“The first question we ask ourselves is what sort of fund we need, in terms of volatility, targeted return and liquidity needs,” Truchi explains. “The second phase of our process we call clustering. We could of course use the Lipper or Morningstar categories to classify funds, but we do it a little differently. We try to go into this phase with as many funds as possible, taking a bigger universe so as not to miss out on funds that do not meet Morningstar’s criteria. If we look for a European credit fund for example, a global fund that has a high weighting to European credit could also qualify. It’s important to allow some flexibility.”
So how does this clustering work? After establishing a universe that could consist of many hundreds of funds, Truchi regroups this universe into several clusters of funds that have similar risk-return characteristics, to compare apples with apples, as it were. “Thanks to clustering, we can get to groups of funds that are more homogenous and therefore easier to compare.”
Filtering
In the third phase of his selection process, Truchi trims his universe down. “We first identify the most attractive cluster of funds in terms of risk-return characteristics and then filter the bad ones out by looking at factors such as the information ratio, downside and upside capital ratio, and the Sortino ratio,” he explains. But, says Truchi, it’s important to strike the right balance. “If you give too high a weight to the Sharpe ratio, for example, you’re never going to select a low volaility absolute return fund because there will always be a lot of funds that realise a higher return but also take more risk.”
Before arriving at the final step of qualitative analysis, a more thorough quantitative check is carried out on the perhaps couple of dozen funds remaining in the race. And Truchi prefers to do this a little differently than most of his peers, too. “Everybody in the industry analyses performance over a three or five-year period. That’s totally arbitrary! One should instead take a period corresponding to a full market cycle.”
Of course, the current market cycle dates back to 2007 and there are very few funds with a track record as long as that.
“Maybe one in 10 fixed-income funds meet this criterion and often the managers have changed over time as well. I admit it’s a difficult one,” he says. “Michael Hasenstab of Franklin Templeton, Richard Woolnough of M&G Optimal Income and JP Morgan’s Bill Eigen are rare examples of managers who have such a track record [in fixed income].”
Truchi aims to arrive at the final phase of his selection process with as few funds as possible. “I aim for about five to 10 funds per cluster. We can’t visit everyone.”
Know your stocks
Truchi actually started off his career as an equity fund manager (see biography bottom right), which he believes is helpful when he finally goes out to see fund managers. “I know what it takes to manage a fund. If you’ve done the job yourself, it’s easier to tell who has the right qualities and attitude to successfully manage a fund.”
To illustrate that point, he recalls a meeting he once had with a US equity manager, who turned out not to be quite as passionate as hoped. “The first question I asked him was what stock he had most recently bought. He couldn’t give a straight answer but had to look through his papers to see what he had bought three days ago. Such an attitude is simply not possible for me.”
