Funds Hub

LIPPER: Equine vs equity investing

Is betting on horses very different from picking stocks? Can understanding a gambler’s approach and mentality give a better understanding of fund managers?

In searching for answers to these questions, I spoke to Paul Moulton, a professional gambler who originally worked in the fund management industry. He then set up a fund research company (Fitzrovia International, which he eventually sold to Reuters), although his working life began with an attempt to become a professional chess player.

Most of the fraternity of professional gamblers who make a living from horse racing are what Moulton describes as ‘traders’ or ‘chisellers’.

This group do not really look at horses at all, but look at market movements, hedging back their bets, and aiming to make tiny but regular profits with much less risk. They remain tucked away in their homes in front of an array of computer screens.

Moulton sees himself as part of a second, smaller group of professional punters, those he refers to as ‘judges’, some of whom look at horses in the paddock to assess their physical condition and thus their chances, while others are more reliant on assessing form based on previous races.

Some of them may even be conscious of the FSA’s warnings on funds’ past performance, which is deemed to be no guide to future returns. Although past performance does tend to shorten a horse’s starting price.

As part of this approach, Moulton has gathered vast amounts of data on all aspects of racing (jockeys, trainers, pedigrees, speed figures and so on) in a database that covers all horses in all races in the UK and Ireland since January 2005.

Rude health, and a changing of the guard?

By Detlef Glow, Head of EMEA Research at Lipper. The views expressed are his own.

The European exchange-traded-fund (ETF) industry has shown some resilience in the face of questions about management practices raised by market observers like the Financial Stability Board (FSB) and regulatory bodies like the FSA in the UK.

The segment grew by 7.74 percent over the first seven month of 2011, with assets under management up by 17.20 billion euros to reach 239.37 billion.

This has come as some critics have characterised ETFs as a systemic risk for financial markets, due to the use of swaps to replicate the underlying index. Another risk that has been highlighted was the liquidity of some securities accepted as collateral to secure the positions in derivatives and for security lending strategies. Also raised was the outstanding short volume in some ETFs.

But as the ETF industry is fully regulated by market authorities and uses typical techniques for derivatives and securities-lending strategies, the risks highlighted are already known. In addition, the assets under management of the global ETF industry are still less than ten percent of the total, and the issues might be better raised with respect to all funds, instead of pointing the finger at one market segment.

Despite publicity surrounding these issues, and in contrast to the expectations of some market observers, the industry has shown a pretty normal growth pattern in terms of newly-launched funds, with 167 new products hitting the market during the first half of 2011. Most of those were equity funds (102), with commodity funds a significant minority (22).

To see details of the new ETF launches click here and here.

Risk Management: Did fund managers learn their lesson?

By Detlef Glow, Head of EMEA Research at Lipper. The views expressed are his own.

In the last decade investors and fund managers faced two major crises in the stock markets, the popping of the technology bubble in 2001 and financial crisis starting in 2006.

Portfolio managers suffered average losses of about 50 percent in the wake of both crises, leading investors to question what their fund managers learned.

A Lipper and Avana Invest study on the maximum drawdown of actively managed funds found that those fund managers must have introduced new risk management tools after the bust of the technology bubble. Still, they failed to meet investor expectations on managing risk.

The changes led to smaller tracking errors, but the funds suffered nearly the same losses shown in their respective markets during the 2006-2010 financial crisis.

The study by Lipper and Avana, a German asset management boutique firm, found that portfolio managers started a risk management system that measured relative risk compared to their benchmarks instead of measuring absolute risk in terms of losses.

The new management guidelines did not meet the expectations of private investors and led to the following conclusions:    Relative risk management systems are penalizing fund managers if their risk compared to the benchmark moved above a defined level. The study found that a fund manager was not allowed to hold a high percentage of his portfolio in cash or decrease the weighting of a specific industry to zero, as this would increase the risk of the portfolio relative to the benchmark.

A choice between risk and return?

By Dunny P. Moonesawmy. Head of Fund Research for Lipper in Western Europe/Middle East and Africa. The views expressed are his own.

Hedge funds have delivered decent risk-return results over the past ten years. And as transparency and liquidity increased post-credit crisis, they have regained their appeal as providers of absolute return opportunities for investors. In addition, an increasing lack of market visibility globally has played to hedge funds’ supposed strengths, with total industry assets under management now exceeding the $2 trillion, according to Hedge Fund Research.

