The Changing Face of Skill A Global Overview Roland Rousseau Head: Barclays Risk Strategy Group Barclays Africa Group Limited roland.rousseau@barclays.com +27 (0)11 895 7535
Which is the Correct Definition of Skill? a) “I beat my ALSI benchmark, therefore I have skill!” b) “I beat my peers ( ie top- quartile), therefore I have skill!” c) “I won a Raging Bull Award, therefore I have skill!” d) None of the above CFA/Literature Definition of Skill: Have you outperformed the risks you have taken?
Historic Evolution of Fund Management Phase I: Era of Heroism (1900 – 1970) Belief: Beat the market through investment skill - Heroes from stock picking and value investing - Good research and hard work is rewarded - Single benchmarks (eg S&P 500) – market cap weighted The Changing Face of Skill 4 roland.rousseau@barclays.com
Historic Evolution of Fund Management Phase II: Era of Realism (1970 – 2000) Belief: Markets are ‘too efficient’ to outperform - Birth of passive investing (‘zero - sum game’) - The only portfolio that matters is the market (eg S&P 500) - Fama: markets are efficient (EMH) The Changing Face of Skill 5 roland.rousseau@barclays.com
Historic Evolution of Fund Management Phase III: Era of Enlightenment (2000 – now) Belief: Markets are irrational, ‘social machine’ - Birth of behavioural finance (‘Predictably Irrational’) - Keynes: investors make mistakes by buying shares they like - Anchoring, recency bias, bandwagon effect are rife - Chasing past performance and trackrecord = willing losers? The Changing Face of Skill 6 roland.rousseau@barclays.com
Latest Global Thinking: Both Active and Passive Investments are delivering unnecessary ‘excess’ risk!
Risk Premia are like Biofuel Risk-Factor eg currency, interest rates 5% 0% Risk-Premium eg equity, value, momentum, EM etc - Why do we invest in Equities? WITS/Barclays SA Risk Premia - Database without survivorship bias - Risk Premia are not a free lunch! - 4 risk-premia explain >80% of active-risk - Momentum, Low-Beta, Stock-specific risk, - Excess returns exist regardless of skill Value, Rand The Changing Face of Skill roland.rousseau@barclays.com
Never Confuse Higher Return with Skill How can we beat these benchmarks without skill? Benchmark Return: 50% ALSI + 40% ALBI + 10% Cash Benchmark Return: JSE ALSI, FTSE 100, S&P500 Benchmark Return: MSCI World Index Is generating a higher return sufficient evidence of a) skill or b) excess risk? The Changing Face of Skill 9 roland.rousseau@barclays.com
Mirror, mirror on the wall… Source: Morningstar, FTSE/JSE Who has the most Skill? 1200 1200 1200 1200 FTSE/JSE RAFI Allan Gray Equity A Coronation Equity R FTSE/JSE Div+ FTSE/JSE ALSI FTSE/JSE RAFI Allan Gray Equity A So, who has Coronation Equity R 1000 1000 1000 1000 FTSE/JSE ALSI FTSE/JSE RAFI the most Skill? Allan Gray Equity A FTSE/JSE ALSI 800 800 800 800 FTSE/JSE RAFI FTSE/JSE ALSI We actually 600 600 600 600 don’t know! 400 400 400 400 Never confuse higher return 200 200 200 200 with skill… 0 0 0 0 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 The Changing Face of Skill 10 roland.rousseau@barclays.com
Exposure vs Relative Return Source: WITS/Barclays Excess Return vs ALSI (pa) Example: Allan Gray Equity Fund Did the risk exposures deliver Stock-Specific Risk Premium Momentum Risk Premium excess return? Excess Return vs ALSI (pa) How about a Value Risk Premium Low Beta Risk Premium direct allocation to the risk premia? Who is going to Source: WITS/Barclays do allocation? The Changing Face of Skill 11 roland.rousseau@barclays.com
The New Definition of Skill Typical Goal New Goal Typical Goal Beat Benchmark Manage Risk Track Benchmark Dynamic Active Passive Risk investing investing Control In near future, imagine investors explicitly incentivised delivering more efficient risk budget payoff (lower costs + lower risk)
Norway begins a ‘risk management’ revolution Government Pension Fund - Global Andrew Ang William Goetzmann Stephen Schaefer Source: NBIM Annual Report Despite broad global diversification many of the asset classes had exposures to the same risk factors (eg liquidity). They showed that ’risk factor’ allocation is superior to traditional asset allocation The Changing Face of Skill 13 roland.rousseau@barclays.com
Future of Investment Skill Current Situation Future Mandate (Asset Allocation) (Dynamic Risk Control) Spot High Medium Low Risk Risk Risk Value of eg Market a) backward looking b) investors’ Maximise my upside with risk tolerance changes c) false ‘shortfall’ or tail -risk less expectations through risk cycle than eg. 15% Requires understanding of risk cycle and Requires understanding of economic risk-factor allocation (eg CPPI) and business cycle The Changing Face of Skill 14 roland.rousseau@barclays.com
How do we Find Skill? “Gamblers are convinced they can beat the system, despite all the evidence to the contrary.” – Overcoming Addiction We need help: stop chasing past performance/trackrecords! Ignore what has happened and focus on what can happen Risk Cycle explains Asset Pricing, not Economic/Business Cycle We can’t all outperform, but we can all lower our risk & cost Future belongs to Risk Managers not Return Managers
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