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Anchor to Windward: Aligning Absolute Return Objectives

PGIM Institutional & Advisory Solutions

May 2018

Following the financial crisis, institutional investors began to place greater focus on investment objectives such as downside diversification, lower tail risk, and performance consistency. Institutional investors turned to hedge funds and other alternatives to incorporate more stable, diversifying return streams into their portfolios. But with unexpected shortcomings with their hedge fund investments, investors have become increasingly interested in more liquid, transparent strategies.

PGIM’s Institutional Advisory & Solutions introduce a new measure of performance sustainability, the Anchor Ratio¹, which can help investors identify strategies and funds with more consistent and sustained performance, as well as other desirable performance characteristics.

On average, IAS found that:

Absolute Return, Event Driven and Credit Long Short strategies provided relative consistency (as measured by the Anchor ratio), altogether with attractive risk-adjusted returns.
Equity Long Short was attractive from a risk-adjusted return perspective
Absolute Return, Multi-Strategy, Event Driven, and Discretionary Macro were most effective in controlling tail risk
Managed Future alone stood out for downside diversification

¹In the game of Cricket, the anchor is a top-order batsman capable of batting for a long duration throughout the innings. Despite playing defensively, the anchor is often the top scorer. In finance, we often use the “hit rate” to evaluate consistency of a manager’s skill, where the hit rate is defined as the ratio of the number of correct decisions as a percentage of total decisions. However, the missing concept is the notion of performance sustainability. How long can a manager hit without having a miss?

Objective	Performance Sustainability	Lower Tail Risk	Downside Diversification	Risk-Adjusted Return
Measure	Anchor Ratio	95% CVaR	Downside Equity	Sharpe Ratio
Absolute Return	x	x		x
Multi Strategy	x	x
Event Driven	x	x		x
Volatility	x
Credit Long Short	x			x
Equity Long Short				x
Macro²
Discretionary Macro		x
Managed Futures			x

Note: An “x” indicates relatively favorable results for the given strategy when evaluated based on the given measure. In each case, an “x” is marked if (a) the strategy-level average of that measure was greater than the overall average of that measure (of all funds evaluated across strategies) and (b) if more than 30% of the individual funds evaluated in that strategy were associated with top quartile results of the given measure. Quartile results for the Sharpe ratio measure, not presented in the paper, are available upon request.

²Macro results are presented at the sub-strategy level here for (a) Discretionary Macro and (b) Managed Futures, given the relatively large number of funds and unique characteristics in each of these categories. The number of eligible funds in GTAA, Systematic Macro, Fixed Income Relative Value and Foreign Exchange sub-strategies were fewer than five each, and therefore were not reported at the sub-strategy level, and overall “Macro” strategy-level results are not meant to represent the characteristics of these sub-strategies.

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Source: PGIM IAS, eVestment. For illustrative purposes only.