BOSTON — Too many stocks spoil returns. At least that's what Richard O. Michaud maintains.
The industry iconoclast is challenging the famous work of Richard Grinold and Ronald Kahn, "The Fundamental Law of Active Management."
The concept is the mainstay of many major quant managers, who collectively manage trillions of dollars in assets.
Messrs. Grinold and Kahn, both senior executives at Barclays Global Investors, San Francisco, wrote in a 1989 Journal of Portfolio Management article that, essentially, a skilled portfolio manager has a greater chance of producing strong returns if he or she is given a greater breadth of opportunity sets with which to work.
Their work was extended in a 2002 article in the Financial Analysts Journal by Roger Clarke, Harindra de Silva and Steven Thorley. They said that removing portfolio constraints by allowing skilled managers to use tools such as shorting and the use of derivatives can increase the manager's "transfer coefficient" — which, essentially is the measure of how much of the manager's skill was incorporated in the returns of the portfolio. Messrs. Clarke and de Silva are investment professionals at Analytic Investors Inc., Los Angeles. Mr. Thorley, a finance professor at Brigham Young University, has worked at Analytic. In 2004, JPMorgan Asset Management, New York, used the articles to validate its "130/30" strategy, a portfolio that is 130% long-only stocks, and 30% short stocks. Firms such as BGI; Analytic Investors; Mellon Capital Management, San Francisco; and Goldman Sachs Asset Management, New York, all have adopted the philosophy in various strategies as well.