The Changing Face of Skill A Global Overview Roland Rousseau Head: - - PowerPoint PPT Presentation

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?

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

Historic Evolution of Fund Management

The Changing Face of Skill

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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)

Historic Evolution of Fund Management

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The Changing Face of Skill

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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?

Historic Evolution of Fund Management

The Changing Face of Skill

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Latest Global Thinking:

Both Active and Passive Investments are delivering unnecessary ‘excess’ risk!

Risk Premia are like Biofuel

The Changing Face of Skill

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• Why do we invest in Equities?
• Risk Premia are not a free lunch!
• Excess returns exist regardless of skill

Risk-Factor

eg currency, interest rates

0% Risk-Premium

eg equity, value, momentum, EM etc

5%

WITS/Barclays SA Risk Premia

• Database without survivorship bias
• 4 risk-premia explain >80% of active-risk
• Momentum, Low-Beta, Stock-specific risk,

Value, Rand

Never Confuse Higher Return with Skill

The Changing Face of Skill

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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

• f a) skill or b) excess risk?

Mirror, mirror on the wall…

The Changing Face of Skill

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200 400 600 800 1000 1200

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

FTSE/JSE RAFI FTSE/JSE ALSI 200 400 600 800 1000 1200

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Allan Gray Equity A FTSE/JSE RAFI FTSE/JSE ALSI 200 400 600 800 1000 1200

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Coronation Equity R Allan Gray Equity A FTSE/JSE RAFI FTSE/JSE ALSI 200 400 600 800 1000 1200

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

FTSE/JSE Div+ Coronation Equity R Allan Gray Equity A FTSE/JSE RAFI FTSE/JSE ALSI

We actually don’t know! Never confuse higher return with skill… Who has the most Skill? So, who has the most Skill?

Source: Morningstar, FTSE/JSE

Exposure vs Relative Return

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Momentum Risk Premium Value Risk Premium Stock-Specific Risk Premium Low Beta Risk Premium

Example: Allan Gray Equity Fund

Did the risk exposures deliver excess return?

Excess Return vs ALSI (pa) Excess Return vs ALSI (pa)

Source: WITS/Barclays

Source: WITS/Barclays

How about a direct allocation to the risk premia? Who is going to do allocation?

The New Definition of Skill

Passive investing Active investing

Typical Goal Beat Benchmark In near future, imagine investors explicitly incentivised delivering more efficient risk budget payoff (lower costs + lower risk) Typical Goal Track Benchmark

Dynamic Risk Control

New Goal Manage Risk

Norway begins a ‘risk management’ revolution

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Despite broad global diversification many of the asset classes had exposures to the same risk factors (eg liquidity).

Source: NBIM Annual Report

Government Pension Fund - Global

Andrew Ang William Goetzmann Stephen Schaefer

They showed that ’risk factor’ allocation is superior to traditional asset allocation

Requires understanding of economic and business cycle

Future of Investment Skill

The Changing Face of Skill

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Current Situation (Asset Allocation) High Risk Medium Risk Low Risk a) backward looking b) investors’ risk tolerance changes c) false expectations through risk cycle Future Mandate (Dynamic Risk Control) Maximise my upside with ‘shortfall’ or tail-risk less than eg. 15%

Value of eg Market Spot

Requires understanding of risk cycle and risk-factor allocation (eg CPPI)

How do we Find Skill?

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

“Gamblers are convinced they can beat the system, despite all the evidence to the contrary.” – Overcoming Addiction

questions