Evaluating Investment Manager Performance

Beacon Pointe Advisors utilizes a proprietary performance evaluation model, which allows us to filter the vast universe of investment managers and narrow it down to a focused group of strong candidates for further due diligence.  Our analysis utilizes a long-term horizon, defined as two full market cycles.  At present, our typical time-frame for evaluating managers’ track records is 13 years (from January 1, 2000 to December 31, 2012) and includes the bear markets of 2000-2002 and 2008 and the bull markets of 2003-2007 and 2009-present.  This allows us to study how a particular strategy behaves in various market environments, understand its risk/return profile, and set reasonable expectations for the role it can play in client portfolios.

Our performance scoring methodology emphasizes consistency of results versus the appropriate peer group universe.  We measure manager consistency by focusing on rolling five-year periods rather than simply looking at a snapshot of trailing returns over the one-, three-, five-, seven-, and ten-year periods.  The latter methodology, which is very much the industry standard, introduces a significant – though unintended – short-term performance bias.  For instance, an exceptionally strong or a very poor last year can significantly impact a strategy’s annualized returns.  Trailing returns with a randomly selected end point do not paint the full picture and can be misleading.  We believe that sub-optimal decisions often result from investors’ tendencies to weigh the most recent past more heavily than would be prudent.

In order to minimize that bias, our process for evaluating manager performance relies on rolling period analysis.  With a 13-year time frame, the periods included in our analysis are:

  1. Five years ending 12/31/2004
  2. Five years ending 3/31/2005
  3. Five years ending 6/30/2005

33.   Five years ending 12/31/2012
This methodology allows us to capture considerably more information and gives each data point an equal weight in the performance scoring.  Consider the following example:

investment manager performance graphIn this example, a Large Cap Growth manager (that is not on Beacon Pointe’s recommended list) appears very compelling in the top half of the chart above.  It has outperformed its benchmark – the Russell 1000 Growth Index – by a wide margin over all trailing periods.  A closer look at the bottom half of the chart, however, reveals a meaningful divergence in results over time.  Although the strategy has ranked very highly in recent 5-year rolling periods, it has ranked in the bottom quartile of the Large Cap Growth peer group in earlier periods.  For a different insight into the performance history, we analyze the strategy’s calendar year returns shown below.  In challenging market conditions –such as the 2000-2002 bear market and the Great Recession of 2008 — this manager’s performance has been quite disappointing.

investment manager performance graph

Beacon Pointe’s Investment Committee pays special attention to capital preservation.  When assessing an investment manager candidate, our team factors in the strategy’s downside capture ratio.  In this case, over the 13-year analysis period, the sample manager captured 105% of the Russell 1000 Growth Index’ downside.  Such large losses disrupt the compounding mechanism.  The mathematical reality of capital destruction means that:

  • If you lose 10%, you need to make 11% to get back to even;
  • If you lose 25%, you need to make 33% to get back to even;
  • If you lose 33%, you need to make 50% to get back to even; and
  • If you lose 50%, you need to make 100% to get back to even.

After completing the performance evaluation for this particular strategy, Beacon Pointe’s research team concluded that the investment manager does not meet our minimum requirements for further review.  The rolling period framework and our focus on downside protection guide our due diligence efforts and reinforce our manager research discipline centered on consistency of results and the long-term compounding of our clients’ capital.

Important Disclosure: This content is for informational purposes only. Opinions expressed herein are subject to change without notice. Beacon Pointe has exercised all reasonable professional care in preparing this information. Some information may have been obtained from third-party sources we believe to be reliable; however, Beacon Pointe has not independently verified, or attested to, the accuracy or authenticity of the information. Nothing contained herein should be construed or relied upon as investment, legal or tax advice. Only private legal counsel may recommend the application of this general information to any particular situation or prepare an instrument chosen to implement the design discussed herein. An investor should consult with their financial professional before making any investment decisions.

© Beacon Pointe Advisors. All Rights Reserved.


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