These types of strategies often make extraordinary claims, and extraordinary claims require extraordinary evidence. They tend to say they can deliver around cash plus 5 per cent (some aim higher), which is what global equities have done over the past 100 years or so. They further suggest this return will be achieved with a lot less risk – often with half the risk of equities, for example.
It is a genuine have your cake and eat it outcome. But there is an additional objective, too; that they can achieve these outcomes with significant regularity, which is usually on a three or five-year rolling basis. Our bar for evidence is, unsurprisingly, very high.
These strategies also tend to have a strong macro aspect and we always find qualitatively impressive macro views and teams. Yet we also know that most economists are smart and eloquent, but few tend to consistently have views that play out as expected.
The risk teams behind these strategies are impressive (as are their risk tools) and again we can easily get qualitative comfort. Yet risk is also tough to anticipate, particularly when it matters most: at big market inflection points. Therefore, while the teams behind these offerings are some of the strongest around, we tend to assume that a pure qualitative assessment could easily lead us astray so we look at the data.
Where we can get the data, we process every underlying investment idea since inception. By doing this, we aim to separate out signal from noise to see what signs of skill exist. We then do various tests on these since inception. For example, we look at the base hit rate – what proportion of ideas deliver as expected over time, versus those that don’t. We also look for bias: have trade types done most of the heavy lifting or is there genuine diversification?
We test how the individual strategies do when market conditions are weak or negative – can they deliver returns when markets are not supportive? It would be important that they have broad-based skill, across many (not all) strategy types. This would increase their odds of achieving their goals regardless of future market conditions. These and many other tests help us build a detailed picture of whether they can achieve their goals.
We also look at risk and test whether they manage risk well. For example, is the magnitude of returns generally commensurate with the risk being taken?
Currency or equity strategies often take a lot of the risk budget and payoffs are not always commensurate. Bonds have often been the opposite – where payoffs have been exceptional, but risk taken has been disproportionately low. We ask, are they taking enough risk? We then build a detailed picture of whether we feel they can achieve the upside with the lower levels of risk they take inside the fund.
Given the deep dive needed, it takes many months to evaluate each strategy and go through the data. In the end, you can look past the many moving parts and complexity, and gain a very clear bottom-up picture of whether these funds are likely to deliver the extraordinary outcomes they target. Unfortunately, more often than not, we find the odds of these strategy types achieving their tough goals seem low.
Rory Maguire is managing director at Fundhouse
