Research Methodology

Funds Research Process

The following is a brief explanation of Zenith’s Fund research process taken from the document titled 'Regulatory Guidelines'. Please contact Zenith directly for more information on Zenith’s fund research process.

1. Compile sector universe
2. Conduct preliminary screening
3. Successful candidates issued research agreement
4. If agreement executed, formal due diligence conducted
8. Report finalised
7. Draft report issued to manager for fact checking (without rating)
6. Results submitted to Zenith Research Committee for ratification
5. Draft report prepared and peer reviewed
9. Zenith subscriber clients notified of rating
10. Fund Manager notified of rating
11. Ongoing survellance and data collection
12. Annual review cycle (back to #1.)

1. Investment Process

1.1. Overview

Zenith offers its clients access to the investment managers we identify as the “best of breed” through a comprehensive, multi-dimensional selection process. The selection process is rigorous in both its qualitative and quantitative analysis and each component is equally weighted.

As a dedicated provider of managed funds research, Zenith is completely objective in its selection process. Zenith does not manage any proprietary assets and as such is able to choose investment managers with absolute independence.

Our philosophy and commitment is simple. By exploring the investment landscape in a diligent and detailed fashion, Zenith is able to uncover the best opportunities on behalf of our clients.

1.2. Screening Process

An effective screening process is critically important to the overall research method. It ensures greater efficiency by directing the research team to concentrate their efforts on funds with superior qualitative and quantitative parameters.

The process begins by dividing the universe into the following broad asset class categories:

  • Australian Equities – large & small cap
  • International Equities – large & small cap, listed infrastructure
  • Property – domestic and international
  • Fixed Income – domestic & international fixed interest, mortgages
  • Alternatives – ETFs, Private Equity and Hedge Funds
  • Diversified Funds.

Zenith considers all Australian registered managed funds and a limited number of unregistered products. To avoid entering multiple funds for each investment manager, where appropriate, a flagship fund is used as a proxy for the manager’s capabilities in that asset class.

We generate fund data surveys from our extensive database. We begin with the broadest universe to avoid any selection bias at this early stage. Data is collected directly from the investment managers. The collection of in-house propriety data is rare within research houses, however Zenith considers this to be an important source of value add. This method has uncovered many opportunities prior to their coverage on commercial databases. In addition, there is a growing band of investment managers who are looking to limit growth in funds under management to remain within their target capacity limits. As a result, they are not represented on commercial databases. The early identification of quality fund managers is one of our key competitive advantages.

As the number of managed fund products offered to the Australian retail investor continues to expand, we will see offerings from the largest fund managers complemented by the growing band of smaller boutique players. Zenith believes that research groups with the necessary systems and contacts in place to act quickly will be best positioned to offer their clients access to an ever expanding world of opportunities.

1.3. Quantitative Screen

From its database, Zenith selects a list of leading contenders who pass the initial performance and risk screens. These quantitative screens include:

  • Absolute return (total, income & capital gains)
  • Information ratio
  • Sharpe ratio
  • Sortino ratio
  • Consistency of Outperformance ratios (total, rising & falling markets)
  • Beta
  • Alpha
  • Number of negative performance months
  • Maximum drawdown
  • Tracking error
  • Standard deviation
  • R-squared
  • t statistic

All quantitative measures are examined over rolling three-year, five-year and annualised periods.

Zenith has undertaken a detailed study into the appropriateness of differently weighted time periods and believes a three year period is the ideal benchmark. Whilst other timeframes are considered as part of the analysis, beyond this period investment team composition may be highly variable. Furthermore, annualised data may be inconsistent given its short term, possibly cyclical orientation.

1.4. Qualitative Screen

Whilst the first stage of the investment process tends to focus on the manager’s risk adjusted and absolute performance, the second stage incorporates an important qualitative overlay. The initial quantitative filter may identify a strongly performing manager who subsequently fails the qualitative filter given Zenith’s view on the team, organisation or process. Conversely, the quantitative filter may look less attractive if the current market conditions do not suit the manager’s investment style. For example, a growth manager will typically underperform in falling markets. However. Zenith may highly rate the team, organisation or process. Under this scenario, the manager may be added to the contender’s list despite its short term performance.

