Peer Group Analysis

Summary: Investors often try to gauge a managers skill by comparing the managers performance to the performance of a group of similar managers. This is typically called a universe or peer group analysis. Zephyr Associates has developed an improved way of presenting universe groups which is detailed in this article. Investors often try to gauge a managers skill by comparing the managers performance to the performance of a group of similar managers. This is typically called a universe or peer group analysis. Many consider a universe or universe composite to be a good benchmark for a manager. In fact, manager universes do not have the qualities that make a good benchmark. They are not investable, they are not specified in advance, and they are usually too broadly defined. For more information about what makes a good benchmark, see Benchmarks. Universes also suffer from what is known as survivor bias because many of the poor performing managers drop out of the universe. Poorly performing mutual funds, for example, are often merged with more successful funds. When this happens only the successful funds track record is maintained, so the poor performance is not represented in any universe that includes the fund. Once a product no longer exists, for whatever reason, it is dropped out of the universe. Despite these limitations, peer group comparisons continue to be popular with investors. Zephyr Associates developed an improved way of presenting universe groups. Figure 1 is a peer group analysis using the standard floating bar chart. Figure 2 is a graph that Zephyr developed years ago to provide more information. Notice that the floating bar graph shows where Fidelity Magellan ranked in the universe for only six time periods. The bottom graph shows where Magellan ranked every month for the last 25 years. Looking at the top graph one might conclude that Magellan had never been in the bottom quartile of the universe. With the bottom graph we can see that there are two such periods. Managers may not want to show all the periods, so for them the floating bar graph might be best. Sponsors, consultants, and advisors should always use the more comprehensive graph where no time periods can be hidden.

Figure 1

Manager vs. Zephyr Large Core Universe

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Figure 2

Manager vs. Zephyr Large Core Universe

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Another thing to be aware of is the difference between cumulative time periods (last one year, three years, five years etc) and rolling time periods. This relates to end point bias, which is discussed in Mutual Fund Analysis. When a managers recent performance is good, cumulative analysis tends to make its longer term performance look good, regardless of past performance. Beware of this illusion. Figure 3 shows the cumulative rank of RS Emerging Growth Fund Ending December 1999. This tech heavy fund was up 182% in 1999. That means that if you owned that fund at the end of 1999 and purchased it anytime in the last 12 years your funds performance would have put it in the top one percentile of all small cap growth funds. This does not mean that the fund was consistently in the top of the universe. Figure 4 shows a rolling three year window. Here we see that this fund was in the bottom quartile of the universe for a number of three year periods.

Figure 3

Manager vs. Zephyr Small Growth Universe

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Figure 4

Manager vs. Zephyr Small Growth Universe

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To give you an idea of how important 1999 was for the high cumulative rank we see in Figure 3, look at Figures 5 through 8 below. In all four cases we are looking at cumulative rankings (last one, three year etc.) Only Figure 5 includes 1999. Figure 6 ends December 1998; Figure 7 ends December 1997; and, Figure 8 ends December 1996. In the first example we could see that rolling returns removed the illusion of a consistent high ranking. But in this second example we see that even the cumulative returns were erratic if we remove the one standout ending year, 1999. I believe that the great majority of professional investors and advisors get fooled into thinking that managers were consistently good performers by this kind of analysis.

Figure 5

Manager vs. Zephyr Small Growth Universe

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Figure 6

Manager vs. Zephyr Small Growth Universe

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Figure 7

Manager vs. Zephyr Small Growth Universe

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Figure 8

Manager vs. Zephyr Small Growth Universe

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There is no reason to limit peer group comparisons to returns. StyleADVISOR generates 27 statistics that can be used to compare a manager to his peers. Figures 9 through 12 provide several examples. These graphs can be viewed for cumulative time periods (last one year, three years, five years etc.) or for various rolling periods. You can display rank, as shown in these four graphs, or the raw statistics (not shown).

Figure 9

Manager vs. Zephyr Small Growth Universe

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Figure 10

Manager vs. Zephyr Small Growth Universe

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Figure 11

Manager vs. Zephyr Small Growth Universe

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Figure 12

Manager vs. Zephyr Small Growth Universe

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A discussion of peer groups wouldnt be complete without some discussion about universe construction. We believe that the Zephyr universe construction methodology is the best in the business. Zephyr does style analysis on all the domestic equity separate account managers and mutual funds as well as domestic fixed income managers. (For a complete discussion on how these are constructed see Zephyr Universes). Our methodology creates universes of managers with similar styles. The broader the universes, the greater the style difference among managers. The smaller the universe, the less significant the results. Look at Figure 13. This is the mid-cap growth mutual fund universe. Managers that plot near the border of two or more universes may share behavioral characteristics with managers in the bordering universe(s). The Thomas White fund could almost be classified as a large cap core fund. If the time period used for an analysis favored value this fund would most likely look good relative to its peers despite the managers skill or lack thereof. If growth is in favor the opposite would be true. One way to minimize this distortion is to create a custom universe where the manager analyzed is placed in the center of the universe.
Figure 13

Small - Large/Value - Growth

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Figure 14 is Zephyrs unique scan search graph. Here we selected all U.S. equity funds with at least a five year history on a style map. Next, we drew a circle around the funds that fell close to Thomas White. We can make this circle as large or small as we like depending on how large we want the universe to be. Those funds represented by the red dots will be designated as a custom universe for Thomas White.
Figure 14

Small - Large/Value - Growth

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Peer group and manager universe comparisons are a poor substitute for a good benchmark. Nevertheless they seem to be extremely popular among investors and advisors. Zephyr has redesigned the typical peer group analysis to give investors more information and better understanding of how a manager has ranked against his peers. We have also strived to create better universes and to give our clients the ability to create better custom peer groups.

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Sujata Srinivasan Sujata Srinivasan is a Connecticut-based freelance business journalist with over 10 years of reporting and editing experience. Key positions held include: Editor of Connecticut Business Magazine, Senior Financial Editor at Ness Technologies, and Correspondent and Interim Bureau Chief at CNBC-TV 18. She has a bachelor's degree in Business Management, a post-graduate diploma (hons) in journalism, and an M.A. in Economics. By Sujata Srinivasan, eHow Contributor

Stock Market Risk Factors The stock market is impacted on an ongoing basis by a series of complex risks, resulting in lower valuations, a bear run, or even a total collapse. While investors cannot insulate their portfolios from macro-economic risk, they can minimize unsystematic (business-related) risk through a strong diversification strategy. Any investment in the stock market carries a certain amount of risk based on your exposure. So evaluate your risk profile before investing. Other People Are Reading

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Print this article Micro-economic Risk

The stock market rises or falls based on the share price of companies, which in turn is based on corporate performance that hinges on micro-economic risk--that is, the risk of doing business (unsystematic risk). These include variables that impede the realization of revenue and profit such as financial risk (debt related), operational risk (for example, high input and process costs, inefficient manufacturing platforms, redundant and cash-guzzling acquisitions), legal risk (litigation and lawsuits), competition, management vision, brand risk (negative brand image) and product risk (bad product, bad market timing). Such adverse internal factors negatively affect the balance sheet, shaking investors' confidence in the company and lowering the share price. Investors can reduce micro-economic risk through diversification among different asset classes, as well as within the same asset class. Macro-economic Risk

When the macro-economy catches a cold, the stock market sneezes. In other words, recession, war, interest rates, lack of credit availability--which are all external factors (systematic risk)--impact companies that are publicly traded and thereby affect the index. Investors cannot insulate themselves from macro-economic risk through portfolio diversification. Sponsored Links Optimize Your Portfolio Download our Spreadsheet Based Optimizer for Free! sites.google.com/site/ Valuation Risk Valuation risk is among the most difficult to calculate. The basic investing rule is to buy low and sell high. However, there is a high probability that investors may not realize their expected returns upon sale of the stock because the market values the stock lower than the seller's estimated price. Speculative Risk Investing in stocks carries higher speculative risk than, say, investing in treasury bonds, which are guaranteed by the government. However, long-term investors bear less speculative risk than short-term investors or day traders, whose portfolio is subjected to greater price volatility in the short run. Leverage Risk

Investors increase their exposure to the stock market by investing borrowed funds (leveraging), thus exposing their investment to a high degree of leverage risk. In their paper entitled "The Dynamics of Leveraged and Inverse Exchange-Traded Funds," Minder Cheng and Ananth Madhavan discuss the systemic risks associated with leveraged, inverse or leveraged inverse exchange-traded funds, which require daily hedging (see References). According to the authors: "Essentially, these products require managers to 'short gamma' by trading in the same direction as the market." Sponsored Links Risk System Selectionwww.lepus.com Risk Mgmt System Selection Tool 200 Attributes from 27 systems RMSS - Risk Managementwww.rmss.com.au Enterprise Risk Intelligence Risk / Events / Compliance Make Huge income at Homewww.xforex.com Sign Up to XForex And Learn How To Increase Your Monthly Income. Portfolio Managementwww.perfios.com/managingyourmoney A Free, Safe & Simplified Tool for Managing Your Money. Try It Now! Related Searches: It Risk Management Stock Market Day Trading Corporate Risk Management Stock Market Performance Risk Management Tools References The Dynamics of Leveraged and Inverse Exchange-Traded Funds More Like This

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