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Johannesburg - The turmoil in global financial markets has forced investors and asset management firms to review how they measure the skill of their fund managers and ultimately manage the risk associated with handling other people's money.
"Beating a benchmark is not sufficient to demonstrate skill," said independent quantitative analyst Roland Rousseau.
Rosseau gave a media presentation on portfolio construction and management on Wednesday.
He said: "Investors need a positive return that covers or exceeds the opportunity cost of not investing, and they need a positive return after costs."
The fund management industry has come under fire in recent months as professional money managers failed to deliver amid the market turmoil.
Many traditional long-only managers - those who cannot benefit as the market moves down - have, however, pointed out that they still "beat the benchmark" by losing less than their competitors.
This has not satisfied many investors who are out of pocket, and who now question how much of their fund managers' previous outperformance can be attributed to skill and how much to just investing during a major bull market.
Rosseau pointed out that much of the "excess returns" generated by fund managers comes from the luck of being overweight in a particular share or sector. However, committing to an overweight position ultimately means excess risk for the investor.
"Risk is not skill," he said
An example of this is the small-cap sector where investors benefited from "good stock-picking" when small-caps were in favour. But the risks became increasingly apparent when fund managers couldn't exit these positions when the market went against them due to the size of their holdings and illiquidity of the underlying shares.
Slamming 'absolute' returns
Rosseau was particularly critical of unit trust investments being marketed as "absolute return" funds, which are supposed to guarantee the value of the investor's capital. The funds make use of derivatives and other tools to hedge their positions.
"These people are selling snake oil and there is a lot of marketing hype around absolute return investments," he said.
The funds, which benchmark themselves against cash or consumer inflation plus a fixed percentage, are in fact focusing on return targets - not benchmarks - and do not accurately reflect the risks taken by the manager.
One of the ways that both institutional and retail investors could better manage risk in their portfolios is to use investments in exchange traded funds (ETFs), said Rosseau.
An ETF is a passive investment option that traditionally merely tracks a market index. For example, an ETF tracking the JSE's index of the biggest 40 shares will only invest in the shares of the index and try to mirror the index performance.
He said: "Traditionally, ETFs have focused on sectors, countries and markets - the new types of ETFs are driving the commoditisation of risk factors such as value and momentum." He added that the new types of ETFs offered in developed markets allowed investors to track issues such as volatilty and "risk" in the market.
Rosseau expects more of these kinds of products to become available to local investors and assist them in building better portfolios.
Craig Chambers, deputy MD of Umbono Fund Managers, said that his firm, which offers a number of index tracking products, had done a lot of research on the blending of passive products into active fund management portfolios. It found this had helped reduce risk for managers.
He said: "There is no doubt that these types of products can help an active manager."
But Richard Carter, who heads up product development for leading active manager Allan Gray, told Fin24.com that his firm did not consider the use of any ETFs or tracker products in their portfolios. However, the Allan Gray Optimal Fund did make use of some hedging instruments to help them manage the risks.
Carter said he "wouldn't be surprised" if Allan Gray clients have ETFs as part of their private portfolios.
- Fin24.com