The use of a rolling 3 year timeframe as the benchmark review period aims to smooth out style biases which can often lead to distortions.

If the Zenith team do not have prior knowledge of the credentials of investment personnel but the manager looks attractive on the quantitative filter it will source a view from its network of industry contacts. If negative commentary does not arise, we undertake a preliminary meeting to determine the appropriateness of this manager’s representation on the list.

1.5. Detailed Due Diligence

After a short list has been constructed, detailed due diligence is undertaken with the investment manager. At this stage we thoroughly examine every aspect of the manager, from the overall philosophy and process to the people behind it. This level of due diligence is only achieved through detailed face-to-face manager interviews, a thorough review of all documentation, including the Investment and Financial Services Association (IFSA) standard questionnaire, and an in-depth look at the portfolio’s construction.

The face-to-face interview with the investment manager is regarded as a critical component. Our process extends beyond meeting with the Head of the Asset Class; other members of the investment team, regardless of seniority, are interviewed. This promotes forthright discussions and ensures there is consistent approach within the entire team. This aspect of the interview process is an important element as it provides us with a better understanding of team dynamics, the spread of responsibility, succession planning, team depth and key personnel risk issues.

In addition to interviewing the investment team, Zenith reviews the manager’s corporate strength through meetings with the Chief Executive Officer/Managing Director, Chief Investment Officer and Sales/Distribution Executive. These meetings help us fully understand the manager’s corporate strategy & direction, executive team capability & structure, and any operational issues.

During the course of the interview process an assessment is undertaken on three key attributes: organisation, philosophy & process, and personnel. This section of the review is qualitatively driven.

1.6. Organisation Assessment

Key points Zenith considers include:

  • Ownership structure – global alliance, overseas parent, joint venture, staff equity ownership (particularly relevant for boutiques);
  • Organisational structure – whether the business is solely focused on asset management or operates in broking, investment/retail banking or financial planning;
  • Management team structure – board composition, reporting lines (domestic, regional and/or global basis);
  • Executive team analysis – CEO, CIO, Board of Directors, Asset Allocation Committee;
  • Organisational history – timeline of major events (acquisitions, restructures etc);
  • Funds under management – total, split by wholesale, retail & asset class, history of gross inflows/outflows and decomposition of mandate and client type;
  • Remuneration & contractual structure;
  • Administration - back office capabilities, client reporting;
  • Communication – access to portfolio managers, sales/distribution staff.

At the organisational level, Zenith is looking for clean reporting lines, a commitment to the domestic business, an experienced & well credentialed executive team, diversified sources of funds under management, effective administration and strong communication.

1.7. Investment Philosophy & Process Assessment

Zenith examines the following points:

  • What is the manager’s underlying investment philosophy?
  • How does this philosophy seek to exploit inefficiencies in the market and is it aligned with the investment process?
  • Has the manager’s philosophy changed over time?
  • Is the investment philosophy a global house view or has it been tailored for the domestic market?
  • Does this philosophy differ at various stages of the business cycle and/or between sectors?
  • Is the majority of the research internally or externally organised?
  • Does a panel of brokers exist? How often is this reviewed & how is brokerage tagged?
  • Does the manager have any soft dollar arrangements in place?
  • What is the frequency of formal and informal meetings amongst the investment team?
  • How is the universe of securities filtered to arrive at an investable universe?
  • What information sources/data feeds are used?
  • Is a standard template used for building stock models or is this left to analyst discretion?
  • What is the level of reliance/importance placed on qualitative (Porter style analysis) and quantitative (valuation model) analysis?
  • Is the qualitative assessment formally ranked or scored?
  • Are analysts required to assign levels of conviction to recommendation? (i.e. target price, quantitative score or suggested over/under weight position)
  • Does the process make use of model portfolios?
  • What is the investment processes sell discipline?
  • What is an indicative level of turnover per annum within the product? Is this considered before a trade is implemented?
  • How many stocks/securities are typically held in the portfolio?
  • How concentrated is the portfolio?
  • How are the portfolio stocks weights decided, portfolio manager discretion versus matrix approach?
  • Is there a minimum stock weighting on entry into a portfolio?
  • In what type of increments do stock position moves typically occur?
  • At what FUM size would the manager consider closing the fund or portfolio due to capacity constraints?
  • Has the investment process or style changed as FUM has increased?
  • How does the manager define risk?
  • How is portfolio risk managed?
  • Is tracking error actively monitored and is this formally constrained?
  • Who is responsible for risk management and what is the process?

