I have used the saying ‘If you can measure it, you can manage it’ in quite a few of my writings. Last week (Start by looking for quality shares), I used the processing of quality data to ‘measure’ companies that currently stand out as quality companies. I also mentioned that that processes based primarily on companies’ last 12-months’ financial statements, and therefore only the first step in a much greater process. Personally, I always prefer to combine an extra-long-term data measurement with the short-term data measurement, in order to help me to identify companies that have managed to achieve greater success over the longer term.
In other words, we are trying to analyse historical data in such a way that it gives us a clearer indication of how attractive one investment is relative to another. One of the most powerful tools at our disposal to conduct a relative analysis, is the information ratio. It is mainly used to compare a fund manager to an index, for example. The ratio doesn’t only look at the fund’s ability to outperform the index, but it also analyses the fund manager’s ability to outperform the index consistently. In a nutshell, the greater the ratio, the greater the fund manager’s ability to outperform the index.
When we analyse the SA General Equity Unit Trust funds, it becomes clear that the Aylett Prescient Equity, 36One BCI Equity, Coronation Top20, Coronation Equity and Marriott Dividend Growth funds were the five funds with the highest information ratios over the last 10 years, relative to the sector. This means that according to historical data, these five fund managers managed to best outperform the FTSE/JSE All Share Index. Not only did these funds manage to outperform the index by an average of 4% per year, but at 12.92%, they managed to experience only 71% of its volatility (of 18.15% per year).
Although the information ratio isn’t usually applied to direct shares, I applied it to the growth in earnings of all shares that currently find themselves in the FTSE/JSE All Share Index and which already have a 10-year profit history, and the results were quite surprising. It actually makes sense that this ratio would also point out a company’s management team’s ability to achieve consistent profit growth. The 10 shares that have the highest information ratio based on earnings relative to the FTSE/JSE All Share Index’s growth in earnings over the last 10 years, are:
- Mr Price
If you were lucky enough to have equal weights invested in an investment portfolio consisting of the 20 highest information ratios over the last 10 years, your portfolio would have grown by a staggering 22.6% per year (excluding dividends). Not only is that nearly 16.5% more growth per year than the FTSE/JSE All Share Index over the same period (also excluding dividends), but during the great correction of 2008, it only would have experienced 36% of the market’s total decline. Even though I only used 20 shares in my analysis, which should have been more volatile, these 20 shares combined actually only experienced 13.3% volatility per year over this 10-year period (i.e. 73% of the market’s annual volatility over the same period).
Again, I would like to point out that this analysis is based on historical data, and not unlike last week’s quality analysis, it shouldn’t be used exclusively in any analysis, but it should rather be combined with another investment tool to help you with your decision-making process.
What the information ratio clearly shows is, is firstly, that it is a promising tool to use to identify good fund managers and secondly, to identify good management structures in listed companies.
PSG Wealth is a division of PSG Konsult, and just like Capitec, it is partly owned by PSG Group. The opinions expressed in this blog are the opinions of the writer and not necessarily those of PSG. These opinions do not constitute advice. This is intended as general information and does not form part of any financial, tax, legal or investment related advice. Although the utmost care has been taken in the research and preparation of this blog, no responsibility can be taken for actions taken based on the information contained in this blog. Since individual needs and risk profiles differ, it is always advisable to consult a qualified financial adviser before taking action.