Presentation Transcript

1. Active Investing – The alpha, the beta & what’s importantParadigm Regional Workshops

   Nov/Dec 2013
2. Learning objectives Active and passive management – understanding their roles in a portfolio and the differences between them A refresh of your knowledge on alpha and beta and why they work together To gain insight into some key risk metrics such as Sharpe & Information Ratio and their relevance / importance – illustrated by some industry examples A brief insight into how Threadneedle can assist your business and clients on active investing via Tatton Portfolios & OBSR PT/12/01027
3. 1 Active vs Passive
4. Active & Passive They both have a role! PT/12/01027
5. 2 Absolute Risk (Volatility)
6. Absolute Risk (Volatility)The formula Population Standard Deviation Sample Standard Deviation (Bessel’s Correction) PT/12/01027
7. Absolute Risk (Volatility)In practice Absolute risk indicates the (historical) volatility in a fund’s annual return. It is calculated as the annualised (% p.a.) standard deviation of the monthly returns of a fund over a three year period. Interpretation and use of absolute risk PT/12/01027
8. Absolute Risk (Volatility)In practice The volatility of a fund is partly driven by the asset types to which it is exposed. A fund exposed to equities will normally have a higher volatility than a fund with no equity exposure. This is reflected in the absolute volatility of some of Threadneedle’s funds. A fund with high absolute risk exhibits greater uncertainty than a fund with a low absolute risk. Source: Threadneedle, in GBP, as at 31st July. PT/12/01027
9. 3 Beta (Market Risk)
10. What is beta? PT/12/01027
11. Beta (Market Risk)A measure of how sensitive the fund is to the market Absolute Risk = Applies to all companies CANNOT be reduced with diversification Specific to the company CAN be reduced with diversification This is beta PT/12/01027
12. Beta (Market Risk)The formula Where Cov (Rp,Rm) is the covariance of the portfolio return with the market return and Var (Rm) is the variance (or standard deviation squared) of the market return Beta R Squared – Measures the correlation between fund and benchmark: gives an indication of the reliability of Beta. Above 0.9 indicates a high degree of correlation. Below 0.75 would suggest that no reliance should be placed on Beta R Squared – Measures the correlation between fund and benchmark: gives an indication of the reliability of Beta. Above 0.9 indicates a high degree of correlation. Below 0.75 would suggest that no reliance should be placed on Beta PT/12/01027
13. Beta (Market Risk)What it means Beta provides a measure of a fund’s sensitivity to movements in the market in which it is invested, at a particular point in time. By definition, the market/benchmark has a Beta of 1 Beta is only of use when calculated against a relevant benchmark. If there is little correlation between the fund and the benchmark, the resultant Beta will be of little use as a risk measure A Beta of 1 means the fund moves in line with the market / benchmark (e.g. perfect tracker) Beta > 1 means the fund is more aggressive than the market / benchmark Beta < 1 means the fund is more defensive than the market / benchmark A Beta of 1 means the fund moves in line with the market / benchmark (e.g. perfect tracker) Beta > 1 means the fund is more aggressive than the market / benchmark Beta < 1 means the fund is more defensive than the market / benchmark *Source: Threadneedle, as at 31st July 2013, against the benchmark over 3 years. PT/12/01027
14. 4 Jensen Alpha
15. What is alpha? PT/12/01027
16. Jensen AlphaRisk-adjusted performance measurement Capital Asset Pricing Model (CAPM) The Security Market Line Undervalued stocks = R + ? ( - R ) Expected return E(R) f a f Overvalued stocks Where: R = Risk free rate E(Rm) f Market portfolio ? = Beta of security a R1 = Expected market return Jensen Alpha is simply the excess return over that expected by CAPM β=1 Systematic risk β PT/12/01027
17. Jensen AlphaIn practice Jensen Alpha is the difference between the return you would expect from a fund, given its Beta, and the return that it actually produced. If a fund returns more than its Beta would predict, it has a positive Jensen Alpha, and if it returns less than the amount predicted by Beta, the fund has a negative Jensen Alpha. Worked Example If the Risk Free Rate was 3.5%, the expected return on the market was 10% and a fund had a Beta of 1.2, CAPM would be calculated as follows: Expected Return = 3.5 + 1.2(10-3.5) = 3.5 + 7.8 = 11.3% If the portfolio actually returned 13%, it would have a Jensen Alpha of 1.7. If it only returned 10%, it would have a Jensen Alpha of -1.3 Positive Jensen Alpha indicates an outperforming fund If the portfolio actually returned 13%, it would have a Jensen Alpha of 1.7. If it only returned 10%, it would have a Jensen Alpha of -1.3 Positive Jensen Alpha indicates an outperforming fund PT/12/01027
18. 5 Sharpe & Information Ratios
19. Sharpe RatioRisk-adjusted performance measurement The Sharpe Ratio is the excess return, over cash, generated per unit of volatility (or risk). Formula Where: R = Return of portfolio p R = Risk free rate (cash on deposit) f = Standard deviation of the portfolio PT/12/01027
20. Sharpe RatioIn practice Worked Example A fund returns 24%, has a Beta of 1.1 and a Standard Deviation of 19%. The risk free rate is 3%. Sharpe = (24 – 3)/19 = 1.11 Interpretation and use of Sharpe Ratio A higher number means you get more return per unit of risk One significant advantage of the Sharpe Ratio over the Jensen Alpha is that it measures the volatility of a fund’s return – not relative to an index – so we don’t have the problem of index correlation The primary disadvantage of the Sharpe Ratio is that it is just a number and it is meaningless unless you compare it to several other funds with similar objectives A higher number means you get more return per unit of risk PT/12/01027
