Tue. Oct 26th, 2021

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By Professor Leonard Kostovetsy of The Chimpanzee with his eyes blindfolded, guest contributor

Many disciplines divide professionals into two basic types: the specialists, who are experts in a specific area, and the generalists, who have a certain level of expertise and understanding in many different areas. While medicine is an obvious example, this division is also found in fields such as law, mathematics, science, entertainment, management, and finance. Among financial analysts and investment managers, some specialize in a particular subdivision of the stock market, usually defined by industry or sector, while others deal with all parts of the market. In an article I co-authored with dermatologist Vladimir Ratushny, we look at what types of skills are best for generating higher portfolio returns.

Healthcare fund managers

To answer this question, we examined the performance of a set of mutual funds that invest entirely in health-related actions. health sector investment fund—A natural laboratory for understanding whether specialized knowledge about an industry is useful for selecting stocks that are likely to outperform. We define a specialized mutual fund manager as one who is a physician or has a degree in a field related to medicine, such as biology, chemistry, biochemistry, and so on. (or both). In practice, most specialized healthcare fund managers are doctors who decided that they could earn more by managing portfolios than by practicing medicine. It is defined that any fund manager who is not a specialist is a generalist.

An example of a specialist is Kris Jenner, who graduated from the Johns Hopkins School of Medicine in 1993 and decided, after her residency, to pursue asset management. He became a fund manager for T. Rowe Price, the well-known Baltimore company he managed T. Rowe Price Health Sciences Fund from 2000 to 2013. After 2013, he left T. Rowe Price to found his own hedge fund company Rock Springs Capital. As the graph below shows, the percentage of specialists, such as Dr. Jenner, among health care fund managers grew until 2012 and has remained in the 30-40% range for the past decade.

Comparison of fund performance

Once we determine which investment funds in the healthcare sector are managed by specialists and which are managed by generalists, we compare the performance of their funds. We compare risk-adjusted returns and control for other characteristics of managers (such as age, gender, etc.) and funds (such as fund size, fund age, expense ratio, etc.) .). The following graph contains the takeaway keyword.

Specialized performance

If you started with $ 1,000 at the beginning of the sample period in 1998 and each month reallocate your capital to all health care funds managed by specialists, you will end up with more than $ 13,700 in December 2018, the end of the show period.

Performance of the generalists

On the other hand, if you have done the same but have reallocated your capital to all funds managed by generalists, you would only have $ 5,500 in December 2018, slightly better than the $ 4,700 of a passive investment in the entire healthcare industry. The average fund managed by specialists exceeds approximately 0.4% per month, which is approximately 5% per year, a highly significant difference that shows the advantage that specialists have when choosing health actions.

Specialists benefit from health-related work experience

In the rest of the paper, we perform a lot of additional testing to understand how specialists can perform better. When we define education-based specialists separately compared to work experience, we find that having health-related work experience provides an additional performance bonus, suggesting that work skills or connections could be part of the puzzle. When we compare fund managers with other STEM-related degrees, such as math, engineering, or physics, they are not able to function like those in health-related fields, suggesting that our core outcomes are not due to rigor or higher intelligence working in STEM fields.

Specialists are able to better interpret sector-specific information

In our latest work experiment, we looked at whether specialists are better able to schedule their stock purchases or sales around important market-driven events, including FDA decisions about whether to approve or reject. a new drug application and merger and acquisition announcements. The average return on three-day shares around FDA rejections is -13.2% and specialist fund managers have a lower stake in these shares than generalists during these adverse events. In contrast, the average return on three-day shares around an announcement that the company will be the target of an acquisition is + 32.7%, but there are no differences in the holdings of specialists and generalists during these positive events.

Our interpretation of these results is that our main conclusions are NO because specialists can get inside information (as this would allow them to perform better both during FDA decisions and in merger and acquisition announcements), but because specialists can better predict or interpret industry-specific information that affects the prospects of the company.

Doctors have an advantage when it comes to choosing health-related stocks

What should we draw from the results of our study?

