Presentation summarizing the value of using an equity risk model built for oversight.
Over a third of U.S. equity mutual funds are currently so passive that, even if they exceed the information ratios of 90% of their peers, they will still fail to overcome a typical fee.
Or How to Tell if You Are Paying Top Dollar for a Flawed System.
Returns-based analysis can be effective—but only when a manager does not significantly vary exposures to passive market, sector, and macroeconomic factors.
Security selection returns, when properly calculated with a robust factor model, persist and yield portfolios that outperform. Both skill and lack of skill persist, and the lack of skill persists most strongly; while it is important that investors correctly identify the talented managers, it is even more important to divest from their opposites.
Security selection returns of the top U.S. stock pickers in 2016 were positive. When hedged to match market risk, a consensus portfolio of the top institutional U.S. stock pickers outperformed the Market by approximately 2%.
Whereas nominal returns and related simplistic metrics of investment skill revert, security selection performance – once properly distilled with a capable factor model – persists.
20% of long U.S. hedge fund portfolios surveyed are currently so passive that, even after exceeding the information ratios of 90% of their peers, they will still fail to merit a typical fee. Investors must monitor the evolution of their hedge fund managers towards closet indexing and mitigate fee harvesting.
Traditional, or dumb, Market and Sector Betas account for over 92% of variance for most U.S. equity smart beta ETFs. Smart beta, unexplained by the traditional Market and Sector Betas, accounts for under 8% of variance for most U.S. equity smart beta ETFs. With proper analytics, investors and allocators can guard against elaborate re-packaging of dumb beta as smart beta.
Equity portfolio oversight that fails to consider market and other factor exposures overlooks the principal drivers of performance and risks focusing on noise. Read More
Passive exposures to market and other factors overwhelm the impact from security selection and market timing on risk and return – explaining 98.7 percent of absolute performance and two-thirds of performance relative to the market. Read More
Properly-designed risk models can be used to filter out the effects of systematic risk, exotic market bets, and luck. When these models are designed from the ground-up to evaluate skill, and are combined with robust statistical techniques, the result is predictive analytics. Read More
Property and casualty insurance company portfolios share a few systematic bets. These crowded bets are the main sources of the industry’s and many individual insurers’ relative investment performance. Since the end of 2013, these exposures have cost the industry billions. Read More
Avoid complexity for the sake of complexity. Read More
We analyze historical positions and returns of approximately 3,000 non-index U.S. Equity Mutual Funds over 10 years. Read More
Complex equity risk models may offer no better predictions than robust statistical models with a few intuitive factors. Read More
An intuitive Global Statistical Equity Risk Model using Regional and Sector/Industry factors delivers over 0.96 correlation between predicted and reported portfolio returns for a median U.S. Equity Mutual Fund. Read More
Effective benchmarking provides sufficient information to determine as early as possible when corrective action is necessary. Read More
Plagued by overfitting and collinearity, returns-based style analysis frequently fails, confusing noise with portfolio risk. Read More
With predictive analytics and a robust model, investors can not only identify persistently strong stock pickers but also construct portfolios with predictably strong nominal performance. Read More
What would you do if your equity manager underperformed the index by six percent? Three steps to meaningful, actionable performance reviews. Read More
Impact of Taxes on Asset Allocation
Tax considerations influence both relative rates of return and variability of asset classes, increasing the relative attractiveness of equity.
© Stephan Pastis