›

Benchmarks and Risk-mapping CIPs. What do you do?

LizziSmithLizziSmith Member
in Technology & IT

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

Share on Google+

Comments

  • Janeen.StevensJaneen.Stevens Member

    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!

    Share on Google+
  • parawhatparawhat Member
    edited May 2020

    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!

    • For instance, are you talking about individual sector funds or managed/multi-asset funds?
    • What ratios do you use and when e.g. alpha, beta, sharpe, sortino, information ratio and r-squared?
    • Should you use different ratios and benchmarks when comparing individual sector funds vs managed/multi-asset funds?
    • Over what time periods should you measure performance?
    • Should you even look at performance?
    • What reliance do you give to third party 'scores' e.g. FE and Morningstar ratings?
    • Should you be researching the fund or the manager (for active funds)?
    • Do you stick with quantative research only or add a qualatative overlay?
    • How deep do you dig into understanding what the fund's mandate is and what it is currently invested in/can possibly invest in (the Neil Woodford issue)?

    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:

    1. 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.

    2. 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:

    • Minimum investment track record of 5 years
    • Minimum manager tenure of 3 years
    • Minimum fund size of £10m
    • Maximum fund size of £1 billion
    • Max OCF of 2% etc
    • No initial or exit fees
    1. The slightly controversial one: You'll be familiar with the phrase "past performance is not an indicator of future peformance", or something along those lines. How much reliance should we be putting on past performance when picking/reviewing funds then? Short answer is probably less than we are. If you want convincing Google and read up on the SPIVA persistence scorecards which usually concludes along these lines:

    “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.

    1. Art or Science?: The next step is arguably more art than science (if it was science surely everyone would come up with the same answer every time?). Basically, you've now got to take your list of funds and start to short list those funds that show good risk adjusted returns. There's a number of ways of doing this, but one way is to pull together all of the following and compare it to your benchmark for each of your risk profiles:
    • Cummulative performance over 1, 3, 5, 10+ years etc
    • Discrete perfromance over 1, 3, 5, 10+ years etc (good for spotting rubbish funds that got lucky with one good decision)
    • Scatter charts over various periods
    • Ratios over various periods (making sure you use appropriate underlying benchmarks) e.g. sharpe, information ratio, beta and volatility
    • Also useful to look at max gain and max loss/drawdown
    • And remember to check the fund mandate/objective is something sensible and not too off piste
    • You might also want to bring in some high level qualatative screening here e.g. what's the team supporting the manager like, do they have enough resources, what would happen if manager left etc

    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.

    1. "The final bit": Once you've got your final shortlist, you now need to have a really in depth look into each fund, it's objective, what it invests in, a closer look at the quant figures again. Potentially you might also want to try and speak to the manager/BDM and ask any further due diligence questions. Hopefully, it should become obvious which fund you're going to select. Well done! :smiley:

    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:

    Jonny (paraflex)
    Share on Google+
  • parawhatparawhat Member

    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:

    1. 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.

    2. 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.

    3. Absolute return - you could use something like CPI+X% with the X depending on the different risk levels of your portfolio.

    4. 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/

    Jonny (paraflex)
    Share on Google+
Sign In or Register to comment.