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‘Good risk takers will have good portfolio attribution’

This is part two of Citywire South Africa’s two-part series on the questions that local fund selectors be asking their global fixed income managers.

‘Good risk takers will have good portfolio attribution’

A period of market turmoil is inevitably uncomfortable. But it is also often the best opportunity to scrutinise fund managers.

Understanding how managers have navigated through the what has happened in 2020 will tell investors a lot about how their philosophy and process translates into action.

For local fund selectors looking at global fund managers, asking about the past seven months is therefore an excellent starting point.

‘You really want to be asking your manager how the attribution breaks down in their portfolio,’ said Alex Harvey, co-head of research at Momentum Global Investment Management, and manager of the Momentum International Income fund. ‘For me, if a manager can’t attribute their performance, that’s quite a big red flag.’

Allocating risk

For Harvey (pictured), attribution and risk management are linked.

‘Good risk takers will have good portfolio attribution as well,’ he said. ‘Given what we’ve experienced this year, attribution will tell you a lot about how the manager has evolved the portfolio, and where they have generated returns. You want to understand properly where risk is being allocated.

‘It’s useful to ask your manager to give you a narrative of the year to date – to explain how the portfolio’s risk profile has changed, particularly in terms of duration,’ he added. ‘In recent years there have been quite a few managers caught offside by an underweight duration bias in portfolios. So, what has their duration positioning been like and how has that adjusted through time?’

Looking at the risk taken relative to the expected profile of the fund is also important.

‘You want to know if risk has been taken within the confines of the benchmark,’ said Harvey. ‘If the fund has an investment grade benchmark, has the manager been allocating within that construct, or have they gone into high yield, emerging market debt or sub-investment grade to capture yield? You need to understand that benchmark or off-benchmark risk allocation.

‘And if they have been taking risk for in high yield or emerging market debt, for example, do they or people within their organisation have a demonstrated capability in taking risk in those asset classes?’ he added. ‘You may also find that you are doubling up on risk because you have allocations to those areas in other parts of your portfolio already. You may not want that manager to be straying off-benchmark.’

The big risk

When looking ahead, Harvey believes that selectors should be scrutinising managers’ views on inflation.

‘I think understanding what their view is around inflation and what they are doing in the portfolio to protect it down the line is important,’ said Harvey. ‘The biggest threat to returns form a global bond portfolio will be inflation because we are on such a low base of yields today that returns could be very quickly eroded. So, you should understand what the manager is doing today.

‘Some will say inflation is dead we are not going to see any for the next decade and maybe they will be right,’ Harvey added. ‘But if inflation protection is very cheap today, I would say you should buy straw hats in winter. If you can buy that protection today for very little, and if it’s the biggest threat to your return down the line, then it’s prudent to potentially think of layering in some protection.’

This, he suggests, would primarily be through inflation-linkers.

‘The benefit for a global manager is that they can really shop anywhere they want, and then hedge the currency risk out,’ said Harvey. ‘So they don’t need to be bounded by region or country. They can buy inflation protection where its cheapest or where they think the risk is greatest.’


For David Shochot, CEO of Stylo Investments and manager of the Stylo Global Bond Prescient fund of funds (pictured) it’s also important to consider the role that passives can play. The low-cost advantage that they offer becomes even more significant when yields are so low.

‘As is the case in any asset class, the low fees of passive should lead to better net returns than the average active fund,’ he said. ‘The average active bond fund fee in the US is around 40 to 50 basis points, whereas it is 10 to 15 basis points for passive.’

It is, however, worth treating some passive solutions with caution. This is the case for corporate credit more than government bonds.

‘I think the key criticism of passive in the corporate space is that you are getting a higher allocation to the more heavily indebted companies,’ said Shochot.

Where this is most important to consider is in the high yield market.

‘We’ve not gone into that space because there is real risk in terms of a credit default,’ said Shochot. ‘What we saw during the crisis in March is that liquidity also dries up significantly in those ETFs tracking smaller, less liquid instruments. You can get big spreads in your trading price to NAV.’

For Harvey, it is also important to consider operational questions when considering when passive managers.

‘You will want to ask about things like whether there is lending in the portfolio, and whether the portfolio is managed directly or if it’s replicated with derivatives,’ said Harvey. ‘It’s important to do a due diligence with passive managers as well.’


Read part 1 of this series here.

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Related Fund Managers

David Shochot
David Shochot Average Total Return:
1/54 in Bonds - South African Rand (Performance over 3 years)
Alex Harvey
Alex Harvey Average Total Return:
1/2 in Bonds - Global Short Term (Performance over 3 years)

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