Our latest case study (access the full version here) features the management team of a concentrated, low turnover equity fund ($1bn AUM) that was able to unlock over 4% of incremental alpha per year by using Essentia’s behavioral analysis, tailored nudges and expert coaching.

The case study provides another example of the growing role played by behavioral analytics in active management (a trend increasingly of interest to asset allocators), and illustrates how even those portfolios with longer holding periods and less trade data can now benefit from the rich analysis that characterizes it.

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Case study highlights

Drilling down – What did Essentia discover?

Essentia was asked by the fund’s two managers to provide a comprehensive analysis of their strengths and weaknesses. Their motivation was twofold: to make use of the new generation of behavioral data analytics tools now available; and to establish continuous improvement as an integral part of their investment process.

Despite starting with less than the 2,000 trade data points usually required to draw statistically significant conclusions, the Essentia Insight platform revealed two important areas where alpha was being lost by the managers to weaker decision-making patterns:

While successful with their larger holdings, the PMs were found to be consistently destroying value with smaller, lower-conviction positions (impacting fund performance by -270bps in 2017 alone).

In addition – and like many long-term, low turnover managers – the PMs were holding onto positions well beyond the point at which they were generating incremental alpha. This behavioral tendency, reflected in poor exit timing and scaling out, was explored in our research paper The Alpha Lifecycle, and is a manifestation of loss aversion and the endowment effect.

Behavioral Alpha Frontier

The case study fund’s Behavioral Alpha Frontier (a report available to Essentia Insight users) showed the alpha drag on fund performance caused by exit timing, when compared to other key decision types.

Building a data-driven feedback loop

Armed with this data and aided by the expertise of their Essentia Insight Partner, the fund’s portfolio managers set about implementing a data-driven plan to improve performance and mitigate alpha loss.

Essentia Insight Partners are former portfolio managers who work one-to-one with clients as specialist coaches that can interpret and adapt Essentia’s proprietary analytics to each manager’s investment process. They also configure the behavioral nudges that are a key part of the Essentia Insight offering.

Tailored to each portfolio manager’s needs, our automated, intelligent nudges can be used both to capture valuable context about a PM’s decision-making, and act as an alert when an adverse behavioral pattern or significant decision point is emerging.

In this case study, you’ll learn how the PMs integrated a number of behavioral nudges into their day-to-day investment process. This included Essentia’s Alpha Decay Nudge (which provides an automated heads-up of each position that has passed what has historically been that manager’s “peak alpha” point) and the Vulnerable Position Nudge (based on a complex set of backtests, this nudge notifies the PMs of positions in the portfolio that have exhibited sustained underperformance such that, historically, now would have been the time to act).

Smarter behavior – Stronger performance

By integrating Essentia’s insights and making a series of adjustments and improvements to their decision-making process, the fund featured in this case study was able to generate 400bps of additional alpha through more deliberate decision-making around small positions, and 600bps per annum of additional alpha at the overall portfolio level.

Driving this improvement was a drastic reduction in the time they took to exit a stock once they had decided to do so (from as long as 70 days in 2016, to less than a week today), in addition to a more deliberate rotation out of smaller, lower conviction positions.

See the full case study for performance and skill improvement detail

Essentia report showing scaling out duration over time

Using Essentia’s data and nudge functionality, the fund’s managers significantly reduced the time they take to scale out of a position.

Commenting on the case study, Clare Flynn Levy, Essentia founder and CEO, said: “Whatever the market is doing, all equity portfolio managers now have the opportunity to achieve sustainable performance gains simply by looking inward and using data to understand and reflect on where their true skills lie. This case study shows that doesn’t only apply to high turnover managers; seen through the right lens, even concentrated, low turnover managers can glean insights and employ nudges that make a significant difference to performance.”