There is a divide, however, with the industry split between single hedge funds — totaling more than 11,000 in the Lipper database — and some 867 funds of hedge funds (FoHFs). The general perception is that single-manager hedge funds are the more risky investment and to cushion that risk, some investors prefer to diversify their portfolio by investing in FoHFs instead. But is it worth it?

An analysis of single hedge funds and FoHFs during the past ten years shows interesting results in terms of performance and risk. Indeed, whether on a cumulative basis over 3-, 5- or 10-years or accounting for calendar years in 2008, 2009 and 2010, single manager hedge funds performed significantly better on average than FoHFs.

For details of performance, click on this link.

Outperformance of single-manager hedge funds is clear during these periods but since the beginning of the year both single managers and multi-managers have performed poorly, in euro terms, with a little advantage for multi-manager funds.

On a risk level, we have an opposite situation. Funds of hedge funds demonstrated better resistance to the downturn, with a maximum drawdown over 3 years of -19.42 percent against -24.55 percent for single hedge funds. If we take their volatility into account, we have similar results, with FoHFs showing smoother performance pattern over 3, 5 and 10 years. We have here the mirror image of the performance factor, with FoHFs demonstrating strong risk-management compared to single hedge funds.

KIIDs can help bridge the trust gap: Lipper

By Merieme Boutayeb. Research Analyst at Lipper. The views expressed are her own.

The European fund industry is getting a second chance this week to improve the way it communicates with investors when selling its products. While the first effort became mired in legalese and complexity, the Key Investor Information Document, or KIID, should offer a golden opportunity to recoup some more of the trust lost during and after the financial crisis. Firms would do well to look past their misgivings and not waste it.

The new requirements are part of the broader changes that come as part of UCITS IV regulations designed to further develop a single market in investment products. The KIID will replace the much-criticised Simplified Prospectus as the means to facilitate the understanding of neophyte investors.

Published by ESMA (the European Securities and Markets Authority, the final KIID layout will be divided into five principal sections: objectives and investment policy; risk and reward profile; charges; past performance; practical information.

A KIID will have to be prepared for each share class in a standardized two-page format. It is probable that the task will be arduous for those funds using deeply complex investment strategies which they are required to distil into simple terminology. But they will have to respect the rule (and might be afforded a bit of extra room) as regulators seek to ensure transparency and comparability between different funds.

The KIID will also have to be available in all the languages of the countries where the share class is registered for sale, a requirement which goes beyond the demands of the Simplified Prospectus and which will result in additional costs.     According to Lipper data, there are about 50,000 UCITS share classes registered for sale in Europe. Taking into account the fact that every share class must have a KIID in each language of country of registration for sale, the number of documents to be produced would be more than 160,000 KIIDs by July 1, 2012. Share classes already in existence before July 1, 2011 have a deadline of one year to develop their KIID.

Professionals from the sector estimate that the cost of a KIID would vary between 50 and 125 euros, assuming the release of a single version in the year. That means the overall production of KIIDs would cost between 8 million and 20 million euros, without taking into consideration changes that may involve the production of an updated KIID.

Are marathon runners trying to sprint?

“The long is short. Investment choice, like other life choices, is being re-tuned to a shorter wave-length.” So stated Andy Haldane of the Bank of England in a speech last month.

If one of the key features of a mutual fund is that it is a long-term investment, then concerns that money is being managed over decreasing time horizons should be treated seriously.

This concern was made all the more potent as it followed soon after a European Commission green paper also pointed to this issue with this comment: “It appears that the way asset managers’ performance is evaluated and the incentive structure of fees and commissions encourage asset managers to seek short-term benefits.”

So what insights can be elicited from Lipper’s data?

Portfolio turnover of mutual funds in the UK provides insights both in the range of holding periods for different funds, as well as how typical holding periods have varied over time.

Among 1,142 actively managed equity funds for which annual accounts have been published and analysed in order to calculate portfolio turnover (the lesser of purchases and sales divided by a fund’s average assets over one year), the median turnover is 59.2 percent.

