Monkeys can pick stocks better than cap-based tools: study
04 Apr 2013
Geneticists have long known that the difference between the human and monkey genome is miniscule; and now a study of investment behaviour finds that active fund managers should perhaps be "benchmarked against monkeys".
The study by researchers of the Cass Business School, based on monthly US share data from 1968 to 2011, found that nearly all 10 million indices weighted randomly delivered vastly superior returns to the market capitalisation approach – a discovery likely to cause consternation among entities that have billions of dollars worldwide invested on a market cap-weighted basis.
The academics found that 10 million portfolios of 1,000 stocks weighted at random would nearly all have beaten the conventional fund benchmark over the last 43 years.
The research found that equity indices constructed "by monkeys" would have produced higher risk-adjusted returns in the US than an equivalent index weighted by market cap.
Funds indexed against the S&P 500 hold $1.3 trillion of investors' money; and another $5.6 trillion of funds are benchmarked against the performance of such indices.
Most of the £700 billion held by UK retail investors in active funds is benchmarked against a market-cap index, and there is £63 billion in tracker funds.
The research claimed that "monkeys throwing darts" could outperform most funds, but did not measure the effects of weighting.
Co-author Dr Nick Motson said, "Beating a market-cap index hands down sounds exciting - but what if I tell you 10 million monkeys would also have beaten it?"
John Belgrove at consultants Aon Hewitt, which commissioned the study, said cap-weighted investment strategies had "inherent weaknesses" but had still been "a challenging benchmark for active managers to beat".
The researchers programmed a computer to randomly pick and weight each of the 1,000 stocks in the sample. ''We effectively simulated the stock-picking abilities of a monkey,'' a co-author of the study said. "The process was repeated 10 million times over each of the 43 years of the study.
Most shockingly, we found that nearly every one of the 10 million monkey fund managers beat the performance of the market cap-weighted index. We should perhaps be benchmarking our fund managers against monkeys."
The finding comes from two papers published by Cass Business School's Cass Consulting, which investigated alternative methods of constructing equity indices.
The authors contrasted investor returns for heuristic, optimised and fundamental weighting schemes against a comparable market cap-weighted index.
''All of the 13 alternative indices we studied produced better risk-adjusted returns than a passive exposure to a market-cap weighted index,'' said Motson.
However, the authors discovered more striking results when they explored whether the superior performance of alternative indices could be explained by luck rather than design.
Out of the alternative indices, the sales-weighted index performed the best in the study, beating 99 per cent of the figurative monkeys' randomly constructed indices.
