A recent US study confirmed the finding that high school grades are the most accurate predictor of student success in the first year of college. This is immediately intuitive. In a similar way, the past performance of investment managers is often imagined to be a useful predictor of future returns. In our industry, intuition does not correspond with reality as a good period of performance is just as likely to be followed by a poor one. This would not be such a problem were it not for the fact that even some of the smartest investors tend to disregard the evidence and their own bitter experience, and treat track records as shorthand for skill. “If they had outperformed then they must be skilful, and vice versa”.

But given that reality is not that simple and track records have proven to be an unreliable predictor of future performance, is it any wonder that even sophisticated pension funds are left questioning if skill exists at all and, if it does, do they have the tools to find it? The extensive evidence from Inalytics’ database of managers shows that skill does in fact exist. This implies that it is the traditional methods used to find it that are failing the industry.

Accepting that managers have skill, but it is the tools used to find it that have let us down, requires a radical change in the way we go about evaluating managers. By turning away from track records, and towards an evidence based approach that analyzes every decision a manager takes to identify their real strengths and weaknesses, we have found the framework we are seeking. This methodology involves putting every investment decision under the microscope to obtain a clear picture of a manager’s DNA. In practice this means analyzing every purchase and sell, and every decision to include or exclude a stock from the portfolio on a daily basis, so as to evaluate how well they construct portfolios and time trades.

Identifying skill comes down to whether:

• Overweight positions in the portfolio perform well;