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Overview of equity investment risk management

How does M&G view equity investment risk?

At M&G, we believe that in order to achieve good investment performance, it is important that fund managers are given the freedom to take risks. This is provided that those risks are consistent with the fund’s mandate, and that they are well understood by both the fund manager and senior management.

Investment risk is concerned with the generation and assessment of portfolio returns, as opposed to other forms of risk management undertaken at M&G, including regulatory, operational and counterparty risk. We do not employ any formal risk control parameters (such as tracking error limits) in the management of our portfolios, other than those required by the regulators and the mandates of the funds themselves.

We view equity investment risk in two ways:

Stock selection risk

Understanding risk at the individual stock level is the role of the fund managers. However, our in-house research analysts provide specialist support to fund managers, with insightful, original analysis that will aid them in their stock selection decisions.

Portfolio construction risk

It is at the portfolio level where we seek to ensure that fund managers are maximising the alpha generated by their stock selection; this is the work of the Portfolio Construction & Risk team.

While the fund manager is ultimately responsible for the risk management of the fund, it is essential to ensure that the correct level of risk is taken to achieve the fund’s performance objectives, and that risk is managed to sustain performance across varying market conditions.

How does M&G manage equity investment risk?

  • Empowering our fund managers to best implement their investment decisions within the constraints of their fund mandates
  • Actively encouraging diversity from our fund managers in their investment approach to aid alpha generation
  • Providing a rigorous and robust infrastructure to ensure that the fund managers are fully supported in the application of their investment views
  • Delivering an effective resource for fund managers, with comprehensive analysis and advice in their management of investment risk

Risk management structure

M&G has two independent risk teams:

1. Portfolio Construction & Risk (PCR), headed by Maria Asprouli – PCR is dedicated to monitoring M&G’s equity strategies.

2. MAGIM Risk, headed by Forbes Fenton – the team’s focus is on retail fixed income, convertibles and multi-asset funds.

The oversight process is headed up by M&G Director of Investment Oversight David McGillveray. Investment Oversight aims to ensure that M&G's funds are managed effectively and in line with their investment objectives.

PCR team structure

The PCR team’s structure combines the two core functions of Portfolio Construction & Risk Management, and Portfolio Analysis & Client Communication.

To support the various equity franchises, the team includes dedicated portfolio strategists who have extensive experience in portfolio and investment risk analysis, as well as strong investment understanding – this is the function led by Maria Asprouli. The portfolio strategists are supported by junior risk analysts, and also work closely with the Performance Analytics team.

There is also a dedicated function to translate the work of the PCR team to our clients in a transparent and insightful manner – this is led by Ritu Vohora.

 

Organisational structure of the team

Source: M&G, as at 21 September 2012

 

Portfolio construction & risk management

The primary functions of the PCR team are threefold:

1. Providing portfolio construction and risk analysis and insight to fund managers as required

2. Delivering analysis for the Investment Oversight process on the drivers of risk and performance within portfolios so senior management can engage with fund managers productively

3. Communicating portfolio construction insight and transparency to our clients

Maria Asprouli, head of the Portfolio Construction and Risk team, is responsible for leading the analysis of risk and performance in our equity portfolios. She is supported in this by a team of analysts.

Working closely with the fund managers, the PCR team’s main objective is to provide in-depth analysis of the investment approach and portfolio construction of our equity funds, and to monitor the various dimensions of investment risk assumed. This includes: active risk (forecast tracking error); beta; volatility; investment style; liquidity; and market-cap bias, as well as exposure to individual countries, sectors and stocks. The team is fully integrated with fund management at M&G, providing ongoing support and challenge to the investment decision making process. However, managers remain ultimately responsible for all investment decisions on their funds.

Regular monitoring of the risks assumed by the funds (provided on a monthly basis, although a wide variety of ad hoc analysis is also undertaken in support of the fund management process) and their interpretation by the team provides the fund managers with the following key analysis:

  • Allocation of the risk budget – quantification of a fund’s absolute and relative risk and how this is allocated among the various sources of risk
  • Identification of unintended risks arising from a bottom-up approach – this includes systematic biases, exposure to sectors and macroeconomic factors (ie, currencies and interest rates)
  • Ensuring managers are maximising returns from high conviction positions by backing those positions with enough risk
  • Assessment of the fund’s investment style on a variety of measures, and its alignment with the stated investment approach of the manager
  • Pre-trade analysis – to scrutinise the effect of potential new positions on the overall risk budget of the fund before they are initiated
  • Developing new screens to support stock idea generation and benefit portfolio construction

The team uses a variety of risk models and techniques to capture intended investment risks and, more importantly, the unintended risks that can arise as a result of a fund’s stock-specific investment approach. (Please refer to the PCR risk systems overview document.)

The PCR team maintains autonomy by reporting directly to the director of Investment Oversight.

Performance Analytics

The PCR team works closely with the Performance Analytics team to analyse performance delivered by funds on an ex-post basis, with attribution analysis carried out at the stock, sector, size, and country levels. Analysis is complemented by our risk systems, which examine the extent to which risk or style biases in a fund contribute to performance.

We believe it is important to align ex-ante risk analysis with ex-post performance data as a means of measuring the extent to which the portfolio is being rewarded for the risks taken. This is because performance driven by intended risks is much more sustainable over the long term.

Portfolio analysis and client communication

The client-facing function is led by Ritu Vohora, portfolio construction and risk specialist. The function is responsible for communication of fund insights drawn from the work of the wider PCR team, and how fund managers work with PCR to manage the risk / portfolio construction within equity funds. This enables us to provide our clients insightful portfolio analysis and information in a transparent manner. In particular, this includes:

  • Providing clients with real insight into the investment characteristics and risks of the funds in which they invest
  • Regular updates and in-depth analysis on portfolio construction, risk and performance drivers
  • Opportunity to provide rigorous external challenge
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