Risk-on risk-off phenomenon creates problems for global equity managers

Standard & Poor’s Fund Services has announced the final release of ratings from its 2011–2012 global equities sector review today. Funds rated in the style neutral, thematic, global small-cap, multi-manager, fundamental indexing, ethical/SRI, and country allocation peer groups are included in this release.

“Risk-on risk-off has been one of the most dramatic developments in global markets since the start of the financial crisis. High correlations are dominating and are at similar levels seen immediately post Lehman,” said S&P analyst Justine Gorman. “Assets are now characterised as either ‘risky’ or ‘safe-haven’ in nature and have lost a great deal of their identity,” added Ms. Gorman.

The degree of correlation at the stock level has major consequences for fund managers. High correlations mean less diversification between stocks. Many fund managers rely on the basic tenets of cross sectional diversification and market recognition of company fundamentals for their investment process to work. Given this environment, many global equity fund managers struggled to perform in 2011.

Five managers are rated four stars in this release, and are considered to offer the strongest capabilities in the sector. The managers are Dimensional, Realindex, Platinum, Advance, and Vanguard.

• Dimensional’s global equity portfolios are built to capture style-based returns from the broader market. Its systematic buy-and-hold stock-selection strategy aims to keep portfolio turnover low, and its trading strategy’s focus on reducing transaction costs and capturing a liquidity premium. Dimensional experienced some departures in its trading team in 2010 but overall staff turnover remains low, particularly in senior and portfolio-management positions.
• Realindex has an index approach, but one based on fundamental, non-price measures of company size, rather than the standard market-capitalisation approach. The methodology uses four fundamental factors to measure a company’s economic size and weight them in a portfolio.
• Platinum’s success has unarguably also been driven by the abilities of the broader analytical team. As a “best ideas” fund, the manager draws heavily on colleagues’ ideas and suggestions. Performance across Platinum’s global, sector, and regional funds has generally been very strong over the long term, and we believe that this is evidence that the talent and capabilities are spread across the team, rather than being concentrated in a few individuals.
• Advance’s bottom-up manager selection is guided by its top-down assessment of the broader market conditions and macroeconomic analysis. The global equity strategy has moved toward a more active approach to portfolio construction and manager blending. In this review, the fund was upgraded to four stars from three stars.
• Vanguard’s index-investment approach seeks to deliver investment returns that closely match the index. For its global equities large-cap strategy, Vanguard adopts a full or close-to-full-index replication approach. It continues to implement this investment approach in a disciplined and risk-controlled way, successfully adding incremental value through the efficient management of cash flows and index changes.