How Investors Can Screen for Top Hedge Funds
Using the Novus Alpha Platform, we'll screen for top hedge funds with our Excel API Add-In and Skill Set Database.
The Novus platform is a great tool for evaluating managers in your portfolio or on a diligence shortlist—use crowdedness and overlap to measure uniqueness, or track a managers’ adjustment to growing assets. You can also learn to decipher manager attribution and deep dive into category analysis. Yet these functions all require that allocators start with a specific fund in mind.
One of the most common requests—and one of the hardest parts of any allocator’s job—occurs just before all this analysis. In this article we’ll take a step back and start toward the beginning of the diligence process: manager screening.
(If you need a refresher on any statistics used in this article, or are reading about Novus-specific metrics for the first time, ask a Novus Analytics team member for any definition by using the hovering button in the lower right hand corner of this page.)
Public Ownership Disclosure
The data used in this article is sourced from our Public Ownership Research. Ownership data refers to positions disclosed by managers adhering to reporting regulations around the world. Using this data, it’s possible to tease out skill sets by stringing historical filings together and linking them to simulate portfolio returns. Doing this tells a rich story—not merely how much was made, but also how the manager achieved returns.
Skill Set Database
Novus keeps an extensive database of manager attributes based on public filings called the Skill Set Database (SSDB). This series represents funds that have comprised the Novus Hedge Fund Universe (HFU), about 700–950 funds in any given year, over the last thirteen years.
The SSDB houses most commonly-used metrics as well as many key stats. We ran a year-by-year analysis from January 2008 through June 2016 screening for the top ninety-fifth percentile of managers in Security Selection Alpha. Separately, we also screened for those funds in the ninety-fifth percentile of Position Sizing skill.
*All screening performed in this article excludes funds with under ten positions and under $100 million in reported market value based off public filings.
Security Selection Alpha – how much a manager returned above and beyond (or below) sector benchmarks appropriate to their sector exposure. This helps isolate performance above the market and negates the effects of being heavily exposed to a sector that just happened to go on a tear.
Position Sizing Skill – the value a manager adds by making sizing decisions. Position Sizing Skill is the return a manager adds (or detracts) over an equal-weighted portfolio. This is a trait that sticks with managers over the years and is more difficult to imitate than other frequently used metrics.
We then counted the number of times each unique fund showed up in either list. Of the 327 funds that appear at least once, we only selected those listed at least 20% of the total possible number of instances.
Novus Excel Add-In
Now that we have a shortlist based on manager skills, the new Novus API (application program interface) can screen manager characteristics. The API, released to all Novus users on May 30th, is a powerful new tool for manager screening. Simply entering manager names and using excel formulas will return the vast majority of data points available on the platform. Investors can sort or screen public managers by sector specialty, market cap focus, size, concentration, performance, and a sea of other possibilities.
The following characteristics were used in our API screen:
- Thirty-day Liquidity greater than 75% – this ensures managers aren’t overly concentrated in names they can’t trade out of. A manager’s alpha might be great if it’s driven by a huge bet on a very illiquid name, but that’s a risk to be cognizant of. There’s a plethora of other reasons to be wary of (or possibly even seek out) an illiquid portfolio. You can learn more here.
- Median Market Cap of Underlying Positions is less than $10 billion – this screen will focus on managers who specialize in smaller companies.
After using a simple Excel filter on the data points pulled from the API, the list has narrowed down the last nine years of Novus Hedge Fund Universe to just five names!
Here are the surviving funds and how they stack up in each metric screened for:
Shortlist in hand, we can now use the Novus platform to do a deep dive on each manager to understand their number holistically. Without giving it away, one of these managers has Security Selection alpha that is ~50% of their total performance inception to date. This alpha consistency leaves peers in the dust!
Pairing the SSDB and Novus Excel Add-In is a great start to any manager screening process. While our screen was merely illustrative and used narrow fields, hundreds of data points are available. At any point in the screening stage, talk to a Novus team member for a full list of metrics that can be screened for (there are over 100!).