These are unprecedented times for understanding the meaning of performance figures and this doesn’t only relate to the shock treatment investors get when they see their latest year-on-year returns, according to Anne Cabot-Alletzhauser from Advantage Asset Managers.
She says it appears that investors are questioning the many principles for deriving value in a long-term investment strategy.
“The anxiety is even more pronounced for pension members who are invested in member choice portfolios, because while they may believe that the markets will recover, the critical question is when.
“The evidence seemed to add to this anxiety as the flagship portfolio of many large asset managers appeared to run performance circles around risk targeted specialists blend solutions for the last ten years,” says Cabot-Alletzhauser.
She contends that in terms of behavioral finance theory when investors are scared or confused, they typically abdicate decision-making, invariably by handling their funds over to the winner of last year’s performance race.
“Similarly the two greatest destroyers of long-term value in pension funds are Regret: Oh why hadn’t we just invested with fund manager X and secondly Misunderstanding performance histories: surely balanced manager Y provides a better option to risk targeted specialists funds because they van change their asset allocation in turbulent times?”
Cabot-Alletzhauser believes there is still a massively compelling story here as to why placing risk budgeting first and foremost in the decision-making process is an absolute imperative – particularly when trustees can also appreciate the magnitude of extra security provided, specifically where governance oversight and consolidated reporting and attribution take centre stage.
She says even in the wake of a significant bull market and its subsequent global financial meltdown, these solutions still achieved what they set out to deliver to clients. And once one digs even slightly below the surface of the shiny performance numbers of the unencumbered balanced manager range, one quickly begins to appreciate that what initially looked like manager skill may well have been an illusion.
“For most of the bull market, balanced managers had significantly high equity allocations. But did this necessarily mean that these managers therefore have asset allocation skill. Research conducted by Allan Gray, provides some fascinating insights and suggests that South African managers appear to be able to add value at the security selection level (something we too believe to be true).
“But of greater interest is the fact that any additional performance that did not come from security selection could only be explained by added value from asset allocation.”
Furthermore, she says the research suggests that once both the bull market (2003-2007) and the 2008 financial markets collapse have been accounted for, the two periods nearly net each other out. In other words, investors over this specific time frame would have gotten only slightly different outcomes from a dramatically increasing equity allocation.
But the most telling point, according to Anne Cabot-Alletzhauser, is that once the full market crash data is included, balanced managers showed no specific asset allocation skill – instead they detracted slightly from performance. “In fact, no conclusive evidence is provided at all about managers’ skill at asset allocation.
But the exercise does illustrate how easy it is for investors and their advisers to leap to that conclusion using conventional performance measurement techniques.
This is of course is the great bane of our industry. “Effectively it pushes us back to our starting proposition – if the numbers can’t be trusted to provide convincing evidence of skill or lack thereof, then the only recourse trustees have is to go back to first principles –long-term strategic asset allocation do provide powerful and meaningful starting points.
“Abandoning them in the mistaken belief that better performance means a better solution (in spite of the fact that solution may not be meaningfully connected to the fund’s predefined funding requirement) can be massively value destroying long-term.”
Cabot-Alletzhauser contends that while the research shows that managers may have appeared to have contributed extraordinary levels of alpha over the last eight to 10 years, however, that may have been ;
· A distinct function of a dramatic increase in herding behavior as the bull market swept all of the larger managers into the same space
· Marked shift to value bias
· Orientation of the peer group manager more to the SWIX, which has a larger small ca bias and lower resources exposure, which paid off over the period (SWIX outperformed the ALSI by 3 percent).
We’ve already seen the market lurch emphatically away from these segments of the market in the wake of the financial meltdown, eroding the earlier gains at an alarming rate. And yet the active asset management industry has most decidedly embraced Value Investing as the veritable Holy Grail of long-term performance.
The collapse of the small cap segment of the market in 1998 provided a sobering lesson for the many new investment boutiques that set up shop while the pickings were easy in the sector. When liquidity dried up and risk skyrocketed, many of these new boutique managers were sent packing.