Shifting from relative to absolute return mandates

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From the course by University of Geneva

Securing Investment Returns in the Long Run

435 оценки

University of Geneva

Securing Investment Returns in the Long Run

435 оценки

Course 4 of 5 in the Specialization Investment Management

In this course, you will learn about the famous dichotomy between active and passive investing, how to appropriately measure and analyze investment performance and what the future trends in the investment management industry are. You will first learn about absolute and relative performance, risk-adjusted returns and how to decompose investment performance. The focus will then shift to the two main categories of investment vehicles, active and passive funds, and what they entail in terms of expected performance. Finally, you will explore the worlds of sustainable finance, neurofinance and fintech, three areas of research that will shape the future of the investment management industry. You will also benefit from the insights of experts from UBS, our corporate partner, on the practical implementation of the various concepts we will develop in this course.

From the lesson

Assessing Performance

Welcome to the second module of the course! Here, we will start by talking about absolute versus relative performance and mandates. The second topic of this module will be performance measurement using risk-adjusted performance ratios but also asset pricing models. Finally, we will see how to decompose and attribute performance between the different types of investment decisions undertaken by fund managers.

What you will learn in this Module11:29

Choosing the right benchmark - UBS guest speaker8:40

Shifting from relative to absolute return mandates8:35

Meet the Instructors

University of Geneva- Tony Berrada
SFI Associate Professor of Finance
Geneva Finance Research Institute
University of Geneva- Ines Chaieb
SFI Associate Professor of Finance
Geneva Finance Research Institute
University of Geneva- Jonas Demaurex
Teaching Assistant
Geneva Finance Research Institute
University of Geneva- Rajna Gibson Brandon
SFI Senior Chaired Professor of Finance and Managing Director of the GFRI
Geneva Finance Research Institute
University of Geneva- Michel Girardin
Lecturer in Macro-Finance - Project Leader for the "Investment Management" specialization
Geneva Finance Research Institute
University of Geneva- Philipp Krueger
SFI Assistant Professor of Finance
Geneva Finance Research Institute
University of Geneva- Kerstin Preuschoff
Associate Professor of Neurofinance and Neuroeconomics
Geneva Finance Research Institute
University of Geneva- Olivier Scaillet
SFI Senior Chaired Professor of Finance and Vice-dean (research) at GSEM
Geneva Finance Research Institute
University of Geneva- Philip Valta
SFI Assistant Professor of Finance
Geneva Finance Research Institute

[MUSIC]

Hi there, in this video, we're going to have a look at relative and

absolute return mandates.

We'll see what are the drivers, what are the factors which may

motivate an investor to ask for one type of mandate as suppose to the other one.

And also we'll see under what condition or

maybe under what circumstances you may be driven to shift

away from typically a relative return mandate to an absolute return one.

But first let's have a look at what are the key motivations for

a relative return mandate.

Relative returns means that you're measuring your returns

vis a vis of benchmark, that's the key notion here.

So associated to that although not strictly.

We could say that a relative return mandate has something like investing in

a pure assets, ie., you tend to focus on an equity portfolio.

Or a bond portfolio and you do so

by asking the manager to be always fully invested.

So no cash, no hedging of market risk.

Basically, he's there in that asset class, and he's investing.

And he's making stock selections,

if it's equities or bond picking, if it's a bond fund.

And you're measuring him or her, the manager, against a benchmark, so

it's a relative return a mandate, the manager needs to outperform his benchmark.

Here, I say we would typically associate a relative return mandate to one of

measuring in a pure, purely, I would say in a pure way, in a specific asset class.

There is something that to be noted

here that actually you can even have a relative return mandate.

If you invest globally across different asset classes and maybe cash,

bonds and equities, and you would define as strategic asset allocation.

For instance, it's 40% equities, 50% bonds, and 10% cash.

And then you compute some kind of composite benchmark

made out of 10% return on cash.

50% of return of bonds and 40% which would be an index of equities.

And there you derive some kind of composite benchmark and

you see whether the manager adds value by going overweight equities.

Underweight bonds and

then reversing that depending on the macroeconomic cycles or valuation.

But here it's more tricky, I would say, to really define a relative benchmark,

because you need to define a composite index based on strategic asset allocation.

It's not as easy as to do this in a specific bucket of your asset allocation.

So typically here, a relative return mandate will be associated

with the idea that the manager invests in a single asset class.

But certainly measures himself against a benchmark,

does not play with cash or does not hedge market risk.

So basically he sticks in a pure way too, is on asset class.

Why would you prefer maybe, to this kind of very strict,

in a way, mandate where you actually ask the manager to be really dedicated

to a specific asset class, and not move out of it?

Would be something which would be more flexible and

would have this idea of absolute return.

And here, basically the mandate is different.

It's not that you beat an index,

it's basically that you strive as much as you can for positive returns.

So here you will ask the manager to deliver

as good returns as it's possible when the market is going up, so

we're to participate to capture part of the returns in a bull market.

But you will accept the fact that maybe if the market is up 20%,

the manager is only up 15%, so

it is underperforming in a relative way the index.

But you will accept this underperformance on the condition

that if the market goes down, by say 15%, you will only be down maybe 3 or 4%.

So upside capture, which should be much higher than the downside capture.

This is the fundamental asymmetry which drives absolute return mandate.

So but clearly in this case and

this is the main justification for asking for an absolute return mandate.

You do not want to satisfy yourself to a manager that comes to you and

says hey Mr Client you know what?

I have very good news for you, you lost 28% of your wealth.

But the market has been down 30% so you're up plus 2%,

so if you're not really happy with this kind of statement.

Then clearly you should be looking more for

absolute return mandates as opposed to relative returns ones.

Now, one final comment, which is based on experience.

I noticed when I worked for in the wealth management industry,

that sometimes we shift away from,

investors tend to shift from one category to another.

And typically we will find that many institutional clients go for

relative return mandates.

And more private clients should fall

absolute returns one because this is closer to their way of thinking.

But, even so, even in the case of institutional clients,

what I can tell you is that when everything is going well.

When markets are delivering positive returns, everyone is striving for

relative in the institutional business, pension funds, typically.

Everyone is looking for relative returns.

And asking the managers, and banging on his head for not delivering good enough

returns when the market is up 30, and the manager is only up 28%.

But, typically, and when is the timing for switching here.

Well, it's when you have severe corrections,

like here in this instance between 2000 and 2002.

Where the markets from peak-to-trough lost 20,

46%, we have the same kind of magnitude also

during the bare markets which came in 2008.

Here at the bottom of the market, you'll find that even the most

aggressive relative return manager on the institutional client will shift away.

He would say, okay, let's forget about all this relative return thing.

Now I'm shooting for absolute return and basically

here you find that basically institutional clients are also humans.

And they will not satisfy themselves with being down

43% when the market has been down 46%.

They will want to switch to an absolute return mandate where you try to

minimize the losses.

In general,

my personal experience shows that this is when the fear is at its maximum.

And we've seen this when we talk about behavioral finance

that the stock market oscillates between these two extremes of greed and fear.

So this is maybe a sign when everyone switches,

wants to switch to absolute return mandate.

That we're not very far from the bottom in the market.

[MUSIC]

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