Our research begins by examining the recent past performance of an investment fund. Although past performance is no guarantee for the future, we can examine the fund and the fund manager’s track record.
There are a number of established techniques for adjusting raw performance data for risk. We use the Sortino ratio in our monthly analysis because of its tractability. The Sortino method is a modification of the Sharpe ratio – developed in 1966 by William Sharpe in one of the earliest study of investment manager performance persistence – given by the following formula:
The ratio seeks to represent the rate of return which is earned, in excess of the risk-free rate of return, for each unit of downside risk. This is an effective method for ranking funds, the higher the ratio the greater the value-added by the investment processes employed by the manager.
As global economic conditions fluctuate we need to be sure that our fund selections are continuing to perform in line with our expectations. We use a range of investment tools to check that a fund continues to “do what it says on the tin”. Detailed research includes the use of Risk and Reward Scatterplots, a Correlation Matrix and Stock Overlap analysis. Examples of these tools can be found on the Morningstar website.
Morningstar is used to filter out individual funds which do not meet our various criteria regarding matters such as fund objectives and performance consistency.
It is important that we keep your portfolio diversified, so we also check on the individual equities which selected funds are investing in, at any one point in time. For example, we would want to know if the Fidelity Special Situations fund was investing heavily in Shell, so as to avoid other UK Equity funds which were over exposed to Shell shares.
Each Asset Class will have sub-divisions, usually based on the differences in Risk & Reward. In the UK Equity sector we have separate sections covering small, medium and large companies. Generally speaking, smaller companies are more volatile and carry more risk, albeit a greater opportunity for growth.