Page 672 – Top1000funds.com

A chief architect of the A$68 billion ($60 billion) Australian Future Fund‘s investment strategy will leave in two weeks to form a new business offering asset allocation and macroeconomic strategy advice to large fiduciary investors globally.

Tony Day, who joined the Future Fund in its early days of 2007, said that at 44 years of age and a career entirely in the public service, it was time to “chance his arm” in the free markets in which he so passionately believed.

He said he hopes he will continue to generate ideas for the sovereign wealth fund, which in the meantime will replace him with his understudy.

Day will go it alone in a new business offering asset allocation and macroeconomic strategy advice to large fiduciary investors. He said he was “in negotiations” for the Future Fund to be an early client, as well as other major institutions, both here and overseas, with whom he dealt during his tenure at Future Fund and before that in his 12 years as chief strategist for Queensland Investment Corporation.

Day will be replaced by the Future Fund‘s current senior strategist, Stephen Gilmore, who joined last August after previous experience with Morgan Stanley, AIG Financial Products, International Monetary Fund and the Reserve Bank of New Zealand.

Day hoped that the Future Fund would “continue to get the best third of what I do”, which was generating thematic investment ideas as opposed to being part of a senior management team.

“It’s probably no secret to anyone that I’ve got a distaste for bureaucracy,” he said. “But the guys [at the Future Fund] have set up a fantastic mandate,” he said.

The chief investment officer of the Future Fund, David Neal, said that Day had “played a critical role during the important establishment phase of the Fund, building a highly skilled team, shaping the long-term asset allocation and helping to protect and grow the Fund in an enormously challenging environment.”

Asked to name the highlight of his Future Fund tenure, Day said it was “hard to beat” the decision to pause the process of getting set in equities in late 2008.

The Fund instead maintained a high weighting to cash, and so was one of the world’s few investors to make a positive absolute return for 2008-09.

“There was that myth around that we got lucky, but I can tell you, we’d been on the march to 70 per cent [growth assets exposure] and to stop it was a really big team call,” Day remembered.

He added it was a “false rumour” that any former QIC colleagues would join him in his new venture, insisting he wished to “keep it small and focussed”.

Using performance, even as a filter, to hire or fire funds managers is a dangerous game, according to head of the international division at Enhanced Investment Technologies (INTECH), David Schofield.

Choosing any partner, whether personal or business, can be fraught with complexity, and the process of hiring and firing managers does not escape those selection perils.

While most sophisticated investors pay more attention to investment process, over performance, the latter still acts at least as a filter for most shortlists.

A recent paper by Enhanced Investment Technologies (INTECH) explores how insidious chasing performance can be.

The paper aims to provide a framework for mitigating the detrimental effects of chasing performance; by putting historical performance in its “proper analytical perspective”, where the focus is on the investment process and historical performance plays a secondary role.

David Schofield, president of the international division for the firm, which adopts a unique investment process based on the mathematical foundation of Stochastic Portfolio Theory, believes a rudimentary screen on process should be preferred over the common default screening on numbers only.

“Investors have to have some sort of screen to narrow the field but by basing it on performance you are probably excluding some good with the bad. The key thing is to attempt to identify the process that makes a priori sense, but most are based on financial theory and equity assumptions,” he says.

“Most sophisticated investors pay more attention to investment process, over performance, but it is still often a secondary attention – the short list still arises through a performance filter. And even those institutional investors hiring on process will fire on performance.”

In the INTECH paper, “Chasing performance is a dangerous game,” authors, Robert Ferguson, Jason Greene and Carl Moss, use a mathematically-based parable to demonstrate the shortfalls of using performance to measure managers.

In the working example (see the paper here) it shows the probability that the good manager beats 20 bad managers over a 10-year period is only about 9.6 per cent.

“This implies that chasing performance leaves the investor with the good manager only about 9.6 per cent of the time and with a bad manager about 90.4 per cent of the time. The investor’s average relative return will be only 19.3 bps annually, his tracking error will be 980.7 bps and his information ratio will only be 0.024. This compared with 200 bps, 800 bps, and 0.25 for the good manager.

“Sceptics might argue that the number of managers at a finals presentation typically is far less than 20. This misses the point. The adverse filtering on historical performance begins early in the manager selection process. The universe of investment managers that the finalists are drawn from far exceeds 20. The problem may actually be worse than depicted here.”

The paper also explores the argument that a good manager may beat bad managers over time and all that is required is a longer historical performance record.

“For manager skill to have a proper opportunity to assert itself there has to have a reasonable length of time and three to five years is nowhere near long enough,” Schofield says.

