The Active Manager Paradox High-Conviction Overweight Positions

A 2019 article written by Alexey Panchekha, CFA called The Active Manager Paradox: High-Conviction Overweight Positions analyzes the performance of a funds' highest conviction positions as measured by position size over the benchmark. Each position was measured net of benchmark weight and the top 80% of positions above the benchmark were bucketed into High Conviction Overweights. The opposite group was the Underweights and everything else was the Neutrals. The Overweights outperformed the benchmark by 2.8% over the past five years.

The author explains the conclusions below:
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According to our research, the average manager sabotaged their returns by shrinking the High-Conviction Overweight stocks to an overall portfolio weight of 55%. The corresponding portfolio allocation to Underweights and Neutral Weights thus acts as a “Beta Anchor” that severely dilutes the alpha generated by High-Conviction Overweight positions.

While it is industry convention to blame these outcomes on higher fees, our research suggests that fees are only a secondary contributor. Diluting the sole source of stock selection alpha to a minority component of a portfolio has far greater structural impact than higher fees.

Assuming overweight position sizing relative to a benchmark is indicative of conviction level, then this research is a compelling example of the talent inherent in active managers and the alpha that is destroyed by a lack of concentration.

This article is one of a long series of “Empirical Proofs” of active manager skill that we’ve been collecting. To see the full list, download a full version of the Concentration Manifesto.

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