Managers are being rewarded for skill like never before. Constraints are being relaxed on their mandates and performance fees introduced to better incentivise the skilled managers.
It looks, on the surface, like the cliched win-win situation. The trick, though, is to identify that skill. The one constraint being increasingly unburdened from equity managers and about which there is no argument from the academics is the long-only constraint. Put simply, the argument is intuitive: allowing a manager to also short stocks provides for greater choice; it’s a breadth-of-market argument. A skilled manager should outperform more consistently, all other things being equal.
The empirical evidence to date supports the theory, however, some will inevitably argue that the universe of long/short managers is relatively small and time periods for study relatively short. The latest Mercer Australian shares survey, for periods to April 2008, shows that the median equitised long/short fund – mostly 130:30 funds but including some with more leverage than that – would have been in the upper quartile of performance for Australian long-only funds for most periods in the past five years (one, three and five years).
The common elements of these funds is that they allow a certain level of shorting and they have a beta of one. This means that, in the case of 130:30 funds, with 130 per cent long and 30 per cent short, the investor effectively has 160 per cent of their money at work.
A customised Mercer survey (see table) indicates specifically how the long/short managers fared since the credit crunch hit the markets last year, when November was the first full negative month post-crisis. This still shows outperformance by the long/shorts, although to a lesser degree than one, three and five-year periods, relative to a long-only universe of Aussie equities managers.
The point about the credit crisis is that many quant-orientated managers tended to underperform their fundamental peers for several months, prompting a lot of debate as to whether they had lost their magic altogether. In Australia, Watson Wyatt produced a client note suggesting that because of the weight of money in largely similar quant strategies, these managers may not outperform by as much in the future as they have tended to do in the past.
The two culprits in Aussie equities – Barclays Global Investors (BGI) and State Street Global Advisors (SSgA) – happen to be the largest and arguably most sophisticated of the quants in the world. They haven’t taken too kindly to suggestions their underperformance may be anything other than cyclical. Richard Lacaille, head of global active equities strategies for SSgA, points out that performance has improved since January. “We’ve lived through various market conditions for a long long time,” he says. “When you have a change of leadership, the quants tend to have a period of underperformance and then they come back.”