  1. Doctors (and other people in health-related fields) can manage investment portfolios better than people with degrees in finance and economics and with years of experience in the financial industry.
  2. Its advantage comes, of course, from its specialized experience, so we would not expect the same to happen for the management of oil stock portfolios or even well-diversified portfolios, just as we would not expect cardiologists are better than internists at treating head injuries.
  3. Choosing individual stocks that outperform is extremely difficult without a competitive advantage, such as having a set of skills or connections that are rarely found among financial market participants.

I hope our study inspires people from all walks of life to think about investing not only as an exclusive domain of Wall Street traders, but as a field for anyone who wants to use their head and their set of specialized skills to make money.

[Editor’s Note: I thought this was an important enough paper in the financial literature that it had to be addressed on the blog. Absolutely I found it interesting to see that in the past, health care mutual fund managers who had actually been educated, trained, and worked in health care prior to becoming mutual fund managers outperformed health care mutual fund managers who had not. If for some reason you wanted to invest in an actively managed health care mutual fund (I don’t but you might), you should definitely pick one run by someone with the experience of actually working in health care.

However, I would not go so far as to suggest that means that individual doctors who are NOT health care mutual fund managers should start picking their own health care stocks. There is no evidence of that in this paper, despite Professor Kostovetsky’s assertion above. In fact, there is substantial evidence that picking your own stocks or even your own actively managed mutual fund manager is a bad idea. Is the health care sector an exception, even for funds run by doctors? Maybe. In my opinion, the jury is still out. 

A reasonable proxy index fund for Health Care is the ETF XLV, a State Street “SPDR” that has been around for 23 years. It follows the health care sector of the S&P 500, essentially large cap health care stocks. It charges an expense ratio of 0.12%. It owns 64 stocks and has a turnover of just 3%. By any measure, it’s a fair representation of this sector of the market. If you look up its returns against its peers on Morningstar (accessed 7/26/21), you will see that it has outperformed 92% of its peers year to date and 74% of its peers over the last three years.


Health Care Fund Performance


If you go out 15 years, you see the record is not so good, outperforming only 42% of the funds in its category. Now why would that be? That’s very unusual for an index fund, isn’t it? Well, yes it is. And the usual explanation is survivorship bias. Do we see that in this sector? Well, yes we do. You can see that we only have 15 years of returns for 82 funds, but there are currently 171 funds in the category. I don’t know exactly how many health care funds there were 15 years ago, but I’m confident there were a lot more than 82. Probably more like 171. 

It’s not like the number of mutual funds in existence has gone down over the last 15 years or something.


Number of Mutual Funds Historical


If anything, there are fewer mutual funds than there were 15 years ago. I have no reason to believe that isn’t the case in the health care sector. In general, about 38% of funds go out of business every decade.


Survivorship Bias


Do you suppose most of the funds that were closed were beating the market? No chance. Market beating funds don’t get closed. So it makes the remaining funds look a lot better. Keep that in mind before you go out looking for a hot actively managed mutual fund manager, much less try to beat the pros at the game. If the pros (even those who worked in health care) are very unlikely to beat the index, what makes you think you can?

I asked the author about how he accounted for survivorship bias in his study and the basic answer was that when a fund went out of business, they just assumed that the investor reinvested in the remaining funds with no tax or transaction costs. Basically, there was no realistic way for an individual to invest to get the returns produced by the study. I’m not sure that was the best way to deal with it given the Morningstar data above, but certainly health care active fund managers have done better than most non-health care active fund managers against their respective indices over the last decade or two. Not enough for me to believe in them, but enough that I don’t think you’re stupid if you do. It’s a non-issue for me as I don’t tilt my portfolio to health care stocks anyway. The author also noted that it really wasn’t a study about active vs passive management, but just among the types of active managers available, so don’t read too much into that question from the results of the paper.]

What do you think? Do you lean your portfolio towards health actions? Are you trying to choose yours? Has this document changed your mind? Why or why not? Comment below!

[Additional Editor’s Note: This article was submitted and approved according to our Guest Post Policy. We have no financial relationship.]

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