Essentia Analytics Unearths Behavioural Alpha
Clare Flynn Levy, chief executive of Essentia Analytics, said active fund managers are recognising that behavioural data analytics is an essential tool for adding incremental returns to their portfolios.
Flynn Levy told Markets Media: “It’s just a matter of managers gaining awareness of it, of how it can be used, and why it is nothing to fear. We have helped clients uncover an average of 94 basis points of excess return per annum that had previously been lost to behavioural biases.”
Essentia calls this behavioural alpha – the added value that a fund manager can bring to a portfolio by mitigating their own biases. “In a world where alpha is scarce, it’s an opportunity that’s hard to ignore,” Flynn Levy added.
She explained that “nudges” are the key to overcoming bias. Portfolio managers receive custom notifications to remind them of their investment process just when their most detrimental behavioural patterns come to the fore.
“It’s the manager who is improving alpha, though, by making more deliberate decisions at key moments – the technology is just there to assist them,” Flynn Levy added.
One of Essentia’s case studies involves a global equity fund within a $300bn investment manager who unlocked 68 basis points of behavioural alpha each year.
Three years of the manager’s trade, portfolio and benchmark data was imported into Essentia’s analytics engine which revealed a tendency to hold on to losers for too long and to exit positions too slowly.
Two nudges were designed – one for when a position underperformed by a certain amount within a given timeframe and another to track the evolution and execution of each investment idea on an ongoing basis. In three years outperformance against the benchmark increased from 25 to 93 basis points, resulting in an added $108m for investors.
Improving returns has become critical for active managers as passive funds have been gaining market share.
“Behavioural analytics gives active managers a far better understanding of what’s working and what isn’t, about their “activeness”, so that they can continuously improve,” said Flynn Levy. “Without that, they are essentially flying blind.”
Essentia believes that a data-driven feedback loop on investment decision-making is fundamental to the “fitness” of any fund manager who wants to survive.
"Behavioral analytics become mainstream for investment management" – one of @AiteGroup's top ten trends in institutional securities & investments for 2020. We're inclined to agree. https://t.co/UxpxDqK6PS #BehavioralAlpha pic.twitter.com/SR3WACnPZX
— Essentia Analytics (@Essentia_AI) January 16, 2020
Essentia’s white paper, The Half-Full Glass, said active fund managers could preserve more than 1.2% of outperformance per year versus passive index funds, net of fees, by paying more attention to the lifecycle of alpha in their portfolios.
Launching Essentia Analytics
Flynn Levy founded Essentia Analytics in 2013 after spending a decade as a fund manager. Her previous experience included running more than $1bn of pension funds for Deutsche Asset Management and as founder and chief executive officer of Avocet Capital Management, a specialist technology hedge fund manager.
She said that when raising finance, many venture capitalists tried to tell her they knew more about the active fund management industry and focused on asking questions about the downside, rather than upside.
Essentia's Philip Maymin, PhD., explores whether judging people to be irrational in their reactions to the coronavirus is itself the manifestation of a new kind of bias. #BehavioralAlpha https://t.co/RreYTqLMIA
— Clare Flynn Levy (@cflynnlevy) March 20, 2020
“When Essentia finally took on venture capital money, it was from a firm where the investors involved are women,” Flynn Levy added. “That wasn’t on purpose, but they gave me the sense that they supported me in growing as the entrepreneur I want to be – far more than any male VC I had ever met.”
She believes that more funding will go to female founders when more venture capital firms promote women within their own organisations.
Fund manager career
Flynn Levy said she grew up in a town full of stockbrokers in the “greed is good” days of 1980s Wall Street.
“My father, who worked for a very large public company, used to joke that if his share price didn’t go up, he wouldn’t be able to pay my private school tuition,” she added. “So I started subscribing to the Wall Street Journal and Forbes, first to keep tabs on his share price, and later to come up with my own trading ideas.”
In college, she worked for Mario Gabelli and the late Liz Bramwell at Gabelli Funds, and decided to become a fund manager.
“I was consistently underestimated, that’s for sure,” she added. “No matter how senior I became, men who had never met me before generally assumed I was only there to pour coffee or take notes. But I thoroughly enjoyed surprising those people – especially in Britain, where I knew their mortification was especially well-felt!”
In the UK she began to work for Morgan Grenfell Asset Management in 1995 when the business was led by Nicola Horlick.
“I figured that a company that had a female boss would be one where I had a chance of succeeding – and I was right,” she said. “Although I experienced plenty of behaviour during those years that would be considered gross misconduct in this day and age, my colleagues weren’t typically the aggressors.”
Flynn Levy began to think about leaving fund management after 9/11.
“I had a great performance run, for a few years, and didn’t ask myself a lot of questions,” she added. “Then I hit a sustained period, post 9/11, where I was having to run very hard just to stay in one place, performance-wise.”
On the Essentia Blog: Seven top investment coaches share their thoughts on how to make good portfolio decisions in a disruptive and turbulent environment. https://t.co/3e6oE2V7rP @DeniseKShull #BehavioralAlpha pic.twitter.com/EWzadxGCxE
— Essentia Analytics (@Essentia_AI) April 7, 2020
She wanted data that could tell her what she should be doing differently but that was not easy to find.
“The more I thought about it, the more convinced I became that if I couldn’t actually prove my competitive advantage, as a fund manager, to myself, it wasn’t a good investment of my energy – I should be doing something where I could,” she said.
Before launching Essentia, Flynn Levy went to work for Beauchamp Financial Technology, now part of Linedata Services.
“I learned a lot through that experience that has served me well in founding and growing Essentia,” she added.
We're proud to share that Essentia CEO Clare Flynn Levy has been named a "Senior Leader" on @InnFin's 2019 Women in FinTech Powerlist! @cflynnlevy #WIFPowerlist2019 #BehavioralAlpha https://t.co/k42VXlANN4
— Essentia Analytics (@Essentia_AI) March 5, 2020
In 2018 The Investment Association chose Essentia Analytics as part of the first cohort to launch Velocity, the UK trade body’s specialist fintech accelerator.
Flynn Levy continued that Essentia is at the point now where there is no question over whether “it works” and increasingly signing up very large fund managers as clients.
Cboe Global Markets works to meet capital markets' demand for more innovation and better solutions.
Open architecture ecosystem delivers integrated middle-office operations.
All the major European equity market venues are now using Liquidity Cockpit.
APEX:E3, a cloud-based platform for digital assets, seeks to expand into traditional finance.
The evolution of analytics will just as critical as the acquisition of data.