In fact, the paper, shows that based on numbers alone it would take 157 years to have 75 per cent confidence that the good manager, in the paper’s example, will beat all the bad managers.

Given the fact it is common practice to filter managers using performance, Schofield believes at the least the limitations of doing that need to be more transparent, and further, that academic studies to assess managers according to process are needed.

“Given the fact an initial focus on numbers is almost unavoidable, people doing that analysis need to be aware of limitations of that analysis, and the role of luck,” he says.

Ironically, for the firm whose corridors are filled with mathematicians, INTECH’s view is a focus on more qualitative rather than pure quantitative analysis for manager selection would be beneficial.

“There is no real certainty in choosing a manager, but the starting point should be the process and then the context of that should be the performance. Investors should look at what needs to happen to deliver the alpha. If not, you may as well throw darts at a dart board. If a manager has had an unusually good or unusually bad run you need to look under the bonnet. Are they still doing the same thing, is the company the same, is the market the same.”

Schofield says this is true of listed products, but perhaps more so for unlisted asset classes where the numbers are less transparent, and it is difficult to measure performance.

Chasing Performance Is A Dangerous Game (PDF)

Hedge funds have had a bad rap for a long time, often undeserved. But the global financial crisis coupled with the Madoff scandal has affected their growth. UK-based alternatives research firm Preqin surveyed 50 institutional investors about their investments with hedge funds and hedge funds of funds (FoFs).

The demands of institutional investors following their experiences of the past two years are re-shaping the hedge fund industry as it emerges from the financial crisis, according to a Preqin report.

The report is based on a survey of 50 institutional investors, which included pension funds, endowments, family offices, asset managers and insurance companies, which took place in June.

The survey showed a trend away from hedge FoFs, but this is primarily among those investors with the most experience in the space. There is still good demand for hedge FoFs, especially among newer investors.

“FoFs are still viewed positively by institutional investors, with a significant proportion utilizing multi-manager vehicles as an educational tool to familiarise themselves with the asset class,” the report says.

“(Hedge FoFs) can expect a steady flow of mandates as new investors are constantly committing to the asset class.

“However, as the institutional market continues to mature, we can expect an increasing number to allocate capital to single-manager funds.

“As a manager of FoFs it is increasingly important to be aware of which investors are looking to take their first steps into the asset class in order to market your fund to the correct audience.”

The survey shows that while 64 per cent of respondents gained their first exposure to hedge funds via FoFs, only 36 per cent still invest solely through the multi-manager vehicles.

Most of the respondents who moved away from FoFs did so during 2008, when hedge fund manager Bernie Madoff was charged with defrauding clients over a long period, some of whom were well-known hedge FoFs.

But the desire for lower fees and more control over their investments are the main driver of the trend. A total of 60 per cent say lower fees from direct hedge funds and 54 per cent say the need for more “control” are the top reasons for going into direct investments instead of FoFs.

Of those who remain invested in FoFs, 66 per cent say that this is because of the diversification benefits, followed by 40 per cent who say it is because they lack the in-house resources to thoroughly research underlying hedge fund managers.

Is it possible for a human being to manage an absolute-returns fund? If you believe the latest behavioural finance research, it must be very difficult.

(more…)

The $32 billion United Nations Joint Staff Pension Fund has outperformed due to a commitment to active management, a willingness to invest away from the trending market, and a realistic target return. (click on the photo for more…)

Global equities The A$25 billion ($21 billion) UniSuper is revolutionising its $4 billion international equities portfolio, terminating every active developed markets manager in favour of passively tracking the MSCI World, while alpha is sought among specialist regional and sectoral managers, with a listed technology mandate to be first cab off the rank.

The chief investment officer of UniSuper, John Pearce, said the overhaul had been in progress over several months, given the volume of assets involved.

“This move is not an argument for passive management: myself and my team here are big believers in active management. It’s just a question of where will the allocation of our research time to find the best active managers yield the best results,” Pearce said.

“And at this stage, we don’t believe that’s in developed-market equities mandates.”

About 10 such mandates have been terminated by UniSuper over the course of 2010, with the money sitting passively for now, awaiting a risk budget re-allocation which will seek more specialist exposures to regions or sectors where Pearce’s team believes there is value to be added.

A specialist technology manager is currently being sought, with Pearce reasoning that this was a natural area of underweight for Australian investors given the market’s scarcity of technology stocks.

UniSuper has maintained its existing active emerging markets mandates, meaning houses such as GMO, Mondrian and Treasury Asia Asset Management continue to run money for the big industry fund.