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Printed: 02 July 2022 2:27 AM

News

16 Jul 2021 - Hedge Clippings | 16 July 2021
By: Australian Fund Monitors

    

Hedge Clippings | Friday, 16 July 2021

 

"Words are words, and promises are promises, but only performance is reality"
Harold S. Geneen, former president of ITT Corporation.

When looking at managed funds, or any financial product, Geneen's quote is increasingly relevant. It probably holds true for politicians as well, but maybe best not to go there just now...

When looking at the performance of managed funds it is not only important to get accurate information, it is equally important to be able to understand and interpret it correctly, and in context.

For instance, a fund that has provided a return of 15% p.a. over the past five years would reasonably be understood to have good performance. But performance compared to what? What if the fund's underlying index or asset class has returned 20% p.a. over the same period, or another fund returned 15% p.a. but with lower fees?

A fund might have outperformed its index or benchmark, but has it performed in line with, above, or below, similar funds with similar strategies and similar geographic mandates - in other words, its Peer Group?

Looking at a fund's total return is only part of the solution - there are a range of key performance indicators that should be taken into consideration.

Next, let's look at consistency. The fund may have returned 15% p.a. on a cumulative basis over 5 years but it's rare - although not impossible - to consistently return 15% for each of those five years simply because market conditions vary. The volatility of those returns - measured as standard deviation over either a monthly or annual basis - is a prime consideration for most investors as it indicates potential risk of loss of earnings or capital.

Generally speaking, the higher the return, the higher the risk, so the Sharpe ratio is used to measure the return relative to the level of risk (volatility) that is being taken.

The Sharpe ratio (named after William Sharpe, later Professor Sharpe) was developed in 1966 to try to provide a single measure to describe the excess return an investment provides for the extra risk (volatility) involved. For those in lockdown and looking for some light reading over the week-end, the details can be found here.

As economists will do, (and noting Hedge Clippings does not lay any claim to being one) others of the same profession developed alternative measures: The Sortino ratio for instance, named after Frank A. Sortino, effectively removes upside volatility from the equation, and therefore only measures downside, or negative volatility. (Further details here)

Both Sharpe and Sortino each attempted to create a single number to allow any investment in any asset class to be measured against any other investment, irrespective of asset class, although in reality it is better to use it as a measure of similar asset classes, so aspects such as liquidity and length of investment can be taken into account.

When looking at managed funds, both are useful but can equally disguise other KPI's - depth and length of drawdowns for instance. For many investors, holding a 'losing' investment, or a fund which has a large negative return, for more than a few months, the situation can be distressing and outside their level of risk tolerance. So let's add size and length of drawdowns to the KPI equation.

Still going? How about Up Capture and Down Capture? Two ratios that are less well used or understood, and which are particularly relevant to potentially volatile assets such as equities.

There are different ways of calculating Up and Down Capture, but www.fundmonitors.com measures the cumulative performance of the underlying market in positive months, and measures the cumulative performance of the fund when the market is positive against that. In rising markets a number above 100% indicates a fund which outperforms, and less than 100% indicates it underperforms.

Possibly of more interest to risk-averse investors is the Down Capture equivalent which measures how a fund performs in negative markets - again on a cumulative basis. Any number less than 100% is good, and a negative number indicates a fund which typically rises in negative markets.

Each of these measures help the investor or advisor look through the words and promises of the fund manager or their advertising, and 'lift the lid' to get a real understanding of how each fund performs.

But wait - there's more! Where and how a fund fits into an overall investment portfolio and provides low correlation to achieve diversification and reduce risk needs to be added to the analysis equation.

After all, "only performance is reality".


News & Insights


Video Interview with Richard Ivers of Prime Value Asset Management

Video Interview with Robert Swift of Delft Partners

Why You Should Look at Capture Ratios When Assessing Fund Managers article by         Australian Fund Monitors


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