Anne Unplugged
Alexander Forbes Research Institute
How do our actions as an industry help or hinder investors’ quests for better solutions
Behavioural finance suggests investors
make bad investment decisions. But....
Consultants and advisers aren’t always helping
Let’s have a long hard look at what
we’re really doing as an industry
Consultants and advisers exist to guide
investors away from potentially damaging
investment decisions –
or to at least guide us to the more prudent
decisions. But....
Ours has become an industry dominated by
heuristics and the “Law of Small Numbers”
Heuristics – Rules of Thumb
 Simplify the message
to the client
 Make the message
easy to remember
 Make it easy for
anyone to become a
“distributor”
 Make it easy to have
cookie cutter
solutions
Investors seeking high returns must accept high risk
This is coupled with “The Law of Small Numbers”
An Industry that is dominated by “The Law of Small Numbers”
Which is the better fund manager:
Quartile performance rankings:
Allan Gray
Sanlam
Coronation
1st quartile
1st quartile
1st quartile
1st quartile
4th quartile
1st quartile
1st quartile
Bias
confirmation
4th quartile
1st quartile
1st quartile
4th quartile
4th quartile
1st quartile
4th quartile
4th quartile
1st quartile
1st quartile
4th quartile
 These were all randomly generated performance numbers
 Collections of random events do behave in highly regular
fashion
 The smaller the number – the higher the probability of seeing
more extreme events
Which row of letters were randomly generated?
BBBGGG
GGGGGG
BGBBGB
All three were – but our minds
refuse to accept this explanation
There are lots of variations on this slide…but you get the gist
Source: Grantham, Mayo, van Otterloo
99% confidence levels?
More importantly:
 We have allowed our industry to be governed by “The Law of
Small Numbers”
 Similarly we have cavalierly (as an industry) ignored how
much “noise” there is in performance data that clouds what
you are really looking at.
 Even Warren Buffett’s performance lies within the range of
potential outcomes for a purely random distribution of
performance outcomes over a 20 year period.
(Nassim Taleb)
 Haugen & Baker paper attacked for only 21 years analysis
 But – do investors really have time?
The Unique Challenges of the South African Asset Manager/Adviser/Investor
Cult of active management
 Easy for fund managers to beat index (?)
 Poor quality benchmarks in terms of representativeness
 Overall costs may be high but not large differential in
fees between active and passive strategies for a strong
push to “smart beta” (passive) strategies
 Surveys and performance dominate decision-making
What can you tell / What can you not tell - from these performances?
What manager performances can tell you:

Which asset classes/sectors drove performance?

Asset allocation vs. stock selection ?

Whether the market was providing alpha opportunities
and where ?

Which investment styles/philosophies were successful in
the environment?

Which strategies were the most volatile?

Which strategies exhibited downside protection in falling
markets or maximum leverage of return in rising
markets?
What we cannot deduce from this information:

