In today’s investment climate, which is becoming ever more challenging and complex, excellent investment performance increasingly requires the support of an effective risk management function. While final decisions on how to invest clients’ money should of course rest with fund managers, we believe effective in-house risk management can be a vital input in the search for alpha.
Such a function can be most effective when it fulfils an advisory role, with risk analysts discussing portfolios with fund managers and looking at how to deliver the best returns. Risk management should involve discussion and debate around the portfolio construction and management processes – looking at the collection of individual stocks in a portfolio and analysing how they behave in connection with each other. This can help fund managers construct their funds in order to maximise returns from stock selection.
We believe in giving fund managers the freedom to implement their ideas in the way they see fit. However risk analysis should encourage them to consider the unintended risks that can sometimes develop in portfolios and can detract from performance. Equally important is highlighting areas where managers may need to take more risk in order to ensure that a particular holding can deliver the returns that are expected of it.
Effective risk analysis can also help managers to understand the sources of fund performance, as performance generated from intended risk is much more likely to be sustained over the long term. In addition, risk analysis can help fund managers understand the effect of a particular stock in the context of a wider portfolio. For example, adding a stock that is very similar to others could create an unwanted thematic bias. On the other hand, stocks that have little in common with others in a portfolio can have a diversifying effect, meaning that a manager can take a larger position in the stock without creating significant risk. Risk analysis can also assist managers in the decision-making process by testing the impact of adding or removing a stock on the risk profile of a portfolio prior to trading.
As well as providing insight for fund managers, risk analysis can also help enhance clients’ understanding of investment portfolios. This is particularly important for institutional investors who are putting their own portfolios together and require a high degree of transparency in the information they receive. An in-house risk management function can therefore provide a tailored service to these clients and explain the granular details behind each fund – where there is volatility, where there is correlation – so they know exactly what they are buying. In this way, risk analysis is able to prove to clients that investment portfolios are ‘true to label’ by backing up what fund managers say with hard evidence.
Importantly, risk analysts should not ‘police’ fund managers on the risk in their portfolios. Risk management exists to help preserve and maximise investment performance. There is now a trend in the market towards much more active fund management so an advisory risk management function is even more necessary in this climate.
Therefore a dedicated in-house risk management function can provide an effective resource to fund managers with comprehensive analysis and expert advice in their management of investment risk, with a view to maximising alpha from stock selection. Additionally, this helps ensure consistency in the investment process and a detailed understanding of portfolio construction.
Case study: M&G Pan European Fund
The M&G Pan European Fund was positioned defensively at the beginning of 2009. Since then, the M&G portfolio strategy & risk (PSR) team has been working with the fund manager, Giles Worthington, to cautiously add beta to the fund and reduce the underweight to GDP- and credit-sensitive stocks. This is intended to boost performance in rising markets, as well as protecting the portfolio in falling markets.
In conjunction with the PSR team, Giles has since reduced the underweight position in financials by buying high quality growth insurance stocks such as Storebrand, AXA and Prudential. While reducing the underweight to financials, a new holding in Banco Santander also provides exposure to a high-quality business (strong dividend and balance sheet) that is both geographically-diversified and has asset growth potential.
The chart below shows the evolution of the fund’s beta as Giles has gradually added risk (beta) through increasing exposure to GDP sensitives and searching for individual stocks with high growth potential.
While stock selection continues to be the key driver of performance, the benefits of increased emphasis on risk management are evident in fund’s improved risk-adjusted returns over the past three years. The fund is now well positioned with a balance of defensive and GDP-sensitive stocks, which enables it to perform well in rising markets, as well as retaining relative performance in falling markets.
Weitere beliebte Meldungen:
