How Treynor can help to get your port­fo­lio into shape

Finweek English Edition - - MARKETPLACE - Editorial@fin­ Schalk Louw is a port­fo­lio man­ager at PSG Wealth.

in­vest­ments and risk have been com­pared to many things, but the one thing that will surely get en­thu­si­asts’ blood flow­ing, is com­par­ing in­vest­ment risk to cricket. Why? On one side, you find play­ers like Chris Gayle who can score 200 runs from only a few balls, only to be taken out the next day af­ter one or two overs with fewer than 10 runs. Then there’s the typ­i­cal five-day bats­man, who can spend an en­tire day dil­ly­dal­ly­ing in front of the wick­ets to score a measly 50 runs.

In my opin­ion, Hashim Amla rep­re­sents the per­fect bal­ance. While giv­ing us the im­pres­sion that he is a slow bats­man, he is ac­tu­ally the bats­man who scored the fastest 20 cen­turies. He has a hit rate of 89%, and 45% of his ODI runs were scored through bound­aries.

It’s easy to com­pare his reg­u­lar high scores to what we call stan­dard de­vi­a­tion in an in­vest­ment. The higher the stan­dard de­vi­a­tion, the riskier the in­vest­ment. A lower stan­dard de­vi­a­tion not only low­ers in­vest­ment risk, but also means that the bats­man isn’t al­ways bowled out early in the game.

Apart from stan­dard de­vi­a­tion, one of the many risk ra­tios one can use to show what re­turns should be for the risk that must be taken is the Treynor ra­tio.

The Treynor ra­tio is used to eval­u­ate the per­for­mance of dif­fer­ent ac­tively man­aged funds by mea­sur­ing the re­turns on these in­vest­ments ver­sus the risk. The higher this ra­tio, the bet­ter the fund’s per­for­mance rel­a­tive to the amount of in­vest­ment risk in­volved. Put dif­fer­ently, a higher ra­tio means that in­vestors re­ceived a higher re­turn on their in­vest­ments than they “should have”, for the risk they took on.

Be­fore we look at the Treynor ra­tio, it is im­por­tant to un­der­stand the con­cepts of mar­ket and com­pany-spe­cific risk, as well as the Beta of a fund.

Mar­ket risk is the risk as­so­ci­ated with cer­tain eco­nomic fac­tors in the mar­ket. In­vestors usu­ally have very lit­tle con­trol over this. When look­ing at the great correction of 2008, it didn’t mat­ter how well di­ver­si­fied in­vestors were – the mo­ment the mar­ket started to re­act to bad news, com­pa­nies (shares) started to suf­fer. Com­pany-spe­cific risk is the risk as­so­ci­ated with a spe­cific com­pany or share. This risk can usu­ally be low­ered by means of diver­si­fi­ca­tion. The Beta of an in­vest­ment mea­sures the mar­ket risk of the in­vest­ment, and to which ex­tent in­vest­ment re­turns move with the mar­ket.

The Treynor ra­tio is cal­cu­lated by sub­tract­ing risk-free re­turns (such as those from the money mar­ket) from in­vest­ment re­turns, and then con­sid­er­ing this in terms of the in­vest­ment’s Beta. The re­sult is re­turns per unit of mar­ket risk, as op­posed to to­tal risk.

This ra­tio can be used to com­pare dif­fer­ent “bats­men”. When ap­ply­ing the Treynor to lo­cal Gen­eral Shares unit trusts (ex­clud­ing Funds of Funds) over the past five years, you will see that the five funds be­low stand out as the ‘in shape’ play­ers over this pe­riod. They are: 1. PSG Eq­uity 2. 36ONE BCI Eq­uity 3. Aylett Eq­uity Pre­scient 4. Ned­group In­vest­ments Pri­vate Wealth Core

Eq­uity Fund 5. 27Four Shariah Ac­tive Eq­uity Pre­scient

Of course, you can­not use his­tor­i­cal data to pre­dict fu­ture re­turns any more than you can pre­dict who will be scor­ing a cen­tury in the next Proteas match. How­ever, if you had in­vested 20% in each of these funds for these five years your re­turns would have been no­tice­ably higher than the FTSE/JSE All Share In­dex at a lower av­er­age stan­dard de­vi­a­tion.

By com­bin­ing the five high­est Treynor funds, their top-10 share­hold­ing (sorted by weight) as at the end of March 2017 would have looked like this (please note that these 10 shares make up more than a third of their to­tal funds): 1. Naspers 2. Sa­sol 3. ADvTECH 4. An­glo Amer­i­can 5. Stan­dard Bank 6. Dis­cov­ery Health 7. Stein­hoff 8. Bri­tish Amer­i­can To­bacco Com­pany 9. AECI 10. Old Mu­tual

Al­though no one may know what the mar­kets will bring to­mor­row, I know that when com­pil­ing my in­vest­ment port­fo­lio, I would def­i­nitely choose the “in shape” play­ers.

Apart from stan­dard de­vi­a­tion, one of the many risk ra­tios one can use to show what re­turns should be for the risk that must be taken is the Treynor ra­tio.

Newspapers in English

Newspapers from South Africa

© PressReader. All rights reserved.