Identifying Characteristics to Predict Separately Managed Account Performance

The authors analyzed a large sample of domestic equity separately managed accounts over the 1991–2009 period and found evidence that manager skill persists. They also found that managers who were more active had better returns, and they documented a strong negative relationship between assets under management and future performance, even for large-cap strategies. Large cash inflows and a high number of accounts under management hindered subsequent performance for small-cap strategies.The purpose of this study was to identify characteristics that help predict the performance of separately managed accounts (SMAs), also known as separate accounts. Although numerous studies have been conducted on the topic of explaining or predicting mutual fund returns, far less research has been carried out on explaining or predicting SMA returns.Previous studies that used SMA return data can generally be grouped into three areas of emphasis. First, several papers examined performance and performance persistence. The second group consists of studies of the relationship between asset flow and SMA performance. Third, SMA data have been used to study performance subsequent to selection and termination decisions by plan sponsors. We believe ours is the first broad-based study to focus on identifying the predictive characteristics of SMA returns.As in many of the studies that use SMA return data, we obtained separate account data from Informa Investment Solutions’ PSN Investment Manager Database. The PSN database is a comprehensive, global database consisting of approximately 2,000 organizations, representing more than 10,000 investment strategies. We focused on domestic equity strategies because of their popularity in the marketplace and the relative ease with which they can be categorized into investment styles. The PSN database’s U.S. Equity Universe was launched in 1984, but it has been survivorship-bias free since 1991; therefore, our analysis of separate account returns covers 1991–2009.Our analysis of domestic equity SMA returns suggests that manager skill persists. We used two measures that serve as proxies for the level of active management: manager selectivity and portfolio turnover (although turnover may consist of both information- and non-information-based trading activity). We measured manager selectivity as a function of the regression R2, and it is a returns-based proxy for the holdings-based measure of “active share.” R2 is the proportion of the return variance that is explained by the regression, so 1 – R2 is a measure of manager selectivity. Our results indicate that manager selectivity is positively correlated with subsequent returns. In addition, we found that portfolio turnover is positively related to subsequent returns; this effect, however, appears to be driven by managers implementing a momentum strategy.Consistent with the argument that having more assets under management in a strategy results in diminishing returns, we found that assets under management are negatively related to subsequent performance. Interestingly, this result applies even to large-cap strategies, which contrasts with the results of other researchers who found that fund size affects subsequent mutual fund performance only for small-cap growth funds. Large cash inflows and a large number of accounts under management also appear to hinder performance, but these effects appear to be limited to small-cap strategies.