How widely portfolio turnover varies can be seen by analysing this data by decile, revealing that the least active, or most long-term funds, had a rate of 18 percent or less (the bottom decile), while the most actively managed funds achieved a rate of 170 percent or more (the top decile). Around 40 percent of funds (accounting for 483 funds) had a rate of 50 percent or less, while just over one quarter (nearly 300 funds) posted a turnover rate of 100 percent or more.

Risk revolution

By Dunny P. Moonesawmy, Head of Fund Research for Lipper in western Europe, Middle East and Africa. The views expressed are his own.

The evaluation of an investment is measured by its potential performance and risk, and historically, investors have given more importance to the former than the latter. Recent events in the market, however, have challenged the hierarchy, placing risk at the heart of investors’ thinking. It is little short of a revolution in the investment industry.

While performance is associated with opportunities, risk is linked with danger and the switch in thinking is prompting investors to take a more defensive approach.

There have been several factors behind that change. The market is more volatile and given to quicker and more abrupt downturns; there is a polarization of economic growth outside core western economies; demographic change has led to the growing importance of liability management; and regulatory constraints have put extra pressure on institutional players to limit risky investments.

Up to 1996, we enjoyed smooth growth trends in markets, with steady periods of drawdown and recovery. Over the past 15 years, however, the nature of market cycles has changed.

Periods of exponential growth have been followed by deep crises, creating opportunities for hedge-fund style managers but a nightmare for long-only managers trying to protect assets. Both institutional and retail investors have had a hard time during these two crises with significant consequences on their risk appetite. For a chart detailing the recent trends, click: http://r.reuters.com/gef88r

Data from Lipper shows 10.18 percent average annual growth of the MSCI World TR in dollar terms between 1970 and 1980, 16.3 percent the following decade and 15.92 percent in the 1990s. The figure stood at only 1.77 percent during the last decade due to the two major downturns — the bursting of the internet bubble and the credit crisis.

Morning Line-Up: Libya and Madoff, hedge funds in North Africa, China in Japan

News and views on the asset management industry from Reuters and elsewhere

Libyan state fund rejected Madoff offer – FT

Hedge funds wary of punts on North Africa chaos – Reuters

China’s stealth investments in Japan – WSJ

Shocking.. Toxic.. Nasties.. Devastating.. Leeches..

.. Some select phrases from this morning’s Daily Mail pop at greedy fund managers who rake in fees whether or not they’re beating the market. It might read a bit like an advertiorial for passive managers like Vanguard (which gets an unusually high number of prominent name checks) but it won’t be comfortable reading for other asset management execs.

The paper’s salvo gives a kicking to firms like Axa and Henderson and makes much of the secretive pay packages earned by the fundies and the marketeers. It also, somewhat bizarrely reckons the grey-suited long-only managers looking after your ISA are responsible for most of the yachts bobbing gently in the Marina at Monte Carlo.

It has been a long-running war of words since the financial crisis and it’s fair to say that active managers who fail to deliver do look increasingly isolated. It has been an immensely difficult market to call and more than ever outperformers have a patina of luck around their achievements. People like ‘safe-hands’ Philip Gibbs have stumbled and Neil Woodford’s jammy sale of BP at the end of last year has been the engine behind a rally back from ho-hum performance.

For balance, the Mail does note that index funds will, by definition always tend to underperform the benchmark once fees are taken into account, but nevertheless, the passive houses have reaped the benefits and have even started to devise ways to hold onto the money which gravitated their way in the market’s darkest days.

Some active funds, meanwhile, have sought to re-align themselves with their skittish customers by shifting the weight of charges towards performance fees, earned on positive returns, while some brave souls have allowed clawback of fees in down years.

Our own funds research firm Lipper has run the rule over the evolution towards performance fees and has produced a report which I’ve copied below. Their conclusion is pretty clear: performance fees in themselves do not solve the problem; if you really want to win back the clients, then you have to become  a client.

In other words, stick your own money in, and manage it like your life (actually) depended on it.

The chart that bounced…

Our graphics team have been busy producing some wonderful interactive contraptions and this is one of the best I’ve seen, a clear and useful look at the top equity fund sectors over the last three years.

No great surprise to see Thailand ruling the roost but interesting to see Italian funds faring so poorly, and who would have picked Israeli small cap managers to make the top 10?.

Most importantly, surfing round the graphic is made a joy by the pleasingly bouncy charts… I’m easily pleased.