recent paper offers a more quantitative method.
Irina Bezhentseva Mateus and Cesario Mateus, both of the University of Greenwich, and Natasa Todorovic of Cass Business School observed that ranking managers neither by their benchmark-adjusted alpha nor by their peer group-adjusted alpha held much predictive value. However, using both models at the same time highlighted managers who went on to post statistically significantly superior Sharpe ratios over the course of the next 12 months.
Looking at almost 1,000 US equity funds between January 1992 and December 2015, they created 23 rolling windows of 36 months each and calculated the funds’ alpha relative to both their benchmarks and their peer groups. These benchmarks were the S&P 500, the Russell 1000 Growth and Value indices and the Russell Mid Cap index, while the equivalent peer groups were US Large Cap Blend, Large Cap Growth, Large Cap Value and Mid Cap.
For none of these benchmarks or peer groups – except Mid Caps – did a single model of alpha yield a statistically significant difference in Sharpe ratio between the top- and bottom-quartile performers. Combining the benchmark and peer group alpha, however, flagged a statistically significant difference of 0.2 between the Sharpe ratios of the top and bottom quartiles for the large-cap segments and 0.44 for the mid caps.The actual one-year forward Sharpe ratios of funds in the top quartile by both alpha models were 0.98 for large-cap blend strategies, 0.94 for growth managers, 0.84 for mid caps and 0.81 for value funds.
‘We argue that the two approaches should be used hand-in-hand: If a fund outperforms the benchmark, it does not mean that it is superior to the peer group and vice versa,’ Bezhentseva Mateus, Mateus and Todorovic noted.
‘Hence, in this study, we illustrate that a US investor picking mutual funds with the highest benchmark-adjusted and peer group-adjusted alphas simultaneously will be better off than those investors basing their fund selection on just one of these two approaches.’