Efficiency rating of asset management companies, 2007

Time of changes

Volatility at the stock market makes shareholders be more selective in choosing a management company. Qualifications and professionalism of managers are much more important than past revenues.

Two years ago the market of collective investments might probably be described as euphoric. It was growing by leaps and bounds. Naive investors were bringing their money to mutual funds. Mutual funds ads were promising annual profits exceeding 50%, 75%, or even 100% (at that time GIPS disclosure standards were almost totally unknown). All the central part of Moscow was filled with colorful invitations to become a shareholder as quickly as you can. Asset management companies were among the largest advertisers. Volumes of net assets and a number of funds were growing on an unprecedented scale. Private investors, accustomed to conservative bank deposits (at that time 10%-11%) and quickly growing and unreachable real estate, rushed to offices of asset management companies. Entry price was pretty low, with profitability holding a promise for bright capitalist future.

If, by way of a simple experiment, you ask an American, a German and a Russian how they perceive, let’s say, an oil company, you will see interesting mental differences. A Russian would, probably, think of rigs, severe faces of oil workers, pipelines, storage tanks – some sort of an industrial giant. A German would rather imagine modern offices, efficient corporate governance, modern technologies and innovation groups. What about an American? Shares, bonds, participation in oil-investment funds, dividends, growing quotations, indexes – that is how an average American perceives an oil business. Since a Westerner is accustomed to stock market and investment in securities from his childhood, he is unperturbed by the market deviations. But sharp moves – upward and downward – may so far be quite a shock for a Russian citizen.

To change one’s mentality you require decades, not couple of years. And unexpected popularity of mutual funds was about to turn into a bad joke. Dramatic growth of the market can not go on forever. Highly volatile side trend came as an unpleasant surprise to the majority of neophyte shareholders. What can you expect from inexperienced investors? But the new trend also surprised many asset management companies – next to having missed correction and change of trend (which is not catastrophic), they also failed to adjust to the new economic situation. And that is really strange. Why did it happen and who was to blame – management companies or purely the invisible market hand? Will euphoria be replaced by disillusionment?

When an investor selects a fund, the first yardstick he has in mind is the past level of profits, which may be a good indicator of future successes. The second yardstick is the size of the net assets fund. The more money has been brought in already, the better – that is the logic behind the choice.

The both above strategies are obviously primitive enough and may bring about (especially the first one) pitiful results. The size does not always matter, and high yield in the past does not guarantee future achievements. Besides, so far Russian asset management companies (with rare exceptions) has not been observing global standards in relation to disclosing information (GIPS), therefore advertised earnings may be incorrect. For instance, instead of being expressed in annual volumes, they may be shown for any other calendar period, like eighteen months, two years, eight months, whatever – the point is to demonstrate maximum achievements. Another popular trick is to take “bottom" as a reference point, and compare it with the largest costs of a unit. Under such an approach the calculation period may not even be multiple to months, and you can not make comparisons with other funds. So, an investor should not make his decisions on the basis of such yardsticks.

Quality ratings of fund asset management by Expert RA are to present objective information about risks and efficiency of investments to different funds. We base our assessments on several key parameters. They are well-known and widely used by analysts all over the world: Yensen alpha ratio, Omega ratio and Sharp ratio.

Sharp ratio is a de-facto standard for assessing activity of investment companies and reflects connection between two notions, vital for the market: yield and risk. Any normal investor would be interested in securing higher yield at minimum risk. The higher Sharp ratio is, the more efficient will investments be. Small ratio means that the yield does not justify the risk level. If the Sharp ratio is negative, investments to non-risky securities would be more profitable.

As a rule, an investor aims at achieving a certain level of yield – level of required yield. Omega ratio permits to determine whether a fund would live up to your expectations as an investor. Higher ratio implies higher probability of achieving a required yield level.

Finally, Yensen alpha ratio shows the role of a manager in obtaining added value in relation to benchmark yield. The ratio makes you see whether your manager is on the winning or losing side of the market. The point is to compare earnings of an asset management company with average market figures. Higher ratio means higher quality of asset management. Negative ratio implies negative management.

21 asset management companies were engaged in our study and presented 55 funds to be appraised. The total cost of net assets in the project neared 92 bln rubles by 28.09.2007 – about 60% of all assets of mutual investment funds (open and interval) at the market, in line with our rating conditions. Our conditions were quite simple: at least one year of operations (otherwise the statistics might be incorrect), cost of net fund assets should be no less than 30 mln rubles by 01.10.2006 (there is no point in assessing very small funds by standard indicators).

In the first half of the current year the Russian stock market has experienced two correction waves. They were not as strong as in May 2006, when the RTS index sagged by about one third: from 1765 points to 1234. During February and April corrections of 2007 reduction was about 15%. In the both cases the decline stopped above the psychological level of 1700 points. In the intervening period the RTS index reached its historic maximum of 2008 points. Against such a background the inflow of investments to mutual funds at the first quarter of 2007 exceeded 21 bln rubles. The stock market February drop has been connected with the stock market downfall in Shanghai (9% loss). After declining down to 1737.7 (-12.5%) points (RTS index), the Russian stock market regained its upward trend.

Gradual stock market rehabilitation allowed the RTS index to take by storm another height at the beginning of the third quarter (2091.3). Meanwhile in the middle of the quarter stock markets all over the world were confronted by the US mortgage crisis. Russia was no exception. On the one hand we are pleased to say that the Russian financial market is highly integrated into the world system and responds to outside events in time with the main world markets. On the other hand, the Russian banking sector had to deal with liquidity problems, and the stock market immediately responded to the negative circumstances. The situation provoked the third correction wave. Presently everybody expects annual reports: how big losses of funds and investment banks are going to be? Many top financial figures already went down the list; Merrill Lynch and UBS showed net losses by the end of the quarter. The market has entered the most unpleasant stage for investors – the side trend with strong volatility, a so-called “saw".

Under the circumstances only most professional and resourceful management companies, capable of maintaining highly qualified specialists on their staff, developing risk-management, improving investment technologies, may uphold sustainable level of risk-earnings ratio. Again, it is not too difficult to show high yield at a certain period of time, but what you really need is to retain good risk-yield ratio all along. Quality of services and efficiency of asset management companies is reflected in their individual ratings, assigned by Expert RA, and in management quality ratings (see the table).