Leon Greyling, COO at ICTS
I visited Wimbledon once and one of the attractions for going was the strawberries and cream. Well actually it was more like strawberries and milk (nothing like what was advertised on tv) but who’s complaining!
The similarity between strawberries and cream and risk and return lies in the concept of balance and complementarity. Both represent pairs that work best when combined in the right proportion, where one element enriches and depends on the other to create an optimal experience or outcome. Let’s unpack that:
Strawberries and Cream
Balance: Strawberries bring a natural tartness, while cream adds smooth sweetness. Together, they balance each other.
Complementary Relationship: Without the cream, the strawberries might feel incomplete, and vice versa.
Risk and Return
Balance: Risk represents potential downsides (volatility or losses), while return is the reward for taking on that risk.
Complementary Relationship: High returns are generally not possible without taking on higher risks, and low-risk investments typically offer lower returns.
In both cases:
Optimal Combination: Success lies in finding the right blend – enough cream to complement the strawberries, or enough risk to achieve the desired return.
Interdependence: Strawberries and cream don’t shine alone in the same way they do together, just as risk and return are inseparable in the investment world.
Ultimately, both are about creating harmony: a delicious dessert in one case, and a sound investment strategy in the other.
So that all makes total sense, but when we analyse investment surveys how do we assess optimal combinations and assess their interdependence? What should you as a consultant or trustee be looking for (or at)?
I looked at the Equity surveys this month – particularly the “benchmark cognisant” results. They provide risk stats by way of:
Standard deviation measures the dispersion or variability of returns, around their mean. It is a common indicator of risk. A higher standard deviation suggests greater volatility, meaning the returns fluctuate widely, while a lower standard deviation indicates more stable returns. It helps investors assess the uncertainty and potential risk associated with an investment i.e. good return at high volatility indicates the potential for that picture to change quickly.
Tracking error measures the divergence between the performance of an investment portfolio and its benchmark index. A high tracking error indicates greater deviations from the benchmark, often due to active management strategies, while a low tracking error suggests the portfolio closely mirrors the benchmark, as in passive or index investing. Tracking error helps investors assess how closely a fund aligns with its stated benchmark and evaluate the impact of active management decisions.
Information Ratio measures the efficiency of a portfolio manager’s ability to generate excess returns relative to a benchmark, adjusted for the risk taken to achieve those returns. It is calculated by dividing the portfolio’s average excess return by its tracking error. A higher Information Ratio indicates that the manager is delivering more excess return per unit of risk, signifying skillful active management.
Well done to 36One who have produced the top active returns over a 3- and 5-year period, while doing so without excessive volatility. In fact, they rank 4th and 6th over each period respectively for lowest volatility. Their tracking error (risk assumed) is reasonably high (not excessive compared to others) which puts them right at the top of the pops when considering Information Ratio. Stanlib’s Core Multi-Factor Equity Fund looks good on the same basis over 3-years, dropping a bit over 5 years, while the lesser recognized Mentenova is consistently strong over both periods.
Is that helpful for fiduciaries though in making decisions?
Again, there’s a lot of detail and data in the surveys. Too much for the layman to make head or tails of it, so here is my view on how you should approach this, and it starts at the beginning…
When setting an investment strategy a fund should (along with the advice and analysis of their investment consultant) determine the return they require and in doing so assess the risk they will need to assume i.e. you want to aim for x in return, you should expect y in risk. But what is that y?
My view, y is the experience you can expect i.e. the ride, in getting to your destination i.e. the x, so that when the road gets bumpy (volatile markets, unexpected events etc. occur) you can be better prepared and less emotional at those moments and make good decisions, rather than knee-jerk reactions i.e. unnecessary and costly changes. More simply put, you need a reference to look back at and this should be the cornerstone in all reporting at total strategy and individual investment manager level. I would argue that you should always quantify the expected downside risk i.e. expected number of negative returns and extent thereof for your chosen strategy, as it is when things look bad that it’s difficult to avoid bad decisions. Off the back thereof, select specific risk measures for your chosen investment managers upfront and compare thereto as you progress. I unfortunately haven’t seen good risk reporting (from a fiduciaries perspective) in the industry…yet!
Here’s something extra to chew on though….
The average active return over 3 years is 0,12% per annum i.e. that’s performance above benchmark. Over 5 years it is 0,76% p.a. Remember, these are gross of fees i.e. before taking off fees. Given that active management fees are generally about 0,5% more than on passive/index funds, it makes one think now, doesn’t it?! This picture changes somewhat when looking at the “not benchmark congisant” portfolios but with a requisite increase in volatility – makes sense i.e. more risk/more return but is the risk worth it? The dispersion between manager returns is high. In other words, if you select the wrong managers (the stats show you have about a 50/50 chance of getting it right, or wrong!) you can get badly burnt, and when you do, you’ll tend to move to those that look good, and we know how that story plays out….
Strangely, despite this, passive management hasn’t been all that popular in South Africa to this point!
Thank you to those of you who wrote to me post my last article expressing your thoughts about the industry surveys. This column is intended to assist the industry (and perhaps the survey providers) in ultimately making better informed decisions. I hope it serves an ace on that!
Next month we’ll consider risk, return and its relationship with assets under management.
But right now…. it’s time for dessert.