On the philosophy and process front, Zenith is looking for a fundamentally sound investment philosophy, a consistent and discipline investment approach, transparent portfolio construction and robust risk management.

1.8. Investment Personnel

  • Does the investment team have sufficient resources to implement its stated investment process?
  • What is the depth of experience and track record of the investment team?
  • What qualifications does each individual hold?
  • How are responsibilities split (stock, sector, mandate/portfolios, committee involvement etc) within the team?
  • How many stocks does each analyst cover?
  • Do portfolio managers also have stock responsibility?
  • Is a succession plan in place and do any key personnel risk issues exist?
  • Recent personnel changes and the reasons why?
  • What is the frequency and nature of formal and informal meetings within the investment team?
  • How are personnel remunerated?

On the personnel front, Zenith is looking for a well resourced, highly credentialed investment team with a solid track record of value add. A spread of responsibility within the team should limit key person risk, whilst an appropriate remuneration structure should incentivise all members of the team.

1.9. Quantitative Portfolio Attribution

In addition to the qualitative assessment undertaken as part of the detailed due diligence, a more in-depth analysis is performed on portfolio attribution.

Whilst the quantitative data gathered from the initial filter process is re-examined in the detailed due diligence phase, it is the testing of the manager’s portfolio which drives this part of the process.

Key information sought by Zenith to undertake this task may include:

  • Full portfolio listing with accompanying benchmark weighting;
  • Top ten active positions;
  • Top ten absolute positions;
  • Portfolio sector exposure relative to index;
  • Market capitalisation, GICS sector classification, Price/Book, Price/Earnings, Dividend Yield, NTA, EPS growth
  • Listing of any stocks where the Group exposure is above 5% of issued capital and which product they are held in;
  • Monthly portfolio turnover data;
  • Listing of stocks added/deleted on a monthly basis;
  • Monthly attribution analysis dissecting portfolio performance and risk, highlighting the key contributors to both.

This data is supplied on a monthly basis and is electronically delivered to Zenith to allow for ease of data implementation into internal database systems.

The data gathered from this quantitative review is then compared with responses from the qualitative interview process with managers on process and philosophy. During this process we are looking for consistent responses. For example, does the portfolio trading data match the manager’s response to a query on an indicative level of portfolio turnover?

Important trends and themes we look for in the quantitative analysis include:

  • Can the manager successfully pick winners as well as avoid the “blow-ups”?
  • Does the portfolio reflect a manager who backs his willing to back his or her judgement?
  • Has the manager added value across all market sectors or does a sectoral trend exist, allowing for style biases?
  • Has any style drift occurred over time?
  • Does the manager’s style favour a certain market condition? i.e. cyclical recovery?
  • Is the manager nimble to news flow?
  • Has the manager been successful at timing entry and exit points on stocks/securities along with identifying undervalued opportunities?
  • Does the manager need to turn the portfolio over regularly to add value?
  • Does the manager hold positions which may be difficult to exit, due either to the size of the position and/or liquidity of the security?

1.10. Summary

Zenith’s key competitive advantage is that we recommend only the best investment products for our clients. Initially we apply both qualitative and quantitative screens to identify funds worthy of further consideration. Detailed due diligence is undertaken on the resulting short list. This involves a highly comprehensive review process which encompasses an assessment of key criteria including the organisation’s structure, the investment philosophy and process, the calibre of the investment personnel and an in-depth portfolio attribution analysis. The best funds are added to the “Recommended List”, a list of our highest conviction products.

