WMA JOURNAL Issue 4 Autumn 2015
In this issue
Defence against Cybercrime The changing face of research 25 facts celebrating 25 years of the WMA Industry Statistics The importance of implementing a robust policy management programme
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The Changing Face of Research: Quant Is Not Enough Fortuna AllFunds
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The nature of Research is changing as investors and advisors demand more information before they select a fund, or a manager. Quantitative analysis remains the foundation for many decisions, but qualitative judgements are just as important.
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hanges which have affected the asset management industry since the onset of the global financial crisis are also having a significant impact on the nature of Research and its place in the investment chain. Among many advisors and wealth managers, fund selection used to be undertaken by the in-house team, whose ‘day job’ was stock selection. This made sense, since stocks and shares used to comprise a far higher proportion of any investment portfolio than they do now. However, there are now more funds listed than shares, and especially since the rise in passive strategies, there are more fund holdings than individual stocks in any pooled investment structure. To keep up with the proliferation of product implies a high level of resource, specialist skill at selecting funds, and a process which relies heavily on rigorous, independent Research.
Managing fund buylists llfunds Bank began investment research after having developed a requirement to present mutual funds in a consistent way to clients. It then honed its fund selection skills and tools which enabled clients to determine exactly where managers create value, via performance and risk management. The AFB Platform now has more than £145bn assets under administration and offers close to 40,000 funds from 450 fund managers. As ever, regulation has provided the impetus for changing Research models. Previously, wealth managers would tack fund selection onto equity research, producing a list of funds which they liked, but which were not necessarily consistently researched. In a post-RDR environment, that no longer satisfies higher levels of
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governance, or investor demands. Financial advisors at all levels have to be able to demonstrate how they compile their buylist, as well as how it is monitored and reviewed. he risks of doing otherwise have become clear. With the proliferating number of fund platforms, the assumption that all funds are bought through advisors is no longer valid. Given the vast global fund universe, few organisations have the resources to conduct proper due diligence on each product. The result is that many advisors simply revert to the financially strong, high-paying, well advertised big ‘brand’ names for their buylists.
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Moral hazard uch ‘pay to play’ is a moral hazard for the industry: the larger product providers are recommended and grow assets under management, while managers with fewer and smaller funds struggle to get noticed at the very point where they tend to produce the best returns for their investors. A fresh, unconflicted and cost-effective solution is essential for a modern business model. Is selecting a fund so much more complicated than buying a stock? The answer has to be yes, since the fund should be deconstructed to fully understand the client’s overall risk profile. A UK Equity fund, for example, may have considerable emerging markets exposure if it has FTSE100 stocks, and that may be duplicated elsewhere in the client portfolio.
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basis point counts. Debate continues over the precise contribution to overall returns of each part of the fund selection process. Does asset allocation or stock selection add most value? Eighty percent of value may be derived from asset allocation and just 20% from stock picking, but in current conditions, few would forego that 20%. Clients are now increasingly only prepared to pay for Alpha, so how
“Debate continues over the precise contribution to overall returns of each part of the fund selection process.” does independent Research deliver this? It inevitably starts with thorough quantitative analysis. Researchers can run the statistics, set up the algorithms and work out the equations. At Allfunds Bank, we would argue this is a necessary, but not sufficient step in the process. Research cannot begin and end with the industrialisation of Alpha. The Quant is not enough. Investing, for all its global reach, remains a cottage industry, albeit a complex one. In a post crisis era, regulatory compliance and demonstrable governance are absolutely critical, delivered not via tickboxes and automation, but with holistic, intelligent analysis applied to each mandate. Wholesale outsourcing responsibility for this appraisal to a ratings system is also unacceptable.
Adding value In buoyant markets, small shifts in a fund manager’s style and process may be ignored, as the rising tide floats all boats, but in a low-return market, every
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Research challenges So the demands on the Research function continue to build up. It has to determine where quantitative processes are robust, but qualitative judgement is weak. It has to ascertain exactly how much Beta is hidden in the fund management process. It must point out opportunities, identifying the rare instances where value is undetected, the nature of that value generation, and match those moments to client needs.
The flaw in a purely quantitative process is that it is backward looking The hazards of performance data, where a top quartile fund may drop quickly to bottom quartile, highlights the challenge of consistency. All marketing literature carries the warning that “past performance is no guide to future returns�, and yet managers and investors continue to act as if it does. The flaw in a purely quantitative process is that it is backward looking. Experience shows that forwardlooking qualitative judgement has to be wrapped around quantitative approaches. Not only is objective analysis probably not possible, but peer-tested subjective analysis can be valuable by bringing all-important experience to bear. Fund selection is not just about analysing future market trends, but also judging how a particular manager might perform in that future environment. Therein lies the Alpha.
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Combining Quant and Qual t AFB, we run a two part process – starting with compliance and governance and the analysis of the objective numbers, and continuing with informed peer review. One team conducts the quantitative and qualitative assessment of both funds and fund management companies, and another takes that research and tailors it to individual client needs. Our own capability is constantly under scrutiny. In December 2014 we attained the ISO 9001:2008 standard for our Research process from the British Standards Institute, recognition of our consistent approach to the Research function, which emphasises meeting customer requirements, adding value, monitoring performance and effectiveness as well as ensuring continual improvement. Wealth managers know that a muddle-through approach to Research and fund selection is no longer adequate. Clients deserve a quality outsourced option, publicly recognised for its internal process disciplines, its content and customer service.
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Case study:
Allfunds Investment Research Backs A Fund Through A Temporary Blip
AFB Quintile Ranking
In 2013, the Jupiter European Growth fund experienced a performance blip, slipping down to third quintile in the Allfunds proprietary ranking tool. However, analyst Mark Hinton still recommended the fund for AFB’s Insight List demonstrating the importance of qualitative analysis. Over the five years to end June 2015, the fund is +33.9% ahead of the MSCI Europe Index. Since inclusion on the list in May 2013, it has outperformed the MSCI Europe Index by +10.9%.
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Why the fund was selected in 2013 and remains a High Conviction ‘Insight’ fund:
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Manager Alexander Darwell’s philosophy and process is proven and has been consistently applied since 2007 for this fund and since 2001 for a similar Europe ex-UK strategy Regular meetings with Jupiter management and the fund manager demonstrated a clear understanding of the fund’s process, positioning and performance drivers The fund screened consistently well in the AFB proprietary ranking tool. It was 1st quintile in the peer group (Europe Growth funds) in the period up to inclusion in May 2013. The reason for the fund’s temporary performance dip – its quality bias and structural underweight to cyclicals in a strongly rising market – was clearly explained. The fund performance rebounded strongly as quality growth stocks regained favour. It is benefitting from the weak euro, and has good exposure to global growth outside of Europe. The fund’s AFB ranking returned to 1st quintile from H2 2014 and has remained there through 2015. The fund is top quartile over 1, 3 and 5 years, and since April 2007 when Darwell became manager.
Jupiter European Growth fund: Five years relative performance (to end June 2015) vs MSCI Europe, and AFB Quantitative Quantile Ranking evolution
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Report designed by Cicero No responsibility for loss to any person acting or refraining from acting as a result of any material contained in this publication can be accepted by the WMA, the author, publisher or printer. The views expressed by individual contributors are not necessarily those of the Association. Company limited by guarantee. Registered in England and Wales. No 2991400. VAT registration 675 1363 26. Published for the WMA by WordWide London. Copyright WMA 2014.
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