21. Information Ratio Information Ratio is a measure of how successful a fund has been at taking risk relative to the benchmark. Formula Information Ratio = Worked example: Funds A and B outperform their benchmarks by 4%. Fund A has a Tracking Error of 8% and Fund B’s is 5%. Fund A Information Ratio = 4/8 = 0.5 Fund B Information Ratio = 4/5 = 0.8 Fund B has a higher Information Ratio as it has achieved the same outperformance by taking less risk than Fund A. Anything positive is above average, 0.3-0.5+ is very good. A negative Information Ratio means the fund has underperformed its benchmark. The larger the number the more skilled the fund manager has been. Fund B has a higher Information Ratio as it has achieved the same outperformance by taking less risk than Fund A. Anything positive is above average, 0.3-0.5+ is very good. A negative Information Ratio means the fund has underperformed its benchmark. The larger the number the more skilled the fund manager has been. PT/12/01027
22. 6 A couple of examples – UK Equity Income & US
23. Key UK Equity Income funds vs Benchmark Performance table from UK Retail UT and OEICs universe Source: Morningstar as at 30 September 2013. Rebased in GBP and ranked within table. The value of units can fall as well as rise. Past performance should not be seen as an indication of future performance. Our UK Equity Income features in both Tatton & OBSR
24. Key American Funds vs Benchmark Performance table from UK Retail UT and OEICs universe Source: Morningstar as at 30 September 2013. Rebased in GBP and ranked within table. The value of units can fall as well as rise. Past performance should not be seen as an indication of future performance. Our American fund features in Tatton
25. Learning outcomes Active and passive management – understanding their roles in a portfolio and the differences between them A refresh of your knowledge on alpha and beta and why they work together To gain insight into some key risk metrics such as Sharpe & Information Ratio and their relevance / importance – illustrated by some industry examples A brief insight into how Threadneedle can assist your business and clients on active investing via the Tatton portfolios and OBSR PT/12/01027
26. Important information For internal use and for Professional and/or Qualified Investors only (not to be used with or passed on to retail clients) Past performance is not a guide to future performance. The value of investments and any income is not guaranteed and can go down as well as up and may be affected by exchange rate fluctuations. This means that an investor may not get back the amount invested. Threadneedle Investment Funds ICVC (“TIF”) is an open-ended investment company structured as an umbrella company, incorporated in England and Wales, authorised and regulated in the UK by the Financial Conduct Authority (FCA) as a UCITS scheme. TIF is registered for public offer in Austria, Belgium, Finland, France, Germany, Hong Kong, Ireland, Italy, Luxembourg, the Netherlands, Portugal, Spain, Switzerland (some sub-funds only) and the UK. Shares in the Funds may not be offered to the public in any other country and this document must not be issued, circulated or distributed other than in circumstances which do not constitute an offer to the public and are in accordance with applicable local legislation. This presentation and its contents are confidential and proprietary. The information provided in this presentation is for the sole use of those attending the presentation. It may not be reproduced in any form or passed on to any third party without the express written permission of Threadneedle Investments. This presentation is the property of Threadneedle Investments and must be returned upon request. Income may fluctuate in accordance with market conditions and taxation arrangements. The difference at any one time between the sale and repurchase price of units in the scheme means that the investment should be viewed as a medium to long term investment. Investments may be subject to sudden and large falls in value, and the investor could lose the total value of the initial investment. Shares in the Funds may not be offered, sold or delivered directly or indirectly in the United States or to or for the account or benefit of any “U.S. Person”, as defined in Regulation S under the 1933 Act. This material is for information only and does not constitute an offer or solicitation of an order to buy or sell any securities or other financial instruments, or to provide investment advice or services. Please read the Prospectus before investing. This document is a marketing communication. The research and analysis included in this document have not been prepared in accordance with the legal requirements designed to promote its independence and have been produced by Threadneedle Investments for its own investment management activities, may have been acted upon prior to publication and is made available here incidentally. Any opinions expressed are made as at the date of publication but are subject to change without notice and should not be seen as investment advice. Information obtained from external sources is believed to be reliable but its accuracy or completeness cannot be guaranteed.Subscriptions to a Fund may only be made on the basis of the current Prospectus and the Key Investor Information Document, as well as the latest annual or interim reports and the applicable terms & conditions. Please refer to the ‘Risk Factors’ section of the Prospectus for all risks applicable to investing in any fund and specifically this Fund. The above documents can be obtained free of charge on request from: Threadneedle Investments’ Client Services department P.O. Box 10033, Chelmsford, Essex CM99 2AL. Issued by Threadneedle Investment Services Limited. Registered in England and Wales, Registered No. 3701768, St Mary Axe, London EC3A 8JQ, United Kingdom. Authorised and regulated in the UK by the Financial Conduct Authority. Threadneedle Investments is a brand name and both the Threadneedle Investments name and logo are trademarks or registered trademarks of the Threadneedle group of companies.