Comparing funds under management (FUM) to total market size is a “crude and misleading” way to measure manager capacity, according to New Zealand Superannuation Fund (NZS) head of asset allocation, David Iverson.
“What’s so special about 1 per cent or 2 per cent [of total market size],” Iverson said. “These rules of thumb are more like rules of convenience, not substance.”
He said the inadequacy of FUM-based measures prompted NZS to conduct its own research into the capacity limits of a handful of local equity managers.
The NZS research, published last week, back-tested actual portfolios of six local fund managers over a number of years, varying the assets under management to establish a capacity profile for each firm.
Iverson said the aim was to develop a more nuanced measure of manager capacity based on real investment behaviour rather than arbitrary market size constraints.
“While easy to understand and implement, [manager FUM compared to market size] does not discriminate among trading strategies with different turnover requirements (e.g. non-market cap versus market-cap) or different styles (e.g. large-cap versus small-cap),” the NZS research paper says.
Capacity is better expressed as the point where managers “can no longer implement their best ideas in the market”, Iverson said.
“All the managers we looked at had their own definitions of capacity that didn’t match up with ours,” Iverson said.
As well as its current roster of local equity managers (Devon, Mint and the suspended Milford), NZS applied the process to three other firms.
“We weren’t looking to grab all the managers in the market, just the ones we were interested in,” he said.
However, Iverson said NZS also capacity-tested its in-house equities team, which until recently managed over $800 million of NZ shares. The internal NZ shares portfolio has been pared back recently following a $150 million mandate awarded to Mint Asset Management, while an unknown amount has also been shunted off into a passive pool.
“We have a view of capacity internally,” Iverson said. “Although we were more limited [back-testing] the in-house portfolio as it has a much shorter history.” NZS created the active in-house local shares portfolio in 2013.
If current managers do breach the new NZS capacity limits (which are expressed with a margin of error), Iverson said that would not automatically end the mandate.
“Pulling money off them would not be the first option. It would prompt a conversation,” he said. “For example, if liquidity was drying up in stocks [important to manager strategies] we would question whether it was temporary or permanent.
“Or we may request a curtailment around what assets they take on from others.”
Earlier this year actuarial consulting firm Melville Jessup Weaver (MJW) reported many local equity managers were butting up against capacity limits. MJW, and Mercer in a 2013 report, found NZ share managers typically would branch out to the Australian market to ease capacity pressures.
“There’s an issue with getting capacity by entering Australian shares,” Iverson said. “There’s a trade-off between skill and liquidity. The alpha expectations may not be the same [for NZ managers investing in Australian shares] and it’s harder to gauge.”