Clear Portfolio Analytics & Communications

Building a Portfolio’s Story: The Catch-22

Wednesday 15th March, 2017

This is the first article in a four-part blog series on a factor-centric approach to understanding performance, discussing market, peer group and portfolio analysis.

As Q1-2017 draws to a close, the investment community is preparing for the upcoming performance review season. During these investment performance reviews, investors are seeking objective and comprehensible stories that ultimately serve to either shake or strengthen their investment manager relationships. However, performance reviews are not solely about measuring performance to the third basis point. Investors are also incorporating context and perspectives about what has happened in various geographic markets and how that led to specific classes or peer groups having outperformed. Performance review season is ultimately about creating, delivering and gaining confidence around a story. It is a complex process and, unfortunately, today there exists a widespread problem.

More Sophistication? Or More Confusion?

With increasingly sophisticated and powerful technology, investors should theoretically have all the information needed to create their story right at their fingertips. Yet a “catch-22” exists. Investment research and calculation platforms are extending coverage and capabilities while also upping their complexity. This is particularly true with vendors commonly inserting their own IP into proprietary models and methodologies. While vendors achieve product differentiation, users are left with tools that are increasingly disconnected. As more investment products are developed, and more tools to measure the “success” of those products are created, the process of evaluating performance gets more complex, not simpler.

As investors, if we want to know how “Value” did this past quarter, there are various external sources and opinions we may use. Then, to know more specifically how a group of Large Cap Value managers performed recently, we would likely turn to a different vendor completely. If we want to know how our own value-oriented portfolio compares to the benchmark on “Earnings Yield” there are dozens of ways to calculate that. To pinpoint which stocks are driving that exposure? Again, likely another tool.

Can the information cobbled together from all these resources form a coherent story? Is a story even there? Will clients be able to follow along?

A More Effective Investment Performance Review

The challenge is constructing a narrative every quarter, from start to finish. A cohesive explanation that provides detail and accuracy, but is easily comprehended by the target audience. In other words, assembling the story is just the beginning. It still has to translate well in a manner both transparent and logical. Most investment firms have access to a variety of powerful systems, each of which provides a different dimension to the investment process. There’s a problem with repurposing them and cobbling together the outputs to create a story: underlying methodologies differ from solution to solution. This is ripe for causing confusion and friction. As the story moves from markets to peer groups, and from peer groups to individual products, and from a product to its individual securities, the disparities in methodology lead to inconsistencies and gaps. If a story asks the listener to make a leap of faith beyond what they think is reasonable or comfortable, then the flaws are in the making, not in the telling.

Consistent Factors: The Common Thread

The more effective approach is to establish a range of well-known, easily understood factors that objectively articulate important facets of an individual portfolio. Then use those same measures to calculate supporting insights across appropriate geographic markets and associated peers sets. Armed with consistent perspectives across markets, peers and portfolios, investors can more easily assemble a coherent story. More importantly, this connected and consistent approach allows investors to:

  1. Clearly understand how markets have performed on specific factors, providing transparency into broader and often overly-blunt, style themes.
  2. Identify those product classes or style/factor groups which likely benefited most and why some products have outperformed others within them.
  3. Track the story using these objective measures right down to an individual portfolio and its individual securities.

Connecting markets, peer groups, and products through sensible and easy-to-communicate measures builds up a highly credible and complete narrative, and one that the investment audience can understand and accept.

Looking Ahead

Over the next three weeks, using this factor-centric approach, Style Research will examine each component in more depth. What factors have outperformed in the recent equity market? How have specific product groups benefited from this market? How have specific products in those groups maximized these drivers and stood apart? All of this can be done using consistent and approachable measures that are easily consumed by investors.

That’s a good story.

Author: Tom Idzal | Categories: Insights, Markets Analysis, Peer & Competitive Analysis, Portfolio Analysis

What questions do you have? How are you addressing the challenge of understanding quarterly performance? Send us your comments and questions to discuss in this blog series.

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