How manager skill translates to returns in a total portfolio

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As big super funds insource more of their investment management they will probably be changing the way they think about their whole portfolio. A new research paper provides some interesting insights into the relationship between individual manager skill and total portfolio returns.

The research, by implementation manager Parametric, goes to support the use of centralised portfolio management (CPM) which is a service the firm provides, and show what it calls an “implementation annuity”.

But the research also shows that manager skill, or alpha, does not impact the process. The benefits of CPM are just as high with highly skilled managers as they are with lowly skilled managers. And there are benefits on a pre-tax and post-tax basis.

The notion of managing money differently from a whole of portfolio basis, rather than on the traditional segmented basis – asset classes, manager selection, individual investment selection – has been pioneered in Australia by the Future Fund.

The Future Fund, which is fully outsourced in its investments under its charter, operates under a “one team one portfolio” approach, which it adopted a couple of years ago.

David Neal, the Future Fund chief executive, described the approach and its benefits to a Women in Super lunch last month. Since adopting a “one team one portfolio” approach, where every decision is judged for its impact on the whole organisation and not against a sectoral benchmark, the Future Fund has tended to become more adventurous and less conservative, he said.

“One team one portfolio” takes you to a different place, Neal said. “You tend to make decisions that you wouldn’t have made before.”

Whether or not the asset owners make different decisions, the Parametric research shows that at the implementation level, the added value of a whole-of-portfolio approach by a fund exists whether a manager has a high level of skill or a low one.

The paper was written by Paul Bouchey, Parametric’s CIO, Mahesh Pritamani, senior researcher, and Raewyn Williams, managing director, research, in Australia. It examines how “the whole of an equity portfolio can be more than the sum of its parts”.

On a visit to Australia last week, Bouchey said that people recognised that various frictions were a cost in the investment process. The biggest of these was tax.

The paper says: “Our results not only show the existence of what we call an ‘implementation annuity’, but show that it is noticeable in size and can meaningfully improve a fund’s equity outcomes.

“Further, we have shown that it does not matter how skilled the underlying equity managers are – the value of a specialist focus on implementation efficiency is something that, it seems, virtually all superannuation funds investing via a multi-manager equity structure can harvest.

“All of the scenarios we investigated verified the potential to generate an implementation annuity, from a low of 19 basis points to a high of 57 basis points per year. For a moderately skilled manager mix, we quantified the potential implementation annuity to be 38 basis points per year, which would be available to funds on top of market returns and manager alpha, simply by reconfiguring the way they invest into equities.”

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