JD van Heerden
Senior Lecturer, University of Stellenbosch, South Africa.
Albertus Francois Botha
Post-Graduate Student, University of Stellenbosch, South Africa.Using a Dynamic Benchmarking Approach to
Measure South African Equity Managers’ Skill
This study focuses on an alternative approach for evaluating the
performance of portfolio managers along with measuring the skill of
the specific manager. The two methods that are most commonly used in
order to evaluate portfolio managers are peer group comparisons and
comparisons to an index. Both of these methods have several
drawbacks, for example the concentration of South African equity
indices, composition bias, classification bias and survivorship bias.
An alternative approach can be used in order to eliminate these
problems. In general each manager has a “unique” investment
opportunity set which conforms to the specific manager’s investment
philosophy (or style). In order to determine these individual investment
opportunity sets the constituents of the South African FTSE-JSE All
Share Index (ALSI) were divided into nine mutually exclusive indices
based on the different investment styles, namely value, growth and
size. By making use of return based style analyses it is possible to find
the combination of these indices that contributes most to the return of a
specific equity portfolio during a specific period of time. This
combination can then be seen as the investment opportunity set of the
specific portfolio manager for the period under review. When these
investment opportunity sets are known one can make use of computer
programming to simulate thousands of random portfolios by randomly
picking shares from the identified indices making up the manager’s
style and assigning random weights to these shares. Furthermore, the
random weight allocation to each of the constituents can be adjusted in
order to take the manager’s mandate constraints into account. These
random portfolios represent the range of all portfolios possible to
construct that are in line with the manager’s investment style.
If the portfolio manager is able to outperform most of the portfolios
in the range of random portfolios of similar investment style in a
consistent fashion, then one can conclude that the manager’s stock
picking and portfolio construction ability must be due to skill rather
than chance.