Multi Asset Evolution of Strategies in the Multi Asset Space Presentation by Antony John September 2013
IR = IC x BR Risk adjusted returns can be maximised through applying the widest levels of information to the broadest range of investment opportunities. Alpha from identifying and accessing high quality active investment managers, combined effectively to reduce risk; with, Beta through exploiting changing market conditions and capturing relative value across countries, asset classes, market capitalisation and investment style. Key trend, we are all broadening our research scope and building more diversified portfolio structures Notes: Grinold s Law Fundamental Law of Active Investment Management, where IR = Information Ratio IC = Information Coefficient BR = Breadth. Grinold & Kahn s book Active Portfolio Management (2000, McGraw-Hill) 2
Finding the right balance between past information and future expectations Quantitative Analysis Performancebased Holdings-based What risks? Past Operational Due Diligence Qualitative Analysis Process People Business Market Cycle What risks? Future 3
Some sound selection principles Find managers with skill (i.e. determine repeatability of outperformance) By identifying those managers, with comprehensible, disciplined investment processes, who deliver consistency of investment behaviour; and By identifying patterns in manager performance against its position in market cycles. Avoid decision traps (i.e. evaluate alpha risk) By evaluating when alpha is negative across a market segment or during a market phase, unnecessary costs are avoided by moving from active to passive strategies. Identify best combinations (i.e. diversify skill) By focusing on the correlations between those funds and asset managers selected and by looking for the optimum spread of strategies to deliver repeatable risk-adjusted returns. Trend, only 18% of managers outperform their benchmarks on a rolling 3 year basis 4
Asset class performance varies during the different stages of the economic cycle Recovery Boom Slowdown Recession Greed Growth Inflation Fear Best Asset Property* Equities Commodities Property* Equities Property* Gov. bonds Corp. bonds Corp. bonds Corp. bonds Cash Gov. bonds Gov. bonds Commodities Corp. bonds Equities Worst Asset Commodities Cash Gov. bonds Cash Equities Property* Cash Commodities Source: Coutts, 2010 * REITS 5
The market emotions cycle managing client expectations more effectively 6
Managers can pick stocks BUT gross outperformance and net underperformance is often delivered Gross active US equity fund return 17.00% Fees Trading costs 0.79% Cash drag Net return Net active US equity fund return 14.63% 0.79% 0.68% 14.63% 0.20% 0.20% 0.10% 14.90% 15.40% 14.90% Gross S&P 500 Index Tracker fund return Net S&P 500 Index Tracker fund return Source: Harvard Business School: Randolph Cohen Typical active US equity fund S&P 500 Index Tracker fund Trend is fee compression and better transparency driven by regulatory changes 7
The multi asset arena has become more complex Active / Passive Relative efficiency of market Evolution of Smart Beta Further scope to actively manage levels of active risk Segregated / Pooled Relative size of investment Efficiency of investment Liquid / Illiquid Different returns profile Correlation profile Alternatives Diversification benefits More absolute return focussed IR = IC x BR: To maximise the Information Ratio 8
9 Evolution of strategies in the multi asset space Three distinct stages of manager selection, not just for active managers! Quantitative analysis: construction of peer groups Screening, Clustering & Scoring of Opportunities Qualitative research and interviews undertaken by our analysts in order to evaluate performance consistency and attribution, as well as asset managers, The Risk Management Team separately assesses operational risk: To detect potential for risks related to systems, processes, trading, etc. Ability to veto our analysts recommendations Pre-selection List Qualitative Manager Research Recommendations Operational Due Diligence Approved List On-going monitoring On-going monitoring On-going monitoring 9
Quantitative analysis: Categorisation of peer groups Highlighting of differentiated behaviours Positioning versus the common categorisation Size bias: stable and discriminating factor Style bias: not always discriminating factor Trend towards obtaining a much better understanding of what you are buying 10
Qualitative factors are critical 40% fund manager turnover per annum Reshuffling Hunt for talent Hedge fund drain (now reversing!) 27% product/mandate turnover New and closed mandates Increasingly merged mandates 20% affected by some form of corporate activity And now mergers we never expected to see! Source: FundQuest/ Feri/ Deloittes 11
Qualitative analysis trend is greater emphasis here Two objectives in mind when reviewing performance, philosophy and team, analysts want to: Understand sources of added value; (is it repeatable?) and Identify the period/ context that is most suitable for alpha generation What drove historical performance? Stock selection, factor bets, cash? How consistent have past returns been? What is the methodology in place? How consistent/ systematic is it? Has alpha been generated in up/ down market trends, short up/ down phases or trading range periods? What is the portfolio manager looking for? Protection in down markets or strong outperformance in up markets? 12
Alpha Evolution of strategies in the multi asset space HIGHER Target Return Flexible benchmarked funds LOWER Fixed benchmarked funds Beta Trend is greater diversity of solutions offered at different pricing points 13
Portfolios can be constructed in many different ways Barbell Approach Manager Selection Equal Weighted Style Approach Active-Passive Approach Active Asset Allocation & Manager Selection Approach Client tailored portfolios / bespoke solutions / speciality multi-managed portfolios 14
Risk due diligence costs escalating 1 2 3 4 5 SHORT LIST COMMITTEE OPERATIONAL ANALYSIS ON SITE VISIT REFERENCING MONITORING Due Diligence Agenda Corporate Structure Analysis CEO interview CIO interview COO interview Investment Approval Form (IAF) Documentation Update IAF Update Planification Fund Structure Analysis CRO interview Compliance Off. Interview Risk Profile (RP) RP Update Fund Referencing Background Check Materiality Checks Firm Structure DD Report (DDR) DDR Update Frequency: bi-monthly Portfolio Structure Analysis Trade Process Investment Process Operation, BCP, DRP Ranking Grid (if required) Ranking Grid Update 15
Why operational due diligence is important Cannot have a zero failure regime especially if fraud involved Madoff Losses of $50bn Barings Losses of 680m Kidder Peabody Losses of 300m Beacon Hill Losses of 300m Amaranth Losses of $6.5bn Bank of Montreal Losses of C$680m SocGen Losses of 5bn UBS Losses of $2.3bn 1995 1995 2002 2006 2006 2007 2008 2011 16
Price is what you pay, value is what you get Process is key to building conviction and understanding Breadth of Universe: coverage based on demonstrable skill, business type agnostic Allocation of Research Resource: focused on quality managers only, and intensive Positive Conviction Recommendations: focused lists ensure conviction, no Hold ratings Sell Discipline: dynamic, including relative performance criteria Manager selection is a specialist skill Autonomy / Responsibility Decision making Experience Understanding of non investment issues is key Strength in operational risk management Operational Due Diligence 17
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