Can fund managers asset allocate? Andrew Clare, Dirk Nitzsche

1. Can fund managers asset allocate? Andrew Clare, Dirk Nitzsche & Meadhbh Sherman Centre for Asset Management Research, Cass Business School, London.

2. Overview • What we are assessing are TAA skills • Previous, related work • Data & methodologies • Sub-set of results • Summary • All the results are preliminary; final version of paper should be available in September; also in process of updating the results

3. Some previous work in this area • Sharpe (1988, 1992) asserted that: • a fund’s asset allocation decisions account for almost all of its fund’s performance • Brinson, Hood and Beebower (1986) examine the performance of 91 US pension funds using data from 1974 to 1983 they found that: • the policy mix explained 93.6 percent of the average fund’s return variation over time (as measured by the R2) • Brinson, Singer and Beebower (1991) quarterly returns data on 82 US pension funds spanning the period 1977 to 1987 • active investment decisions did little to improve portfolio performance because any abnormal performance was insignificant

4. Some previous work in this area • Using UK pension fund data, Blake, Lehmann & Timmerman (1999) • the majority of return is derived from the strategic asset allocation decision • Using data on large Canadian and US pension funds Andonov et al (2011) find: • that changes in asset allocation, market timing and security selection generate positive abnormal returns of 17, 27 and 45 basis points per year respectively • Using a small sample of US managers Weigel (1991) finds that • the vast majority (over 75%) of managers exhibit positive, significant market timing ability • managers that are good at market timing are paying for this skill in the form of negative returns to non-market-timing strategies

5. Data • We collected monthly, net of fee returns data on multi-asset class retail funds managed in Canada, the UK and the USA • Data sample is January 2000 to December 2010 – 714 funds • We also collected data on monthly proportions of multi asset class funds invested in: Cash, Govt bonds, Corporate bonds & Equities • Data sample is January 2006 to December 2010 – 355 funds • We use the two data sets as the basis for two approaches to the problem

6. The multi-asset class funds

7. Methodology • We apply variants of two methodologies to determine whether fund managers can ‘time’ their asset allocation decisions • We effectively test for tactical rather than strategic timing abilities • Methodology 1: • This is based on the “conditional beta” approach which imputes timing ability using fund returns (Ferson and Schadt (1996)): • We use several variants of this approach on the longer data set

8. Methodology 1 • If θ2 is positive it implies successful timing of equity market • If θ3 is positive it implies successful timing of corp bond market • If θ4 is positive it implies successful timing of govt bond market • If θ5 is positive it implies successful timing of cash

9. Results – US and UK Timing coefficients • Corporate bond timing more prevalent than equity market timing • UK Cautious Managed, can’t seem to time cash!

10. Results – Canada Timing coefficients • Bond timing more prevalent than equity market timing for Canadian funds • However, overall proportion that are found to have significant timing ability in all three markets is very low.

11. Results – summary • Arguably Canadian managers are the better tactical asset allocators

12. Methodology 2 %ACj,t = α + βjRj,t+1) + εj,t • This approach is much simpler and much more direct, than the returns-based approach • It asks whether weightings rise/fall in proportion to market returns • A positive value for β indicates that it does • Again, we use a number of variants of this approach

13. Timing the equity market

14. Timing credit

15. Timing the govt bond market

16. Timing cash

17. DGF … the new balanced • Most of the research says that strategic asset allocation gives the biggest bang for one’s buck • In this work we are really looking at TAA • There have been a huge number of DGFs launched recently; there is SAA embedded in these funds • Some DGFs emphasise the TAA overlay as an added source of return

18. Summary • These are just a small set of the preliminary results • But the basic finding is that: • Using returns-based data there is little evidence of TAA ability amongst these managers • Using asset class weights, there is much more evidence of TAA ability • However, in both cases it is still very difficult to distinguish this skill from luck • But as we know, sometimes it’s better to be lucky than good!