Thursday, June 23, 2016

Are specialist firms special? Evidence says no

I just finished writing about strategy distinctiveness and hedge fund performance, (see Hedge Fund Strategy Distinctiveness Matters), which stated that there were gains from being different from the crowd when a new research piece on specialist firms crossed my desk. Specialists are investors who concentrate their portfolio bets. These are supposed to be the smart investors. I thought this would just reinforce the idea that those who have specialized knowledge will have more concentrated portfolios which will do better than the diversified funds. 

Unfortunately, the results of this new analysis are not what I was expecting. The author, Daniel Fricke, of "Are Specialists "Special"? The Case of Institutional Investors" draws two conclusions from his analysis. First, there is a significant amount of overall with portfolios even by those who are specialists. Everyone concentrates on the same stocks. Second, the specialists who concentrate their portfolios do no better than those who are diversifiers. The hypotheses that those who have information advantage or skill will have more unique portfolios and generate extra returns is rejected. This is with a more general dataset and may not fully take advantage of the dynamic nature of trading, but it suggests that skill is hard to find. 

There are investors who think they are smart and unique but end up at the same place as diversifiers. The investment theme of having a few eggs in your basket and watching them carefully does not seem to apply.

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