The six “P”s OF FUND SELECTION: WHAT ABOUT PRICE?
The Fund Manager Assessment team, Jon “JB” Beckett and Bill Bulloch, use a framework called “P6” to evaluate and select the externally managed funds included in the Scottish Widows range of pension portfolios. The six “P” factors are: process, performance, people, profile, portfolio, and philosophy. Notably, “price” is not included in this list. In this article, JB and Bill discuss where – and how – fund costs fit into their methodology.
When it comes to choosing the funds that are added to the Scottish Widows range of pension funds, we place customer outcomes at the core of our process. The overarching goal is to evaluate the competence of the fund manager, the efficiency of the investment process and the likelihood that the fund will deliver on or exceed customer expectations.
Whereas many insurance companies outsource the selection of third party funds and on-going fund governance to external rating agencies and multi-managers, at Scottish Widows our dedicated Fund Manager Assessment team conduct this critical process in-house, to ensure that it suits our customer needs and aligns with our proposition and governance framework. We undertake a combination of quantitative and qualitative analysis to research specific funds, as well as market and industry developments and trends. The P6 framework helps make the process of selecting and
evaluating managers a transparent one, with each component assessed individually and carrying a different weighting.
But where is “price” in this model? Although other fund grading methods often embed price into an overall rating, we prefer to approach fund selection and fees separately. This is particularly relevant for actively managed funds, where the aim is to find managers with the insight, process and investment discipline that we think will have a higher probability of sustainable outperformance against their peer group over the medium to longer term. If advisers and customers wish to choose an actively managed fund, our primary aim is to provide access to a selection of funds that will deliver good investment outcomes.
We conduct thorough background checks and ongoing monitoring to avoid potential reputational or customer risk.
We look for convincing, experienced fund managers who we believe can meet our customers’ expectations, working with a clear purpose and as part of a coherent and joined-up structure.
We seek out fund managers who can articulate a convincing rationale for their strategy, and can demonstrate that their approach is considered, consistent and tested.
We assess the strength of the firm’s risk controls and the quality of their research, and expect to find robust, well-thought out processes behind all key investment decisions.
We want to see holdings that are consistent with the fund’s strategy and purpose: concentration of assets, diversification, stock selection, risk awareness or simply good investment fundamentals.
We look for consistent, sustainable returns, and monitor funds for abnormal performance patterns against the strategy, volatility and capital loss.
In this example, the fund analyst has rated the fund manager based on a combination of qualitative and quantitative factors. The fund has scored “Poor” to “Average” on three of the individual factors. However, because the fund’s fees are very low and get an “Excellent” score for that factor, the overall rating for this fund would be “Good”. On the other hand, the omission of price as a factor would give a score of 41 out of 80, or 51%, which would classify this as an average fund.
As this example illustrates, the danger of including price as a factor in fund ratings is that an attractive price can turn an average fund, with a relatively low probability of sustainable alpha generation, into something that appears to be much better than it really is. By considering a fund’s fee separately from its investment fundamentals, we attempt to avoid what is often referred to as the ‘value proposition trap’. It also means we can be more objective in choosing between actively managed and index-tracking funds, on a cost basis at least.
There is much debate within the investment industry about what constitutes “value for money”; it would be easy to see this as a one-dimensional issue relating to the cost of a fund. In respect of actively managed funds, however, we think it’s a more complex debate — one, as perhaps the example above helps explain, in which it’s essential not to confuse cost with value.
JON BECKETT | Senior Manager, Fund Manager Assessment
BILL BULLOCH | Senior Manager, Fund Manager Assessment
Investment markets and conditions can change rapidly and, as such, the views expressed in this update should not be taken as statements of fact nor be relied on when making investment decisions. Forecast are opinions only, cannot be guaranteed and should not be relied on when making investment decisions.