Fund Manager returns negatively correlated with reliance on public information

Fund Manager Use of Public Information:
New Evidence on Managerial Skills

http://finance.sauder.ubc.ca/~mkacpe/Index/skilljf.pdf

Active managers - particularly hedge fund managers - are notoriously inconsistent. This fact is often held up as proof of efficient markets. The assumption: all managers eventually “revert to the mean”, “hot hands don’t last”, and “what goes up must come down.”

As a result, endless resources have been poured into the quest to find some way to predict manager performance other than to simply rely on historical returns. Naturally, such a finding could be lucrative for advisers - particularly those who benefit from the performance of other managers like, say, funds of hedge funds.

The latest attempt to do this has some intriguing possibilities. In a paper published in this month’s Journal of Finance, Marcin Kacperczyk of the University of British Columbia and Amit Seru of the University of Michigan propose a new metric called the “Reliance of Public Information” (RPI) to measure the extent to which a manager’s performance is correlated - not with the markets - but with “public information” (captured by consensus sell-side analyst recommendations).

[...]these academics conclude that manager returns are negatively correlated with their reliance on public information (their “RPI”). This makes intuitive sense to value investors (and raises fundamental questions about the value of sell-side research).[...]

They describe the construction of the RPI as a two-step process:

“In the first step, we find how much of the average percentage changes in a fund’s quarterly holdings can be attributed to changes in analysts’ recommendations…In the second step, we construct the measure of reliance on public information for fund m at time t…In simple terms, RPI equals the unadjusted r-squared of regression (…of percentage change in stock split-adjusted holdings…(against) a change in the recommendation of the consensus forecast…)”.

Their central conclusion:

“…we find that mutual funds with lower RPI, that is, those relying less on information in the public domain, tend to exhibit higher returns adjusted for commonly used risk/style factors such as market, size, value, and momentum.”