Exchange Traded Funds

Managers versus Mandates

To establish whether the manager or the mandate makes the bigger difference, it is necessary to calculate the long-term variability of total returns for representative samples of both managers and markets, as expressed in standard deviations. The greater the difference, the greater the range of returns and the higher the standard deviation, as shown in the table.
 
Fortunately the question of risk adjustment does not arise at this time, because markets have basically round-tripped over the test period - five years to 2004. In 1999 and 2000 shares rose while bonds fell. In 2001 and 2002 shares fell while bonds rose. In 2003 shares recovered while bonds retreated. As shown in the bell curve chart, during this period the largest number of managed funds generated net returns between –10% and 0%.
 
The top part of the table compares variability of international growth funds in TrustNet, representing managers, with the universe of 50 countries and regions researched by Investors RouteMap, representing markets in bold. Results for both are considerably greater than for managed funds, because they lack the stabilising counter-cyclical influence of bond markets in this period. In terms of standard deviations, the differences between equity markets are much greater at 41.1% than between managers of international equity funds at only 26.8%.
 
The bottom part of the table analyses statistics, not just for stock markets, but for all asset classes. It compares variability of returns among IMA sectors, representing markets in bold with different types of fund, whose mandates are broad enough to permit investment in all of these sectors, representing managers. In terms of standard deviations, the differences between markets are again much greater at 22.9% than between the managers of different kinds of Managed Funds, which lie between 8.2% and 16.4%.

This comparison confirms the conclusion that picking the right market makes a bigger difference than picking the right manager, even when the range of investment alternatives is restricted to just one asset class.
 
The search for an explanation leads to the matter of arbitrage. In inefficient markets there may be substantial differences in pricing, which provide profitable opportunities for arbitrage. Typically such opportunities decline as knowledge improves among market participants. That appears to be what is happening among managers but not among mandates.
 
The business of selecting managers is organised mainly by mandate. It is based on the premise that customers have a firm idea of which investment game they want to play and the objective is therefore focussed on which manager to do it.
 
If the majority of participants focus on selecting managers, then there are likely to be unexploited opportunities for those who focus on selecting markets. Investors RouteMap is designed to achieve this.

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