Do Financial Experts Make Better Investment Decisions?

Do Financial Experts Make Better Investment Decisions?

November 12, 2014 Research Insights
Print Friendly
(Last Updated On: January 18, 2017)

Do Financial Experts Make Better Investment Decisions?

Abstract:

We provide direct evidence on the effect of financial expertise on investment outcomes by analyzing private portfolios of mutual fund managers. We find no evidence that financial experts make better investment decisions than peers: they do not outperform, do not diversify their risks better, and do not exhibit lower behavioral biases. Managers do much better in stocks for which they have an information advantage over other investors, i.e., stocks that are also held by their mutual funds. More experienced managers seem to be aware of the limitations to their investment skills as they increase their holdings of mutual fund-related stocks following poor performance of their portfolios. Our results suggest that there are limits to the value added by financial expertise.

Alpha Highlight:

Financial experts beat individual investors (with the same demographic profile) for the following reasons: investment expertise, financial sophistication, and experience.

Wrong.

This paper finds that “Financial experts are no better than their peers:”

They do not outperform!
They do not diversify better!
They do not exhibit lower behavioral biases!

The authors’ claims are based on investment decisions of two groups in Sweden:

  1. “Financial experts” group: paper chooses “mutual fund managers” as a group of “financial experts.”
  2. “Matched Individuals” group: the authors identify a control group of individual investors (peers) who are similar to mutual fund managers in terms of socio-economic characteristics, but do not possess known financial expertise.

The two groups are matched by wealth, labor and capital income, age, sex, family status, and educational achievement.

Key Findings:

The table below shows monthly returns of different groups by position. The difference in average monthly returns for managers and matched peers [(1)-(4)] is only 9 bp — statistically insignificant from zero.

To disentangle the effect of financial expertise from that of information advantage of mutual fund managers, the paper further split portfolios of managers into two sub-groups: MF-related positions–positions that are owned by they fund they manage–and non-MF positions.

Notice that the difference between managers and peers are even smaller when their positions are non-MF related [(3)-(4)], only 5 bp.

2014-10-31 13_06_06-Do Financial Experts Make Better Investment Decisions.pdf - Adobe Reader

 

Table 6 in the paper shows that experts are not better at diversifying their portfolios. Also, Sharpe ratios for managers are indistinguishable from Sharpe ratios for matched investors.

Table 7 in the paper indicates that experts suffer from disposition bias (sell winners, hold losers), just like the rest of us poor blokes.

Are you Smarter than Your Financial Expert? Maybe…


Note: This site provides NO information on our value investing ETFs or our momentum investing ETFs. Please refer to this site.


Join thousands of other readers and subscribe to our blog.


Please remember that past performance is not an indicator of future results. Please read our full disclosures. The views and opinions expressed herein are those of the author and do not necessarily reflect the views of Alpha Architect, its affiliates or its employees. This material has been provided to you solely for information and educational purposes and does not constitute an offer or solicitation of an offer or any advice or recommendation to purchase any securities or other financial instruments and may not be construed as such. The factual information set forth herein has been obtained or derived from sources believed by the author and Alpha Architect to be reliable but it is not necessarily all-inclusive and is not guaranteed as to its accuracy and is not to be regarded as a representation or warranty, express or implied, as to the information’s accuracy or completeness, nor should the attached information serve as the basis of any investment decision. No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission from Alpha Architect.


Definitions of common statistics used in our analysis are available here (towards the bottom)




About the Author

Wesley R. Gray, Ph.D.

After serving as a Captain in the United States Marine Corps, Dr. Gray earned a PhD, and worked as a finance professor at Drexel University. Dr. Gray’s interest in bridging the research gap between academia and industry led him to found Alpha Architect, an asset management that delivers affordable active exposures for tax-sensitive investors. Dr. Gray has published four books and a number of academic articles. Wes is a regular contributor to multiple industry outlets, to include the following: Wall Street Journal, Forbes, ETF.com, and the CFA Institute. Dr. Gray earned an MBA and a PhD in finance from the University of Chicago and graduated magna cum laude with a BS from The Wharton School of the University of Pennsylvania.


  • Michael Milburn

    Wes, I wanted to pass this link along. There might be something interesting to think about here when thinking about market behavior, concensus, contrarianism, and bubbles / booms/ and busts.

    Why Hipsters all look alike
    http://www.washingtonpost.com/news/storyline/wp/2014/11/11/the-mathematician-who-proved-why-hipsters-all-look-alike/?hpid=z5

  • IlyaKipnis

    Yet here I am afraid to recommend almost anything on my blog to any retail investor, when mutual funds fail them left and right! How do so many of these people stay in business when their performance leaves so much to be desired? Just about every academic consensus I’ve gotten a whiff of has stated that mutual fund managers can’t generate alpha, yet some of them charge their fees anyway. What ever for?

  • fascinating!