Anne Unplugged Alexander Forbes Research Institute our actions as an industry help or hinder investors’ quests for better solu
Jan 01, 2016
Anne Unplugged
Alexander Forbes Research Institute
How do our actions as an industry help or hinder investors’ quests for better solutions
Behavioural finance suggests investors make bad investment decisions. But....
Consultants and advisers aren’t always helping
Let’s have a long hard look at what we’re really doing as an industry
Consultants and advisers exist to guide investors away from potentially damaging investment decisions –
or to at least guide us to the more prudent decisions. But....
Heuristics – Rules of Thumb
Simplify the message to the client
Make the message easy to remember
Make it easy for anyone to become a “distributor”
Make it easy to have cookie cutter solutions
Investors seeking high returns must accept high risk
Which is the better fund manager:Quartile performance rankings:
These were all randomly generated performance numbers Collections of random events do behave in highly regular
fashion The smaller the number – the higher the probability of seeing
more extreme events
An Industry that is dominated by “The Law of Small Numbers”
Allan Gray Sanlam Coronation
1st quartile 1st quartile 1st quartile
1st quartile 4th quartile 1st quartile
1st quartile 4th quartile 1st quartile
1st quartile 4th quartile 4th quartile
1st quartile 4th quartile 4th quartile
1st quartile 1st quartile 4th quartile
Bias confirmationBias confirmation
Which row of letters were randomly generated?
BBBGGG
GGGGGG
BGBBGB
All three were – but our minds refuse to accept this explanation
Source: Grantham, Mayo, van Otterloo
There are lots of variations on this slide…but you get the gist
99% confidence levels?
We have allowed our industry to be governed by “The Law of Small Numbers”
Similarly we have cavalierly (as an industry) ignored how much “noise” there is in performance data that clouds what you are really looking at.
Even Warren Buffett’s performance lies within the range of potential outcomes for a purely random distribution of performance outcomes over a 20 year period.
(Nassim Taleb)
Haugen & Baker paper attacked for only 21 years analysis
But – do investors really have time?
More importantly:
Cult of active management
Easy for fund managers to beat index (?)
Poor quality benchmarks in terms of representativeness
Overall costs may be high but not large differential in fees between active and passive strategies for a strong push to “smart beta” (passive) strategies
Surveys and performance dominate decision-making
The Unique Challenges of the South African Asset Manager/Adviser/Investor
What can you tell / What can you not tell - from these performances?
What manager performances can tell you: Which asset classes/sectors drove performance? Asset allocation vs. stock selection ? Whether the market was providing alpha opportunities
and where ? Which investment styles/philosophies were successful in
the environment? Which strategies were the most volatile? Which strategies exhibited downside protection in falling
markets or maximum leverage of return in rising markets?
What we cannot deduce from this information:
Which managers are skilful
The Skill / Luck Continuum and Asset Management
How many factors involved in the path to success?
/
Source: Michael Mauboussin 2010
On understanding return and risk
Diwersification – It’s in the nature of the “beast”
Average share
Specific
Common
factors
Market
movement
(30%)
(30%)
(40%)
Average portfolio
Market
movement(90%)
(8%)(2%)
Source: Barr Rosenberg
(98%)
Multiple portfolios
Market
movement
(2%)
Beta Beta
Understanding manager performance – the heart of the problem
Contribution is unconditional.
Hold a beta of 1.00 and you get 100% of
the market movement
Contribution is conditional:
• availability in the market
• manager skill
Beta Alpha
This exposure you need to meet your long term funding
requirement
This is just frosting on the cake – can help cover
costs
Desperately seeking alpha
Against the ALSI, performance was a function of market structure and not manager skill in 11 out of 12 months.
Focused Blend vs ALSIBenchmark
ReturnPortfolio Return
Outperformed Banchmark
Probability of outperforming
benchmark
Probability of better
performanceJan-03 -4.81% -3.53% Yes 100% 64.40%Feb-03 -3.81% -2.72% Yes 100% 8.90%Mar-03 -7.38% -6.63% Yes 81.90% 0.70%Apr-03 -0.93% 0.34% Yes 100% 0.10%
May-03 14.87% 11.97% No 0% 62.80%Jun-03 -1.78% 0.07% Yes 100% 44.50%Jul-03 5.93% 5.25% No 0% 21.80%
Aug-03 5.57% 4.41% No 0% 4.70%Sep-03 -2.56% -1.37% Yes 0% 10.90%Oct-03 10.13% 8.80% No 0% 9.50%Nov-03 0.44% 1.86% Yes 100% 0%Dec-03 7.30% 6.36% No 0% 15.80%
Focused Blend vs SwixBenchmark
ReturnPortfolio Return
Outperformed Benchmark
Probability of outperforming
benchmark
Probability of better
performanceJan-03 -4.09% -3.53% Yes 98.10% 64.50%Feb-03 -4.71% -2.72% Yes 100.00% 7.40%Mar-03 -7.97% -6.63% Yes 99.20% 0.20%Apr-03 -0.27% 0.34% Yes 80.90% 0.10%
May-03 14.10% 11.97% No 0.00% 64.90%Jun-03 -0.77% 0.07% Yes 100.00% 47.10%Jul-03 5.00% 5.25% Yes 85.40% 24.20%
Aug-03 5.00% 4.41% No 0.00% 6.00%Sep-03 -1.89% -1.37% Yes 94.10% 11.80%Oct-03 9.70% 8.80% No 0.00% 10.70%Nov-03 1.62% 1.86% Yes 12.00% 0.20%Dec-03 6.97% 6.36% No 0.00% 19.30%
• Against the Swix, market structure (during this period) still accounted for outperformance 50% of the time.
Upside-down value chain for the industry
The more you can discern about manager skill, the clearer it becomes that manager selection is essentially a crap shoot
But we seriously end up believing that the greatest value we can offer clients is by being “good investors”
The Unique Challenges of the South African Trustee/Asset Manager/Consultant
Vicious cycle of mediocrity – with an increasing overlay of external controls from an impatient regulator/government
In truth...during times like these our clients need us desperately – we just haven’t listened to what they really need
Charles Ellis and the “Winners Game”
Not financial advisers...............................financial coaches!