1/Few professional managers understand the power of portfolio construction, fewer still can quantify the impact on performance.
2/While students of markets are inundated with knowledge on investment selection, an understanding of portfolio construction is woefully inadequate.
3/To understand how impactful, we need new frameworks that differentiate between skill in construction versus selection.
4/The performance of any investment strategy can be summarized through three dimensions—consistency, magnitude, and conviction—which collectively quantify manager skill.
5/Consistency is how often a strategy generates wins—it’s a batting average—that measures the breadth of wins across a portfolio.
6/Magnitude describes the ratio of wins to losses—how much greater are wins, on average, than losses.
7/Consistency + Magnitude measure investment selection skill on the part of an investor.
8/The 3rd dimension, Conviction, is the X factor. It measures skill in weighting positions in-line with investment outcomes, i.e. overweighting winners and underweighting losers.
9/Among a sampling of large and small value funds, large managers appear to lack skill in portfolio construction, while top small managers appear to be more adept.
10/In my latest piece, I provide a framework which shines new light on manager skill across these dimensions. Feedback welcome!
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