Understanding portfolio attribution on a multi-manager active portfolio
At first glance, fund-by-fund level attribution of any multi-asset active portfolio may appear confusing, with a mirage of both reds (negative relative returns) and greens (positive relative returns). The AJ Bell Active MPS attribution is no exception, and a number of the underperformers have significantly struggled on a relative sense. However, we actually take great comfort in this picture, as too many negative returns – or, indeed, too many positive returns – could indicate a mismanagement of risk and a lack of diversification. Holistically speaking, the AJ Bell Active MPS performance has been pleasing, both since the product’s launch and through the crisis experienced in March 2020, with an encouraging track record when compared with likeminded active peers.
The unspoken truth about single-strategy active fund performance is that most fund managers take on inherent biases through their investment style exposure. This can, on its own, largely explain much of the performance attribution analysis and is the very reason that performance profiles can be very volatile against an index. A fund manager’s performance can be very strong for many years, during which they get heralded as ‘stars’, only to give back some or all of the relative return (against a mainstream index) in the subsequent years, as the market environment changes and their style goes out-of-fashion – often in a dramatic sense, too. They then get labelled as ‘duds’, or other more disparaging terms. For this very reason, the fund research element of the process at AJ Bell is driven by qualitative analysis. Our quantitative screening process is not, therefore, the dominant factor, but more a useful tool to sense-check our understanding of what a fund could achieve in different market environments. It’s only when you understand this about a manager that you know whether they’ve had a favourable tailwind or been pedalling into a headwind.
In building portfolios, we first and foremost want to invest with conviction and back the fund managers we truly believe can deliver to their stated objectives through multiple market cycles, and in a repeatable manner. This should help the portfolios at AJ Bell to deliver better risk-adjusted, long-term returns. At the same time, the whole portfolio should always maintain diversification by both fund manager and investment style.
Typically, the crystal ball tends not to be very reliable and so, when considering asset allocation, rather than forecast macro events and capital market reactions or market peaks and troughs, our preference is to judge what value creation or destruction remains in an asset class. With diversification in mind when constructing portfolios at AJ Bell, we look to award capital to a number of fund managers with different inherent biases. This leads to blending fund managers, which may not necessarily neutralise all risk factors, but certainly mitigates unwanted risks. Otherwise, there is a very real risk that you will end up with one big momentum portfolio that looks great initially, but then runs out of steam when the wind changes direction.
Therefore, it should not be surprising to learn that the Active MPS portfolios tend to be fairly neutral on investment-style risk against our benchmark by owning offsetting positions. These offsetting positions do not necessarily have to be in the same regions, as we consider the portfolio in total. The portfolios have held a couple of funds which have strongly underperformed on a relative sense and, much like any index fund, the portfolio as a whole is exposed to a whole host of factors at any one time. For instance, whilst the first quarter return of 2020 for the Fidelity Index World fund was circa -15%, the large- and mid-cap value stocks within that portfolio equate to around one third of the exposure and yet nearly two thirds of the fund’s performance detraction. A similar pattern can be seen in the active portfolios, whereby one or two funds have heavily detracted from returns but are offset by other funds held.
The value investment style has come under immense pressure over the past three years, as it has significantly underperformed its growth counterpart, a phenomenon that continued throughout the crisis occurring in March 2020. As a result, any fund which is biased towards value is more likely to have experienced severe underperformance against its mainstream respective index, depending on the extent of its skew. This is one of the key reasons behind the extensive effort directed towards fund research, with thorough research being undertaken prior to initiating any position. This is imperative so that a fund manager’s investment process and philosophy is fully understood – while we also delve under the bonnet and spend time understanding individual stock positions, sectors and themes. This enables us as investors to clearly and concisely understand what to expect from any fund behaviour (excluding poor stock selection, of course).
Across the active MPS range, the funds that should resonate with you while considering the content of this article are Man GLG Japan CoreAlpha, Lazard Emerging Markets and D&C Worldwide US Stock; all have had poor relative performances since our launch over two years ago. While we continually challenge our initial investment thesis, when we stand back and check the facts (aside from a spell of poor performance since our initial investment at the launch of the portfolios), these funds continue to behave in a manner that is expected given the market conditions. These funds therefore remain very relevant within the portfolio to play the part for which we awarded capital to them in the first place – and so they live to fight another day!
Value as an investment style remains extraordinarily cheap these days, and we hold confidence in these funds. When the time comes that markets rotate away from growth and start rewarding value stocks, these value funds could be in the right place to benefit handsomely. However, we are the first to admit that we don’t know when that point will be and, as a result, we never bet the ranch on any one view. As such, you should always expect to see a diverse range of holdings in our portfolios, that in isolation may perhaps look questionable, but remember: it’s how the holdings work together that’s important, not necessarily what they do on their own. That is the benefit of portfolio diversification.