Benchmarks and Risk-mapping CIPs. What do you do?
LizziSmith
Member
Hello All,
We are reviewing how to compare different portfolio/funds within our CIP. Do you have any suggestions for which multiple criteria we could use such as Volatility/peak to trough/OCF/past performance etc? Are these suitable or are there others that we should be considering?
What benchmarks have you been using against your different levels in your CIP? We have a range of 6 risk profiles.
Any of your thoughts would be appreciated.
Thanks
Lizzi
Comments
Hi, I'm in the process of data gathering for our CIP review as well. I've gathered all of the above to end of Q1, but I've also run it all to 30.04.2020 to bolster up and show how each fund/MPS has managed the downturn and then the bounce back within that window. The figures are really interesting!
tl;dr I got a bit carried away with this post but short answer is IMO there's no right answer and it's more important to have a robust, repeatable process than it is to worry about making sure you've got the 'best' fund. Oh, and the formatting is a right mess as I can't get the hang of this Markdown business.
Oooh, that's a great but difficult question to answer Lizzi as it can take you down a lot of rabbit holes!
You can make this as simple or as difficult as you like. There's also no right answer, so I think it's more about having a robust and repeatable process than aiming to try and pick the 'best' funds. What is best after all? Best performing? Best risk adjusted returns? Manager with the best personality?!
As a starter for ten, the below sets out a high level approach I'd suggest could get you started and that you could tweak and personalise for your particular firm/CIP (this assumes you have access to FE or Morningstar). This is based on selecting a fund from scratch, however parts of this can be used to review existing funds too:
Initial sector filter: Start by filtering out all the funds you don't need. For example, if you're looking for managed/multi-asset funds to meet your risk profile 3 maybe you just use the Mixed Shares 20-60% and 40-85% sectors as the starting point. If you're looking for individual sector funds you'd just use the relevant sector e.g. UK All Companies.
Hard filters: Next are what I refer to as hard filters, which help to filter out all those funds that don't have the base traits you're looking for. For instance you might decide you only want to consider funds that have:
“Top-performing funds were more likely to become the worst-performing funds than vice versa over the five-year horizon. While 15.3% of bottom-quartile domestic equity funds moved to the top quartile, a greater percentage (31.5%) of top-quartile funds moved to the bottom quartile during the same period.”
Whilst I don't believe you can completely ignore performance as there are definitiely some consistently underperforming funds out there (https://www.bestinvest.co.uk/research/spot-the-dog), the approach I tend to take is the opposite of what normally happens. Rather than simply shortlisting the top 10 best performing funds, I work from the bottom up by filtering out all the funds that have consistently come 3rd and 4th quartile over as long a time period as I can find. I think this is a better way to get rid of the dogs so to speak, whilst leaving in those that could be the next top performers.
You should by now have a much reduced list of funds (aim for 12 as that makes it easier in FE). If not, always worth going through and manually getting rid of the funds that you know you're never going to use for whatever reason e.g. another IFAs in-house funds.
Now go back over everything and try and reduce this down to a final shortlist of 3 to 4 funds. This is where it gets a bit more art than science as you've kinda got to take all that data and combine it all together in your head and decide which funds you think provide the best balance of risk adjusted returns, fund objective, charges etc. A fund manager might refer to this bit as their "proprietary super duper quant screening algorithm" or some such nonsense.
p.s. remember to document each step of this process in terms of what filters you applied and which funds you filtered out to evidence a clear audit trail as to how you arrived at your final decision. Just sticking a copy of the fund factsheet on file won't suffice.
Some other useful links you might want to read:
Morningstar research points to the ‘best’ (but still not that accurate) predictor of future performance being cost: https://morningstar.co.uk/uk/news/149421/how-fund-fees-are-the-best-predictor-of-returns.aspx
Morningstar also did a study on their star ratings system which concluded it only had “some” predictive ability for picking future ‘winners’: https://morningstar.com/content/dam/marketing/shared/research/foundational/780133_The_Morningstar_Rating_for_Funds__Analyzing_the_Performance_of_the_Star_Rating_Globally.pdf
Benchmarks
Again, what benchmarks you use to measure your CIP against kinda depends how complicated you want to make it (as well as how honestly you want to measure your portfolios!). Some options:
Sector averages- Mixed Shares 0-35%, 20-60%, 40-85%, Flexible etc - these are just averages of all the funds that make up that sector, so would be definition include a lot of funds with mandates that don't match what your portfolios are trying to acheive.
Composite benchmarks - you basically rebuild your portfolios using appropriate indices for each asset class that makes up your different CIP portfolios e.g. use FTSE 100 index for the UK equity portion. Shows whether your funds are outperforming the underlying assets.
Absolute return - you could use something like CPI+X% with the X depending on the different risk levels of your portfolio.
Passive alternative - why not take the composite benchmark one step further and populate the benchmark with actual passive funds that the client could own e.g. rather than FTSE 100 index, you could use the Vanguard FTSE 100 fund etc. That way you're showing whether the portfolio is actually outperforming the client could conceivably own instead. If it's not outperforming, what value is your asset allocation, fund picking and fund managers adding?
Or, why not use a cominbation of one or more of the above?
Another couple of useful links for some background reading that explains the above in more detail:
https://cfauk.org/-/media/files/pdf/pdf/5-professionalism/3-research-and-position-papers/benchmarks-and-indices.pdf
https://finalytiq.co.uk/portfolio-benchmarks-and-the-absurdity-of-sector-averages/