The Only Constant Is Change…. and number crunching
15 April 2018
With an ever changing investment environment number crunching is core but it must be supplemented with effective qualitative analysis in order to keep up with the market, argues Richard Philbin, chief investment officer at Wellian Investment Solutions.
Our investment process is a multi-faceted one. Our investment universe is every collective investment available for distribution within the UK and includes open-ended, closed-ended, active and passive funds. There are over 30,000 funds in our database. It is not surprising that a part of the research we undertake is number crunching. It makes sense to us that we apply filters to get this universe down to a more manageable amount.
Number crunching is only one aspect of our research though. We also undertake extensive qualitative research. Although number crunching helps us immensely, it doesn’t tell us everything. The screens we apply via number crunching highlight to us “consistency” and assist us in reducing the universe. Qualitative research comes in a number of forms – it could be reading fact sheets / papers for instance. Qualitative research can also be considered meeting the fund manager face-to-face, listening to conference calls, attending web conferences and so on. The reason for qualitative research is to understand how a fund manager runs the fund they do. Number crunching can provide one outcome on the suitability of a fund for inclusion in a portfolio, qualitative research can provide a very different one.
Number crunching is both unemotional and objective. If for instance, after applying a number of filters, the output could well include active and passive funds. It could also suggest a fund where there are judgement calls that could be used to reduce the field further, and this is why the need for qualitative research is as important (if not more so) in the work we undertake.
Number crunching is pretty much entirely backward looking. Qualitative balances that up and assists in looking forward. If, for instance a fund was managed entirely with a “value” bias, and the market for the past couple of years was entirely driven by “growth” factors, it’s fairly safe to say that from a number crunching perspective (and from a performance angle within that) then the fund in question probably wouldn’t stack up very well. But, from a fund selectors perspective (which, funnily enough we are) and we have a belief that the markets are moving to a value phase of the economic cycle, we might adjust our screens to be more focused on finding funds that have very low correlation to the market for instance. You might also screen for funds that have consistently delivered poor relative performance numbers. But, screening for low correlation might just highlight funds that are just poor and the same can be said when looking at the performance statistics. You need to apply qualitative research. You need to balance the numbers. You have to build an investment thesis.
One thing number crunching systems can’t do (and there are many things they can’t) is let you know about “soft” issues. They cannot let you know that companies such as Aberdeen Asset Management and Standard Life Investments have just merged. They cannot tell you the second derivative – such as the inevitable emotional upheavals the fund managers are likely to undergo – who will or won’t get the job (as there are likely to be some job losses.) There are also likely to be some merging of investment styles and getting used to new colleagues and different working practices and the like. Only qualitative research can help here.
Another thing a systematic approach can’t do is let you know that Richard Penny has recently left Legal & General for a position with CRUX, or that Philip Rodrigs has departed River & Mercantile. From a number crunching perspective, as long as the numbers are being produced (we take our raw data from Financial Express for example) then the machine is being fed and the output continues apace. Qualitative research allows a conversation to happen. What were the factors that drove Richard to CRUX for example, or why did River & Mercantile feel they had to release Philip of his front office duties? You can, also, within time, get to know the other side of the story by talking to CRUX or Richard directly. There could be greater issues at stake – maybe the culture was changing at Legal & General and this is the first of many fund managers leaving the company and this could have a knock-on effect with regard to the wider business. In the case of Philip Rodrigs, the issue might be a single, contained example, or it could have wider impacts and implications for the governance, oversight, dealing and compliance teams. All of the above examples (and there are many more that can be suggested, and by no means are the scenarios I’ve played out above anything but speculative comment) cannot be known by only using a number crunching tool.
There is no way you can either rely entirely on qualitative judgements – with a universe of tens of thousands of funds there is absolutely no way (unless you have an incredibly large investment team) you can only do fundamental due diligence. I read a report (a few years ago mind you, although I think the data is probably as relevant today as ever) that 3 in 4 fund managers do not have 5 years running the same fund. Therefore, if you do have a large team doing fundamental research, there is a need to constantly go back and review the fund as every time there is a change, there is a change!
It’s not just companies that merge, funds do too. Once again, creating change. Market cycles – as previously mentioned – change. Interest rates, inflation, laws, politicians, taxation etc etc all change. Corporate management change too – the person who was CEO of Company A plc moves on – creating change. What will this mean to the share price and the strategy of the company going forward?
It is impossible in our view to be able to create a broadly diversified investment portfolio for a client without the use of number crunching tools AND fundamental research. They complement each other. At different times one approach can take precedence over the other, but they are both important. They are both needed, and both help with balance.
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