2. Ongoing Manager Evaluation

Zenith prides itself on the regularity and depth of its continual vigilance over investment managers. This extends from those managers already represented within the product and / or service to those on the “radar screen” for possible inclusion. Whilst the same process is used in the monitoring of managers to that adopted in the initial evaluation, it often “drills down” to specific issues that may have been identified during the month, quarter or yearly period of review.

In addition should there be a personnel departure (i.e. Peter Morgan from Perpetual in October 2002) and / or a significant process change, Zenith will meet immediately with the manager to evaluate the impact of the change and recommend a course of action to the Investment Committee.

Below we have detailed the specific data reviewed:

Monthly

  • Monthly Performance Update - all underlying managers in the database & Zenith products versus their “manager the manager” peers;
  • Manager Fund Flow Information – detailing any significant wholesale mandates lost and FUM pool totals for each underlying manager & Zenith products;
  • Update database – flows through to the quantitative component of the investment process.

Quarterly

  • Monthly Data “as above”;
  • Quarterly questionnaire – detailing stock / security portfolio holdings, attribution analysis and formally confirming any compliance breaches and / or investment personnel / process changes;
  • Manager update, via teleconference or video-conference. Zenith will speak directly with each portfolio manager to ensure an open dialogue. This update can either be general in nature or address specific issues at hand;
  • Screening update – identifies any new managers worthy of further due diligence and any existing manager who now “fail” the initial screen;
  • Adjust / Amend manager asset allocation weights in the diversified funds / portfolios.

Annually

  • Monthly & Quarterly Data “as above”;
  • Due diligence update – review existing managers and any new managers deemed worthy of addition;
  • Update database - flows through to the qualitative component of the investment process;
  • Review strategic asset allocations for diversified funds / portfolios;
  • Update reserve “B list” of managers.

3. Fund Ratings

Zenith undertakes thorough screening of each asset class to identify quality managed investment opportunities.

This is followed by an extensive due diligence process, where funds are assigned a rating. This rating is based on Zenith’s proprietary scoring system.

The quantitative assessment is flexible in that we do not rely on a performance history of three years to positively rate a fund and may use the history of an investment manager at a previous organisation if required (eg. in the assessment of Orion Asset Management we assessed the performance history of Tim Ryan at Credit Suisse).

Each fund is assigned an overall score/rating:

Rating Score
Highly Recommended = / > 80%
Recommended 70 - 79%
Approved 55 - 69%
Not Approved < 55%


3.1. Highly Recommended

Only a small number of funds achieve a Highly Recommended rating. These products typically rate first quartile on each of the following criteria - investment personnel, security selection, portfolio construction, risk management, organisational strength and risk adjusted performance and product features.

3.2. Recommended

Recommended products are deemed strong investments within their respective asset class, typically rating first quartile on most criteria.

3.3. Approved

Approved products are deemed above investment grade investments within their respective asset class. Approved candidates typically rate above the median on most of the assessed criteria.

3.4. Under Review

The fund rating has temporarily been placed under review due to qualitative and/or quantitative issues that need to be addressed by the Zenith Research Team.

3.5. Redeem

A redeem rating will be placed on a product where: Zenith has downgraded the rating to below investment grade through a lowered conviction in the product or; where a significant event adversely impacts the product to such an extent that investors are advised to redeem their investment.

3.6. Not Rated - Declined

No previous rating held. The fund has passed Zenith’s preliminary screen however the issuer has declined to participate in a full due diligence review.

3.7. Not Rated - Withdrawn

Previous Zenith rating withdrawn due to the issuer electing to cease ongoing coverage, or the fund has been terminated and wound up.

3.8. Not Rated - Screened Out

No previous rating held. The fund has either passed Zenith’s preliminary screen but failed the full due diligence process; failed Zenith’s preliminary screen making it ineligible for a full due diligence review; or is yet to be included in Zenith’s preliminary screen or sector review process.