Hard work pays off
I have mentioned before that one of my mentors once told me that “success in your job is 10% education, 20% hard work, and 70% luck. But without the education, your hard work will be useless, and without the education and the hard work, you will never get lucky.” It seems that hard work does indeed pay off, at least for fund managers.
Boone Bowles and Richard Evans tried to measure the effort mutual fund managers exert in running their portfolios. This is easier said than done because how do you measure effort for a fund manager? You can’t just hire a hundred lab assistants and send them to fund management companies to shadow fund managers over a couple of months and measure the outcome.
They settled on an approach that I think is probably quite flawed, but at least better than nothing. But because of its flaws, I suggest we all take the results with a grain of salt. What they did was analyse the time and origin of requests in the EDGAR database of the SEC. the EDGAR database is a public database of regulatory filings for all companies in the US.
The idea is that by measuring which IP address has accessed these files on what day and at what time, one is able to measure which computer was active and doing ‘work’. By matching the IP addresses with mutual fund firms and even fund families, one can measure which fund management team is doing this work and match effort exerted to a specific group of mutual funds. Based on this data, one can then use the share of work done on the weekend as a simple measure of extra effort.
This short description already tells you why we should take the results of the study only as a first step towards measuring effort. First, just because a fund manager or a member of her team downloads company filings doesn’t mean that they work on these filings or perform an analysis on them. It could simply be a record-keeping exercise. Similarly, I don’t really know why working on the weekend counts as a measure of effort. People could just be unproductive and thus forced to catch up on the weekend to get the same stuff done that other people do during the week. Plus, effort doesn’t start on the weekend. Working late nights is just as much a sign of effort as working on the weekend.
Clearly, then, their measure of effort is only a rough approximation of true effort. But it is better than nothing which is why it is worth reflecting on the results. Their key results are:
Fund families where the members of the team are working harder on average have better performance.
Effort increases after a period of poor performance or fund outflows.
Fund families where the team works harder tend to have lower turnover in their portfolios, a higher active share, and more concentrated portfolios, all metrics that correlate with better performance.
Finally, and most importantly, after a period of more intense effort by the fund management team, performance tends to improve.
Most fund managers are well educated, but to put that education into practice, they need to work hard. And this research indicates that this hard work pays off. It leads to higher conviction investments resulting in more concentrated portfolios and a longer time invested in the same stocks. And that, on average leads to better performance.
I stress the term ‘on average’ in the last sentence because as I said in the beginning, 70% of the success or failure of a fund manager is luck (in the case of financial markets professionals, I am inclined to think that it is even more than that). But if you put in the hard work, the chances of avoiding mistakes and picking stocks that ‘get lucky’ increases.
The study also points to a behavioural cycle that I can attest to having observed in myself as well. When the performance deteriorates the pressure increases and we tend to put more effort into our work to improve performance. But when performance improves, we unconsciously start to ease off. We put a little bit less effort into our work, we check the details a little bit less carefully and we work a little bit less on the weekend (on average about 10% of work by fund managers happens on the weekend according to this study). And while we may get away with taking it easy for a while, mistakes will inevitably happen, and performance deteriorates again. And so, the cycle begins again.
As I said, the methodology is not above suspicion and academics should put in more effort to poke holes in the study (which the authors, much to their credit, actively invite). But the results seem plausible to me, and I can confirm that my efforts follow much the same pattern as described above.