So here, this is a simple way to illustrate how you may select a manager.
And, indeed, this is very crucial, but we'll see in a minute that there
are more sophisticated tools for choosing managers when you're operating in
an absolute return environment, i.e., there's no benchmark.
Here there are actually two benchmarks, which are indicated.
And sometimes when you select managers, hedge fund managers,
when you're running a front of funds, a front of hedge funds,
you put some benchmark just to have an idea of what the market has been doing,
although this is clearly just for reference because those managers are not
actively tracking or trying to deviate from a benchmark.
Actually they never really look at the benchmark.
But it's always interesting to put say the S&P 500,
the performance if you're talking about an equity long-short type of hedge fund.
It's always good to have the S&P 500 as reference, so this could be here, for
instance, Benchmark 1.
And the MSCI world, which is the standard index which is used for
world equities as Benchmark Number 2.
So peer group analysis is clearly also very helpful to identify
the poorly performing managers.
And here you see the same analysis which is done, the same bars, but
you see that, actually the red square,
the product does not perform as well as in the previous slide.
Here it's a different type of analysis because we see it by year.
And we put the year first which is most relevant to us.
It's the last year.
So here assume it would be in 2012, so the first year we put on this chart is 2011.
There's something actually very interesting in this chart,
you see that in 2008, the square,
the red square is way at the bottom of the range of performance, so
it's clearly the least performing manager, or the worst manager of all the lots.
Say 100 managers, if that's the Universe.
And then you see in 09, 2009, he ends up being the first.
So you remember that cartoon I showed you actually was the opposite, right.
There was this really outperforming award-winning fund manager
was getting drunk in the bar because he had been fired by his boss,
because the boss believes in mean reverting assets.
Here it's somewhat the same, although it could be the opposite story.
For, if you have been the last of the 100th
performing managers in a given year, maybe next year you end up being the first.
And actually there is a simple explanation for
this, which you find quite often also in practice.
Is maybe, this manager has been a bit early.
And putting more risk in his portfolio.
For, if you remember, actually 2008 was a severe down market.
This was the Great Recession.
So, markets went sharply down.
And they start bottoming out in March 2009.
So, maybe the manager here, he was right, but too early.
And he put a lot of risk, he tilted his equity portfolio towards growth stocks.
So, in '08 that was a disaster because market went sharply down.
But, in '09 when markets turned around in March he went up, like a rocket.
And so, there he won the best performing fund in 09.
So, anyhow, this is typically the kind of analysis you do.
You look at the range and
you see how a fund is positioned relative to competition.
So peer group analysis may be performed using various criteria.
The compounded annual returns, as we have just seen, but also draw down analysis,
and we'll see in the next video, how useful this measure can prove.
Then we have the famous Sharpe ratio, the Sortino ratio,
which is more suitable for hedge funds and last but
not least, we may also be interested to know the percentage of
a months where the manager has been achieving positive returns.
So when is peer group analysis useful?
Well basically, it's useful when you need to screen a given database
to spot the best managers to assemble in a given portfolio.
So it would be a portfolio of funds, either traditional or hedge funds.
So for instance, you may want to screen your database using
these various, quite restrictive criteria, I've indicated here.
So you look for minimum three year track, track records.
That's pretty standard in the fund industry, but
then, okay, here it's becoming a bit more selective.
You want managers who've been delivering 30% or
plus annually of the three note since exception.
And then, no losing month,
that may be tricky if you include the period of the 2008,
quite difficult to find a manager that who hasn't have a negative month,