In an environment where alpha is at a premium, it’s more important than ever to know which of your funds managers are taking sufficient risks to achieve it. The proliferation of ‘concentrated’ versions of flagship Australian and international equity funds over the last couple of years might tell you that tracking error and stock count are the best indicators of alpha potential – but as this roundtable put together by Investment & Technology and Principal Global Investors last month shows, ‘concentration’ does not necessarily translate as that other buzzphrase of the moment, ‘high conviction’.
Participants at the roundtable were:
• Michael Bailey, editor, Investment & Technology
• Steven Carew, head of investment research, JANA
• Russell Clarke, CIO, Mercer
• Richard Dalidowicz, senior investment manager, AustralianSuper
• Tim Dunbar, executive director – equities, Principal Global Investors
• Kristian Fok, deputy managing director, Frontier
• Laurence Irlicht, investment director – quantitative analysis, VFMC
• Greg Liddell, director – implemented equities, QIC
• Mark Nebelung, portfolio manager, Principal Global Investors
• Amanda White, journalist, I&T Magazine
• David Wright, director, Zenith Investment Partners
Tim Dunbar: I spend a fair bit of time in Australia talking to clients and prospective clients. We always seem to end up talking about concentrated portfolios in one way or another. I think with some of the market turmoil over the last 18 months, some of our clients have seen some of their very concentrated portfolio managers have some very difficult times. And perhaps we’re seeing a little bit of interest back towards diversification. But the focus has and always will be on alpha. Everyone wants a lot of alpha and no volatility, and a lot of risk. And of course that doesn’t exist. So one of the things that we hope to get out of today is exactly what’s meant by ‘concentrated portfolios’, as well as how you determine an active manager from more of a passive manager.
What are some of the tools you can use? Mark, do you want to touch base on some of the work we’ve done and applied to our own portfolios and benchmarks?
Mark Nebelung: Historically there’s been this connection that tracking error translates into how active a particular strategy is. At Principal we’re fairly style neutral, so we’ve generally had fairly low tracking error. Yet in terms of our portfolios we’ve been very active. So we’ve been using the concept of an active share and coverage ratio. Basically looking at what proportion of our portfolio is actually overlapping the benchmark in terms of evaluating how active our portfolio is, rather than tracking error, because tracking error really doesn’t capture activeness, it captures consistency or lack of consistency of your excess returns.