Which managers are skilful
The Skill / Luck Continuum and Asset Management
Source: Michael Mauboussin 2010
 How many factors involved in the path to success?
/
On understanding return and risk
Diwersification – It’s in the nature of the “beast”
Average share
Average portfolio
Multiple portfolios
(2%)
(2%)
(8%)
Specific
(30%)
Beta
Common
(30%)
Market
factors
movement
Market
movement
Beta
(90%)
(40%)
Source: Barr Rosenberg
Market
movement
(98%)
Understanding manager performance – the heart of the problem
Beta
Alpha
Contribution is
unconditional.
Contribution is
conditional:
Hold a beta of 1.00
and you get 100% of
the market movement
• availability in the
market
This exposure you
need to meet your
long term funding
requirement
This is just frosting on
the cake – can help cover
costs
• manager skill
Desperately seeking alpha
 Against the ALSI,
performance was a
function of market
structure and not
manager skill in 11
out of 12 months.
• Against the Swix,
market structure
(during this
period) still
accounted for
outperformance
50% of the time.
Jan-03
Feb-03
Mar-03
Apr-03
May-03
Jun-03
Jul-03
Aug-03
Sep-03
Oct-03
Nov-03
Dec-03
Benchmark
Return
Portfolio
Return
-4.81%
-3.81%
-7.38%
-0.93%
14.87%
-1.78%
5.93%
5.57%
-2.56%
10.13%
0.44%
7.30%
-3.53%
-2.72%
-6.63%
0.34%
11.97%
0.07%
5.25%
4.41%
-1.37%
8.80%
1.86%
6.36%
Jan-03
Feb-03
Mar-03
Apr-03
May-03
Jun-03
Jul-03
Aug-03
Sep-03
Oct-03
Nov-03
Dec-03
Benchmark
Return
Portfolio
Return
-4.09%
-4.71%
-7.97%
-0.27%
14.10%
-0.77%
5.00%
5.00%
-1.89%
9.70%
1.62%
6.97%
-3.53%
-2.72%
-6.63%
0.34%
11.97%
0.07%
5.25%
4.41%
-1.37%
8.80%
1.86%
6.36%
Focused Blend vs ALSI
Outperformed
Probability of
Banchmark
outperforming
benchmark
Yes
100%
Yes
100%
Yes
81.90%
Yes
100%
No
0%
Yes
100%
No
0%
No
0%
Yes
0%
No
0%
Yes
100%
No
0%
Focused Blend vs Swix
Outperformed
Probability of
Benchmark
outperforming
benchmark
Yes
98.10%
Yes
100.00%
Yes
99.20%
Yes
80.90%
No
0.00%
Yes
100.00%
Yes
85.40%
No
0.00%
Yes
94.10%
No
0.00%
Yes
12.00%
No
0.00%
Probability of
better
performance
64.40%
8.90%
0.70%
0.10%
62.80%
44.50%
21.80%
4.70%
10.90%
9.50%
0%
15.80%
Probability of
better
performance
64.50%
7.40%
0.20%
0.10%
64.90%
47.10%
24.20%
6.00%
11.80%
10.70%
0.20%
19.30%
Performance of Active vs. Passive Managers
SWIX Asset Managers
30.0%
600%
25.0%
500%
20.0%
400%
15.0%
300%
10.0%
200%
5.0%
100%
0.0%
0%
25.0%
450%
20.0%
15.0%
300%
10.0%
150%
5.0%
0.0%
0%
-5.0%
-150%
-10.0%
12m rolling performance
Benchmark Cognisant
ALSI Cumulative
Non Benchmark Cognisant
Feb-12
Aug-11
Feb-11
Aug-10
Feb-10
Aug-09
Feb-09
Aug-08
Feb-08
Aug-07
Feb-07
Aug-06
Feb-06
-300%
Aug-05
-15.0%
Feb-05
Non Benchmark Cognisant
600%
Aug-04
SWIX Cumulative
30.0%
Feb-04
Benchmark Cognisant
ALSI Asset Managers
Aug-03
12m rolling performance
Dec-11
Jul-11
Feb-11
Sep-10
Apr-10
Nov-09
Jan-09
Jun-09
Aug-08
Mar-08
Oct-07
May-07
Dec-06
Jul-06
Feb-06
Sep-05
-300%
Apr-05
-15.0%
Nov-04
-200%
Jun-04
-10.0%
Jan-04
-100%
Aug-03
-5.0%
The Unique Challenges of the South African Trustee/Asset Manager/Consultant
Upside-down value chain for the industry
 The more you can discern about manager skill, the
clearer it becomes that manager selection is essentially
a crap shoot
 But we seriously end up believing that the greatest value
we can offer clients is by being “good investors”
Vicious cycle of mediocrity – with an increasing overlay of
external controls from an impatient regulator/government
In truth...during times like these our clients need us
desperately – we just haven’t listened to what they really
need
Charles Ellis and the “Winners Game”
Not financial advisers...............................financial coaches!