Tag Archives: manager

How Valeant Revealed The Dirty Little Secret Of Fund Management

How would you feel if your equity fund manager lagged the index by 5% in a year? Supposing that you hired the manager, or bought his fund, as part of the diversified equity portion of your portfolio and he missed by 5% in a year. Let’s say that you be patient, then he underperforms by another 5% in the next six months. Would you fire someone who lags the market by 10% in 18 months? Returns vs. business risk I have met people who say that they love managers who hit the home run and loathe benchmark huggers, but investors get very nervous when their managers lag the market by as little as 5-10% in a relatively short (1-3 years) time frame. From the perspective of the manager, this level of risk tolerance brings up the issue of business risk. How do you maximize performance using your process, or “secret sauce”, without taking on excessive business risk that sinks the entire firm? Risk comes in all shapes and sizes. For an equity portfolio, common sources of risk are sector and industry risk, market cap risk and stock specific risk. To illustrate my example, consider the lowly issue of stock specific risk, which should be diversifiable (at least according to theory). The recent case of price volatility in Valeant Pharmaceuticals (NYSE: VRX ) is an instructive example in risk control. In the past few weeks, I have spoken to a number of Canadian portfolio managers whose performance was blindsided by specific risk from that one single stock, The outlook for VRX is highly divisive and talking about it is the equivalent of bringing up touchy topics like religion or gun control in polite company. (Incidentally, I have no opinion on the stock.) The chart below depicts the price of VRX in the top panel and the TSX-VRX ratio in the bottom panel, which shows what would have happened to relative performance had a manager had no position in VRX for the past few years. Despite the fact that the stock got hit today, VRX has shown remarkable returns in the past few years. In the space of about 5 years, the stock has become a 10-bagger and anyone who didn’t own it would have underperformed the index (bottom panel). Consider the following effects for a manager who did not hold VRX: If he didn’t own it at the end of 2013, relative return shortfall would be over 8% when VRX hit its peak this year. For some investment organizations, that kind of shortfall could be a near-death experience. Even with the pullback, relative performance shortfall would only be back to 2013 levels and he have not made up for the shortfalls in the previous years. The art of business risk management The analysis brings up a key question for the business risk for investment management operations. Yes, we would all like to have the courage to bet our investment convictions, but how much business risk is the practice willing to take? Supposing that an operation were to lose half its clients because of a single decision on a stock, what does that do to the bottom line? Revenues would go down by about 50%, but there are fixed costs such as rent, salaries, systems, legals, etc. Profitability would plunge in such an instance, is the investment management business willing to take that kind of risk? If not, then there are a couple of steps a manager can do. First, he has to decide the appropriate level of stock specific risk he is willing to take against the benchmark. Supposing a stock has a 3.5% weight in the benchmark, would you hold a 0% if you ranked it a “sell” (-3.5% bet), a non-zero weight, such as 2.5% (+/- 1% vs, benchmark) or 1.5% (+/- 2% vs. benchmark)? On the other hand, if your ranked it a “buy”, would a 5.5% weight (+/- 2% vs. benchmark) be appropriate? What about 8.5% (+/- 5% vs. benchmark)? Another way of approaching the problem would be to try and determine the median competitor weight in the stock (with techniques that I have written about before). Then set benchmark weight to be the median competitor weight instead of the index weight. I show this example as just how a simple decision on a single stock can crash an entire investment management practice. I haven’t even gone into all the other ways that risk can rear its ugly head, such as macro factor, sector, size and so on. Asking too much of managers? This post also illustrates the dirty little secret of fund management. Investors are asking too much of managers and managers are consequently reacting rationally by closet indexing. Investors have to ask themselves: How much rope are you willing to give a manager to succeed? Is John Hussman flaming out, or is he a brilliant thinker going through a bad patch? Other well-known managers like Bill Miller and Ken Heebner have had their ups and downs, how patient are you willing to be? If you have a low level of patience, then you are forcing managers to become benchmark huggers because you are not giving them enough room to win. For managers: Given the realities of the market, how much risk are you willing to take so you don’t crash your firm? The opinions and any recommendations expressed in this blog are solely those of the author. None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.

Investing For Impact: A Brief Guide For The Perplexed

By Travis Allen and Anne Bucciarelli (click to enlarge) Discussions about investment strategies that take values or ethical principles into account can be confusing. Several different terms are used, often interchangeably; in fact, they may be converging. The most common terms we hear are socially responsible investing (SRI); environmental, social, and governance (ESG) principles; and impact investing. SRI strategies usually employ screens to identify companies to include or exclude, based on the manager’s or the investor’s ideas about their social impacts. ESG strategies are similar but tend to focus on certain areas of concern: Environmental factors, including climate change, hazardous-waste disposal, nuclear energy, and natural-resource depletion; Social factors, including human and labor rights, consumer protection, and diversity; and Corporate-governance factors, including management structure, executive compensation, and shareholder rights. Some, but not all, ESG-oriented institutional investors are signatories to the United Nations-supported Principles for Responsible investment (PRI). Impact investing goes further: It seeks to invest (usually privately) in organizations having a positive impact in a particular area, perhaps to revive a blighted neighborhood. Investors often feel empowered by impact investing, but they should recognize the risks. These investments can be as risky as venture capital. Such investments may be best made with capital that exceeds your target financial capital (the amount of money you need to fund you long-term spending). Impact on Portfolios There are many ways to address SRI or ESG concerns. Some investment managers buy or create ESG screening tools to help them avoid investing in companies with undesirable practices or products. We think such tools may be useful but are rarely enough. AB integrates research into potential ESG issues for a company into all parts of our research process, from meetings with company managements, suppliers, and industry experts, to monitoring news reports, as the display shows: But assessing ESG issues can raise as many questions as it answers. For example, if you try to avoid investing in companies with high cardon dioxide emissions or abusive labor practices, do you have to check all the vendors of each company you consider? Many technology and clothing companies are now under attack for the actions of their suppliers, or of their suppliers’ suppliers. Investors should also recognize that both positive and negative screens limit portfolio managers’ flexibility and may affect portfolio returns. Investors with otherwise identical portfolios are likely to have different results, if one of them imposes restrictions on companies in certain industries. Some ESG advocates argue that companies with an ESG focus can outperform the broad market over time. Other people argue that narrowing the universe of potential investments is likely to detract from long-term returns relative to more diversified standard benchmarks. Perhaps the arguments of the ESG advocates are true, but it’s too soon to tell. While the number of managers that invest with a social lens is growing, few ESG managers have a statistically meaningful track record. Therefore, we think it is still too early to assess the relative performance of the ESG segment. Investors whose priority is a portfolio that reflects their personal values now have a range of choices to meet their social as well as financial goals. The goal for such investors should be to work with managers who share their philosophy about social issues, as well as risk and return. Disclaimer: The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AB portfolio-management teams.