James Saunders, quantitative analyst, at Tatton Investment Management tells us that understanding style bias is key to fund selection.
'An area we always discuss with advisers regarding portfolio construction is our process of investment manager selection. Our overall investment process has a split responsibility between asset allocation and fund manager selection. Geographical and tactical asset allocations are taken at a macro level and then applied using specific regions, investment styles or assets.
If we identify a new opportunity and an existing fund does not match our central investment case, we research a fund that can express our view.
At Tatton, we look at our managers using two lenses: how they do against a generic benchmark (for example, the FTSE 100 for a UK manager), and how they do against a much more specific one (such as the UK Mid Cap Growth index, for instance).
We want to be able to identify and understand any inherent bias within a manager’s strategy, not necessarily to discount it, but to understand its dynamics within the balance of the overall portfolio.
We believe this is often ignored. It can easily be overlooked when looking at manager presentations and performance, because these will often refer to a benchmark that, while not necessarily misleading, probably is not the best to assess performance against our portfolio requirements.
When we buy a manager, we have expectations about what their characteristics are and judge them accordingly. For example, a manager can be benchmarked to emerging markets, but if we have identified their strategy as growth then we discount any outperformance on broad emerging markets driven by this growth exposure.
Credit where credit’s due
If the manager trails the sector we want to exploit, then, in our view, that manager has underperformed, and we deserve credit for choosing growth irrespective of the benchmark or sector they are normally attributed to.
This is important, as it gives us a framework to analyse our decisions and manager performance independently, as well as understanding the asset allocation bets we are taking through manager selection.
Unwinding strategy performance in this way is not ultra-precise, but it helps us a lot when thinking about portfolios conceptually, and judging managers without biases is fundamental to the strategy.
A recent example would be the JPM Japan fund, managed by Shoichi Mizusawa. Compared with the broad market index, this has done exceptionally well since the start of the year.
However, around 25% of this outperformance could be attributed to a more specific structural exposure performance of small growth in this case, which would not be evident from analysis of its principal benchmark peers or components and is one of the reasons we selected the fund.
Conversely, the Schroder Global Dividend Maximiser fund, managed by Nick Kirrage, has trailed broad global equity. However, we selected the fund as a value strategy and a large part of this apparent underperformance is down to the performance of value, which we know the fund is structurally exposed to.
In the context of why we are holding the fund, we are comfortable to hold it on this basis, since the bias is in line with our investment thesis.
In both cases, looking beyond what is immediately apparent has allowed us to manage the performance potential of our portfolios from a bias balance performance perspective, rather than simply adhering to a geographical tactical allocation.'