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Risky business

Understanding a portfolio manager’s approach to risk is an important aspect of fund assessment. An impressive track record should always be considered in relation to the degree of risk taken to achieve it.

Many advisers will look at risk-adjusted performance measures when selecting a fund – things like tracking error figures, Sharpe or information ratios. The problem is you need a three-year track record for it to have any value.

As an adviser, what can you do? Maybe turn to a multi-manager fund?

Multi-manager diversification is always going to help lower the level of risk in a portfolio simply because a number of funds are combined. However, in my last column I made it clear that all multi-managers are not the same, which in turn means the risks you are taking on your clients’ behalf can be quite different. Some managers will take large asset allocation bets (aggressive asset allocators) while others will look to add performance through fund selection (alpha generators), and others will look to mitigate as much risk as possible, acting more like an index tracker (risk mitigators).

Looking at these three categories, some comparison work we recently did may be of use. Take the average fees, performance and risk characteristics of multi-manager funds over a three-year period. Probably the most important figure is the information ratio. This combines the risk and performance of a fund relative to its benchmark. An information ratio of 0.5 per cent over the long term (three years) would be considered commendable.

In our figures, the alpha generators information ratio improved from 0.23 to 0.48 while the asset allocators’ IR dropped from 1.18 to 0.89. Why the fall?

It again goes back to the level of risk that you are prepared to take. If you get asset allocation calls wrong then the performance compared with the units of risk you are taking will be put under pressure.

With time being of the essence, advisers may find this sort of analysis difficult. A quick way of looking at the levels of risk you are taking is to compare asset allocations of a fund over one year. Some big changes? Again, this is not necessarily a criticism as such moves are welcomed by an investor wanting to take risk. However, for the more cautious individuals, strategic asset allocation may be to their liking.

Finally, in periods of volatility you may not want the added risk of asset allocation and instead invest in a multi-manager fund that has underlying managers prepared to trade and add positive alpha during such periods.

Philip Morse is business development director of Fidelity International’s multi-manager business.


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