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TD Entertainment & Communications Fund: styled for success
5/26/2017 2:47:07 PM
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The Analyst’s Desk
Informative and authoritative articles on the world of investment funds from Fundata’s Investment Analytics and Research team.



By John Krisko  | Monday, May 01, 2017


 

A SPECIAL REPORT FROM



Returns-Based Style Analysis is a robust tool used to describe the investment style used by a portfolio manager. In a previous article, I looked at how RBSA can be used to help investors capture a statistical picture of a fund manager’s style to see whether it fits with the investor’s financial objectives and risk-tolerance levels. Since then, a new tool has been developed with significantly increased capabilities that allow us to conduct the analysis on a rolling basis for large datasets. To that end, let’s use the tool to look at another of the Canadian mutual fund “greats,” five-time FundGrade A+™ Award-winning TD Entertainment & Communications Fund.

This fund has distinguished itself time and again as the top Global Equity fund with an average annual compounded rate of return of 12% (as of March 31, 2017) since inception in November 1997. In the process, it has earned the FundGrade A+ Award for the best risk-adjusted performance in the Global Equity category every year since the A+ Award debuted. Despite clear outperformance in the last decade and a half, we are interested in what the fund is doing now and if it might be appropriate to add to our portfolio.

Style makes the fund

Funds in the Global Equity category literally have the world at their fingertips, so correctly identifying the investment style of a particular fund is important when considering if it will deliver the desired exposure as part of an overall investment plan. When evaluating a fund in this context, a simple categorization such as “Global Equity” is not very informative or specific. Certainly, a deeper look at the style is required before deciding if an investment is warranted. RBSA will provide insight on exactly this, and by examining a rolling time frame we can also make a determination on consistency of style.

By using daily instead of monthly returns as inputs, RBSA becomes perfectly suited to bridge the information gap left by the large delay between datasets in allocation analysis. Inputs for this style analysis are 566 daily returns from the fund and indices, which represent the investable universe and are too numerous to list here. The rolling analysis will present a regression of 63 trading days (3 months) at daily intervals, from April 2015 through April 19, 2017. The rolling RBSA is complemented by a single-period regression of the entire sample. The single RBSA provides context as an aggregate of the rolling analysis and a basis from which to examine the validity of the model.

 

 

Comparing the two charts above, it is apparent that the major style allocations identified in the 63-day rolling RBSA are generally consistent with the allocations in the 566-day summary portfolio. This indicates that the selection of indices accurately reflects the investment universe of the fund and also that the 63-day rolling window is not subject to excessive noise.

Although TD Entertainment & Communications Fund is classified as “Global Equity,” the 566-day and 63-day graphs both show that the fund actually behaves very much like U.S. large-cap growth stocks. In fact, at the maximum point, the fund performs as if it was nearly 90% allocated to the U.S. large-cap growth index, and it is consistently the most prominent allocation in the sample.

As the fund does not own any Canadian equities, it would not be surprising to learn that the allocation to Canadian large-cap growth from the beginning of the window through November 2015 was a result of the significant depreciation of the Canadian dollar against the U.S. dollar. If this caused the Canadian index to behave similarly to its U.S. counterpart, the regression would have trouble differentiating between the two. Indeed, the correlation of the two indexes over the period begins at 92% before declining as low as 8% in June 2015.

One size fits all

The graphs provide some interesting information about what we might expect by investing in the fund, but what do the numbers say about accuracy? This is where it gets interesting. According to a regression of the RBSA portfolio returns against the fund, while the model portfolio is an excellent match for the fund, it only explains 55% of the performance. This value was 92% for the Franklin Bissett ActiveQuant Canadian Fund, which I analyzed last time, when the fund was called the Franklin Bissett All Canadian Focus Fund. This difference in performance is very noticeable when we look at the growth of $1,000 for both funds.

 

If the model is significant but the explanatory power is only moderate, we need to look elsewhere for the source of the remainder or consider potential errors. Academic researchers Lucas and Riepe (1996)* provide an excellent overview of the four potential sources of data noise and low explanatory power. A review of the paper is highly recommended. The only source touched on here is the poor choice of indices. In this case, a holdings-based analysis of TD Entertainment & Communications Fund reveals investments in securities of private issuers whose risk and return profile will likely differ from the listed securities represented in our indexes. The overall allocation is small, however, so the effect of these investments should be minimal.

With great selection comes great returns

After errors in the model or data are eliminated, the last effect that may account for the difference in returns is manager alpha, that is, the performance that differentiates the best from the indexers. It should be no surprise that alpha is the explanation we’re left with for the top Global Equity fund.

Before getting ahead of ourselves, total alpha is a combination of stock selection and market timing, so we first need to eliminate timing as the root source of alpha. Again Lucas and Riepe (1996) provide some guidance on an informal way to eliminate timing as the primary factor without performing a decomposition of the alpha. If the fund is timing the market, it is entering and exiting positions and will necessarily exhibit a high turnover ratio. It will also be apparent in the rolling RBSA as frequent style shifts and a mismatch with the summary portfolio. For an actively managed equity fund, the fund has a low turnover ratio of 18.3% for 2016. Considered in concert with the consistent style observed in the RBSA analysis, it is likely that a majority of the alpha is due to successful stock selection.

The model indicates alpha generation on the order 5.24%, at a 95% confidence level. This is absolutely massive, and if our conclusions are correct it explains one of the reasons TD Entertainment & Communications Fund is at the top and how it has managed to stay there for so long.

* Lucas, Lori and Riepe, Mark W. “The Role of Returns-Based Style Analysis: Understanding, Implementing, and Interpreting the Technique.” Ibbotson Associates, May 1996.

John Krisko, CFA, BBA, is Senior Analyst, Analytics & Data, at Fundata Canada Inc., a leading source for investment fund information.

Notes and Disclaimers

© 2017 by Fund Library. All rights reserved. Reproduction in whole or in part by any means without prior written permission is prohibited.

Commissions, trailing commissions, management fees and expenses all may be associated with fund investments. Please read the simplified prospectus before investing. Investment funds are not guaranteed and are not covered by the Canada Deposit Insurance Corporation or by any other government deposit insurer. There can be no assurances that the fund will be able to maintain its net asset value per security at a constant amount or that the full amount of your investment in the fund will be returned to you. Fund values change frequently and past performance may not be repeated. The foregoing is for general information purposes only and is the opinion of the writer. No guarantee of performance is made or implied. This information is not intended to provide specific personalized advice including, without limitation, investment, financial, legal, accounting or tax advice.

 
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