Does past performance matter?

13/06/2010

The asset management industry revolves around one theme i.e., past performance. Even though standard disclaimers beat down the importance of past performance, it is quite a popular and common strategy to chase good performers (winners) according to a recent strategic report titled “Persistence in Performance” by M.R. Raghu, Head of Research at Kuwait Financial Centre “Markaz”... should this assumption hold true, two questions come to mind;

Do fund managers outperform, and if so

Do they do it consistently

As part of examining the experience in the GCC context, the research ranked the performance of around 80 equity funds across the region during the last four years. The research indicates that regional fund managers are reasonably successful in generating outperformance (which is in divergence to global experience). However there is no persistency in performance (in convergence with the global experience). The findings are no different between conventional and Islamic funds. Lack of persistency would make the few fund managers that are consistently good performing (top quartile) very precious.

While professional fund managers managing money in international stock markets find it difficult to generate alpha, GCC fund managers seem to enjoy alpha generation capabilities. The very low level of institutionalization in the GCC markets means that there is no zero-sum game between winning and losing asset managers as it would be the case in more advanced markets. The fact that managers are able to outperform easily could also be due to market inefficiencies in general and index concentration in particular. Most of the markets are top heavy in few stocks that account for a large share of the market capitalization. Lack of liquidity reduces this population set even further. This eases the task of the fund manager in terms of research, tracking market rumors, etc. Also, the retail and speculative nature of the markets, means that information gleaned out of “party conversations” are more valuable than “DCF based” fundamental analysis being carried out by non-local research analysts.

Also the second question becomes more important i.e. persistency in performance. Again the global and regional findings are clearly towards lack of persistency. The answer could lie with frequent change in the manager. The asset management industry in GCC relies heavily on local talents (due to language and cultural issues) which is still developing in nature. Due to the high net worth nature of the market, attracting assets under management is quite challenging given the fact that most investors feel confident playing it on their own than entrusting their money with money managers. This in turn leads to very high degree of competition to gather assets which forces managers to take more risk to perform better. This may produce high levels of tracking error leading to variable performance (and not consistent performance).

Furthermore, in many asset management firms the rules for portfolio management may not be that well designed, developed and implemented primarily due to lip service being paid to risk management. Loose definition of rules can make a manager go unchecked in terms of the risk being taken. Also, underperformance is not punished as much as outperformance is rewarded due to lack of skills in this space. This lack of accountability may be a perfect setting to take unwarranted bets in pursuit of alpha.

And finally, fund size does make a big difference. In one case, we observed a very small country-based GCC fund with a huge weight in favor of local market outperforming the peers. Managing a $300 m fund is a very different proposition compared to managing a $3 m fund.

Among GCC funds, most of the fund managers outperformed their benchmark in bear markets (2006 and 2008) but struggled to outperform in bull markets (2007 and 2009). Islamic funds were doing slightly better as five out of seven funds generated positive alpha during the four-year period.

Only four conventional funds showed consistent performance versus their peers and remained either in the first or second quartile throughout the study period. Most of the funds moved from top quartile to bottom quartile during the four-year period, not being able to retain a stable performance versus their peers. All the Islamic funds showed lack of persistency in their performance over the four-year period.

For the Saudi funds, conventional funds enjoyed a better track record than Islamic funds as eight out of 11 funds managed to show positive alpha while only six out of 12 Islamic funds could show outperformance. Conventional funds in KSA showed a relatively narrow range of alpha, as it went from 4.52% to -1.75%.  Outperformance was generated in both bear market such as in 2008 and in bull market such as in 2007. In terms of persistency in performance, conventional funds in KSA fared better than MENA/GCC mandate funds as seven out of 11 funds posted positive alpha at least three out of four years while Islamic funds showed less mettle with 50% of the funds generating positive alpha in at least three years.

For the Kuwait funds, surprisingly, less than half of the conventional funds generated alpha. The gap between the best and worst alpha was actually quite large The Islamic funds fared a bit better with six funds out of eight posting positive alpha, but still a relatively wide range of alpha as it went from  +4.59% to -10.93%. The persistency in the performance of the conventional funds is in line with the findings for the KSA and MENA/GCC mandate funds. Only four funds were able to outperform their benchmark at least three out of four years. The Islamic funds did much better with six out of eight funds maintaining positive alpha at least three years. Three funds have not been able to beat the market even once. Overall, 2009 was a very challenging year for Kuwait funds and very few of them were able to generate positive alpha during that year.

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About Markaz:

Kuwait Financial Centre 'Markaz', with total assets under management of over KD921 million as of March 31, 2010, was established in 1974 has become one of the leading asset management and investment banking institutions in the Arabian Gulf Region. Markaz was listed on the Kuwait Stock Exchange (KSE) in 1997.