Alpha Cloning – Following 13F Fillings

Portfolio managers can’t pick stocks – this is a common saying in the popular press and between proponents of index investments. But research shows it is not such an evident truth. Mutual/hedge fund managers, in reality, can pick stocks but are often too diversified and their “best picks” therefore cannot deliver such a spectacular performance as the fund’s performance is dragged down by the rest of the portfolio.

The 13F Fillings Following system is based on the assumption that stocks in which mutual fund managers (and hedge fund managers) are mostly concentrated (their best ideas) are stocks that will outperform the broad equity index. SEC 13F fillings could be used to track top holdings positions in mutual funds.

Fundamental reason

Mutual fund managers must have highly diversified investment portfolios as current investment doctrine doesn’t recommend highly concentrated portfolios, and most investment managers have fear to divert significantly from the relevant benchmark.

But stocks which are managers’ “best ideas” (high-conviction positions) are often over-weighted in their portfolios. These are also usually stocks which are most understood by those managers. It is therefore fundamentally feasible to track those “best ideas”.

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Markets Traded
equities

Financial instruments
stocks

Confidence in anomaly's validity
Strong

Backtest period from source paper
1991-2005

Notes to Confidence in Anomaly's Validity

Indicative Performance
20.21%

Period of Rebalancing
Quarterly

Notes to Indicative Performance

per annum, 1.26% monthly alpha (geometrically annualized) over 4% risk free rate (estimated risk free rate), performance from table 2


Notes to Period of Rebalancing

Estimated Volatility

Number of Traded Instruments
100

Notes to Estimated Volatility

Notes to Number of Traded Instruments

it depends on investor’s need for diversification (10-100)


Maximum Drawdown

Complexity Evaluation
Moderately complex strategy

Notes to Maximum drawdown

Notes to Complexity Evaluation

Sharpe Ratio

Simple trading strategy

Create a universe of active mutual fund managers. Use 13F filings to identify the “best idea” stocks for each manager. Invest in the stocks which are the “best ideas” for most of the managers.

Hedge for stocks during bear markets

No - Selected strategy is designed as a long-only therefore it can’t be used as a hedge against market drops as a lot of strategy’s performance comes from equity market premium (as investor holds equities therefore his correlation to broad equity market is very very high).

Source paper
Cohen, Folk, Silli: Best Ideas
- Abstract

We examine the performance of stocks that represent managers’ “Best Ideas.” We find that the stock that active managers display the most conviction towards ex-ante, outperforms the market, as well as the other stocks in those managers’ portfolios, by approximately 1.6 to 2.1 percent per quarter depending on the benchmark employed. The results for managers’ other high-conviction investments (e.g. top five stocks) are also strong. The other stocks managers hold do not exhibit significant outperformance. This leads us to two conclusions. First, the U.S. stock market does not appear to be efficiently priced by our risk models, since even the typical active mutual fund manager is able to identify stocks that outperform by economically and statistically large amounts. Second, consistent with the view of Berk and Green (2004), the organization of the money management industry appears to make it optimal for managers to introduce stocks into their portfolio that are not outperformers. We argue that investors would benefit if managers held more concentrated portfolios.

Other papers
Myers, Poterba, Shackeford, Shoven: Copycat Funds: Information Disclosure Regulation and the Returns to Active Management in the Mutual Fund Industry
- Abstract

Mutual funds must disclose their portfolio holdings to investors semiannually. The costs and benefits of such disclosures are a long-standing subject of debate. For actively managed funds, one cost of disclosure is a potential reduction in the private benefits from research on asset values. Disclosure provides public access to information on the assets that the fund manager views as undervalued. This paper tries to quantify this potential cost of disclosure by testing whether “copycat” mutual funds, funds that purchase the same assets as actively-managed funds as soon as those asset holdings are disclosed, can earn returns that are similar to those of the actively-managed funds. Copycat funds do not incur the research expenses associated with the actively-managed funds that they are mimicking, but they miss the opportunity to invest in assets that managers identify as positive return opportunities between disclosure dates. Our results for a limited sample of high expense funds in the 1990s suggest that while returns before expenses are significantly higher for the underlying actively managed funds relative to the copycat funds, after expenses copycat funds earn statistically indistinguishable, and possibly higher, returns than the underlying actively managed funds. These findings contribute to the policy debate on the optimal level and frequency of fund disclosure.

Wermers: Is Money Really ‘Smart’? New Evidence on the Relation Between Mutual Fund Flows, Manager Behavior, and Performance Persistence
- Abstract

Mutual fund returns strongly persist over multi-year periods – that is the central finding of this paper. Further, consumer and fund manager behavior both play a large role in explaining these long-term continuation patterns – consumers invest heavily in last-year’s winning funds, and managers of these winners invest these inflows in momentum stocks to continue to outperform other funds for at least two years following the ranking year. By contrast, managers of losing funds appear reluctant to sell their losing stocks to finance the purchase of new momentum stocks, perhaps due to a disposition effect. Thus, momentum continues to separate winning from losing managers for a much longer period than indicated by prior studies. Even more surprising is that persistence in winning fund returns is not entirely explained by momentum – we find strong evidence that flow-related buying, especially among growth-oriented funds, pushes up stock prices. Specifically, stocks that winning funds purchase in response to persistent flows have returns that beat their size, book-to-market, and momentum benchmarks by two to three percent per year over a four-year period. Cross-sectional regressions indicate that these abnormal returns are strongly related to fund inflows, but not to the past performance of the funds – thus, casting some doubt on prior findings of persistent manager talent in picking stocks. Finally, at the style-adjusted net returns level, we find no persistence, consistent with the results of prior studies. On balance, we confirm that money is smart in chasing winning managers, but that a “copycat” strategy of mimicking winning fund stock trades to take advantage of flow-related returns appears to be the smartest strategy.

Verbeek, Wang: Better than the Original? The Relative Success of Copycat Funds
- Abstract

We construct hypothetical copycat funds to investigate the performance of free-riding strategies that duplicate the disclosed asset holdings of actively managed mutual funds. On average, copycat funds are able to marginally outperform their target mutual funds, but their relative success has increased after 2004, when SEC regulation imposed all mutual funds to quarterly disclose their holdings. We find a substantial cross-sectional dispersion in the relative performance of copycat funds. Free-riding on the portfolios disclosed by past winning funds and the funds that disclose representative holdings generates significantly better performance net of trading costs and expenses than the vast majority of mutual funds. The results indicate that free-riding on disclosed fund holdings is an attractive strategy and suggest that mutual funds can suffer from information disclosure requirements.

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