Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 221

Is your portfolio playing 20/20 or test cricket?

Following the footy finals, sporting eyes will turn to the upcoming summer of cricket, which this year features the Ashes. To win a game of test cricket, a team requires experience, discipline, patience and consistency over extended periods. It involves knowing when to play and when to leave, when to attack and when to defend. Similar traits are required when it comes to successfully managing a portfolio of investments for the long term.

This summer will also feature an increase in the number of 20/20 games, with a focus on short term excitement through increased risk taking. The comparison of cricket and investing is appropriate. The skills required to generate consistent long-term returns look very like that of test cricket, yet investors are often drawn to riskier approaches. As cricket historians well know, Don Bradman only hit six 6’s in his entire test career, yet holds the highest batting average on record.

The landscape for traditional active fund managers is changing leading to increasing levels of active risk being taken. So, it is important to measure the level of consistency or a portfolio’s ‘batting average’ to ensure risk is taken at the right time, and not just for risk’s sake.

Conviction with consistency

The rise of passive investing along with ETFs is disrupting active management globally. The response in Australia from these pressures appears to focus on taking more risk, to ‘prove’ a differentiation to the index.

To demonstrate this effect, Figure 1 shows the Australian universe of long-only actively managed funds taken from the Mercer Australian Shares Long Only Survey as at June 2007. Figure 2 shows the same survey, 10 years later at June 2017. Funds are ranked by return (y-axis) and level of active risk (tracking error (x-axis)).

In 2007, only 20% of long only funds recorded a tracking error (active risk score) greater than 3%. Ten years on, 45% of active managers in the survey are taking on active risk above 3%. Managers appear to be responding to the pressure to deviate returns away from benchmark.

For higher ‘risk’ mangers with higher tracking error above the median (shown in figure 2), there is material dispersion in performance for the same level of risk. On average there appears minimal additional return for some very high levels of risk.

Relevancy of active risk

Active risk can be increased in a portfolio in a number of ways: greater concentration via a reduction in the number of stocks held, large sector tilts, unconstrained cash positions and holding companies which have different risk profiles to the benchmark.

Increasing active risk in a portfolio can result in spectacular differentiated short-term returns. However, the increased risk can lead to greater drawdowns (losses) and prolonged periods of underperformance as well. To continue the cricket analogy, a six, six, four in 20/20 is often quickly followed by a ‘W’ in the wrong column. True, we need to take some risk to get returns, but sometimes risk just equals risk.

Investors should consider approaches that can balance the higher returns expected of a more concentrated portfolio with the level of risk or volatility needed to achieve those returns. Good portfolio management is far less about how much risk you take and more about knowing when to take the risk

Consistency in return prevents large behavioural biases of buying a star performer right at the top of a cycle or losing faith in the approach just at the wrong time. A consistent return series is also more practical for an adviser managing a large client base with multiple investment time horizons.

Ways to measure portfolio consistency and skill

The following are some techniques to monitor the consistency of an investment portfolio over rolling or extended periods rather than short term point in time periods, used in conjunction with analysis of the investment rationale behind the outcome:

1. Batting average is the total months a portfolio has outperformed divided by the total number of months in a given period. For example, if a portfolio has outperformed six months over a year it has a batting average of 50%. Consistency of batting average over time results in a smoother return series.

2. Hit rate shows the number of correct individual stock decisions as a percentage of the total number of manager decisions. Maintaining a consistent hit rate over 50% indicates solid investment skill.

3. Win/loss ratio is a comparison of the alpha generated from the good decisions with the alpha lost from poor decisions. For example, 0.75% excess return in outperforming months versus 0.70% excess loss in underperforming months leads to a ratio of 107%. Sustaining a positive win/loss over extended periods indicates consistency and skill.

4. Information ratio (IR) takes the excess return divided by the active risk i.e. how much return you can achieve for each unit of risk taken. An IR that can consistently remain above 0.5 is seen as a good risk return outcome. Anything consistently above 0.75 implies a high level of skill.

Risk matters

Risk management is central to successful funds management. Using a long-term approach with a level of consistency in returns provides comfort that investors will achieve their objective, irrespective of timing. It may not be as exciting as a 20/20 match, but will provide a superior risk-adjusted return over the longer term, help avoid succumbing to behavioural biases and ensure a smoother ride to your destination.


Andrew Martin is Principal and Portfolio Manager at Alphinity Investment Management, a boutique fund manager in alliance with Fidante Partners. Fidante is a sponsor of Cuffelinks.


Leave a Comment:



Five steps to become a better investor

Does fixed income diversify portfolio risk?

Building better portfolios by forecasting markets


Most viewed in recent weeks

Where Baby Boomer wealth will end up

By 2028, all Baby Boomers will be eligible for retirement and the Baby Boomer bubble will have all but deflated. Where will this generation's money end up, and what are the implications for the wealth management industry?

Meg on SMSFs: $3 million super tax coming whether we’re ready or not

A Senate Committee reported back last week with a majority recommendation to pass the $3 million super tax unaltered. It seems that the tax is coming, and this is what those affected should be doing now to prepare for it.

How much do you need to retire comfortably?

Two commonly asked questions are: 'How much do I need to retire' and 'How much can I afford to spend in retirement'? This is a guide to help you come up with your own numbers to suit your goals and needs.

Meg on SMSFs: Clearing up confusion on the $3 million super tax

There seems to be more confusion than clarity about the mechanics of how the new $3 million super tax is supposed to work. Here is an attempt to answer some of the questions from my previous work on the issue. 

The secrets of Australia’s Berkshire Hathaway

Washington H. Soul Pattinson is an ASX top 50 stock with one of the best investment track records this country has seen. Yet, most Australians haven’t heard of it, and the company seems to prefer it that way.

How long will you live?

We are often quoted life expectancy at birth but what matters most is how long we should live as we grow older. It is surprising how short this can be for people born last century, so make the most of it.

Latest Updates


Australian housing is twice as expensive as the US

A new report suggests Australian housing is twice as expensive as that of the US and UK on a price-to-income basis. It also reveals that it’s cheaper to live in New York than most of our capital cities.

Exchange traded products

The catalyst for a LICs rebound

The discounts on listed investment vehicles are at historically wide levels. There are lots of reasons given, including size and liquidity, yet there's a better explanation for the discounts, and why a rebound may be near.


The new retirement challenges facing Australians

A new report from Vanguard has found an increasing number of Australians expect to be paying off a mortgage in retirement, or forced to rent. A financially secure retirement is no longer considered a given.


Why aren’t there more Warren Buffetts?

Warren Buffett is widely regarded as the most successful investor ever. Rather than keep his secret sauce hidden, he's shared his knowledge for decades, so why aren't more investors able to replicate his methods and success?


Finding joy in retirement

Retirement can last more than 30 years, necessitating thoughtful planning. Many miss workplace friendships, identity, status, expertise, and routine, but these can be replaced with renewed activities and purpose.


Bull and bear case for Australian equities for FY25

ASX market bulls point to corporate balance sheets and earnings, while bears highlight company valuations and persistently higher inflation. It's best to ignore short-term noise and focus on investing in quality companies.


How gold can help diversify your portfolio

As inflation is likely to remain stubbornly elevated, the correlation between bonds and equities could remain high, reducing diversification within portfolios. A gold allocation may help to better protect your investments.



© 2024 Morningstar, Inc. All rights reserved.

The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. To the extent any content is general advice, it has been prepared for clients of Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), without reference to your financial objectives, situation or needs. For more information refer to our Financial Services Guide. You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.