Australia: International equity sector review

Navigator has released its annual review of international equity funds, finding there are only five fund managers which offer global funds displaying the characteristics necessary to justify a 5-star rating. These are:

• Advance (Morgan Stanley)
• AXA (Bernstein)
• Credit Suisse (Capital)
• UBS
• Vanguard.

All 5-star funds were assessed as being very strong across the entire spectrum of assessment criteria. Interestingly, the top rated funds came from managers who demonstrated different styles and investment processes.

Mr Stuart Fechner, Navigator research manager, said the primary objective within the review is to identify quality managers and funds. This is achieved by the review process producing individual fund ratings based on the characteristics, performance and risk of each fund. Ratings are formulated under a rigorous program of fund manager visits, quantitative assessment of performance data and an extensive peer review process.

The review encompassed 25 managers and the rating of approximately 140 funds within the international equity universe.

For the first time global emerging markets funds were included in the review, with the team reviewing offerings from three managers – Citigroup, ING and Macquarie.

"Considering the sometimes volatile nature of the markets these funds operate in, it was reassuring to note the quality of each manager’s investment process and the calibre of the investment team," Mr Fechner added.

The requirements placed upon fund managers investing in such a broad category as international equities revealed a number of interesting differences in the investment approaches taken by some managers, including:

• Region versus Sector based portfolio construction?

Mr Fechner said while historically most managers have had region based investment processes, this appears to be changing in response to the demands of analysing many increasingly global companies within a global sector context. "

"In general, we believe a sector based approach is preferable since it tends to promote more detailed comparisons of companies globally. We also believe stock selection and risk control at a global level allows for more efficient implementation of analysts stock recommendations. However, in forming our ratings such considerations are secondary when compared with the logic and discipline of the investment process and quality and skill of the investment team," Stuart said.

• Currency hedging.

The impact of currency movements on returns from international investments has been significant over the past 12 months.

Mr Fechner said while the majority of international sharemarkets have experienced substantial rallies, the strong appreciation of the Australian Dollar has eroded the majority of these gains for funds that were not hedged against currency movements.

"Despite many managers having the discretion to adjust a fund’s currency hedging up to a certain level, they can sometimes be reluctant to use a large amount of their tracking error in a single active decision. Currency exposure is therefore one issue of many for advisers and clients to actively consider in setting a client’s investment strategy" Mr Fechner added.

• Stock vs Factor Risk.

Tracking error can be decomposed into stock specific risk and factor risk (such as country, sector and style type risks). Some fund managers allocate their active risk towards high levels of stock specific risk whilst others choose to take large factor risks. Mr Fechner said while one approach is not necessarily better than the other, it is important for investors to know the types of risks managers take, as it can affect the nature and repeatability of the fund’s performance.

Full research details are available to advisers who use Navigator, enabling them to better assess the potential of specific international equity fund investments for their clients.

"Fund ratings should not be considered in isolation, but in conjunction with the more detailed report and information that is available to advisers when they are assessing and selecting funds for a client’s portfolio", Mr Fechner said.

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Stuart Fechner is available for interview on 0407 839 080.

Attached
- Rating methodology
- Rating definitions

For further information, please contact:
Simon Morgan, Group General Manager, Public Affairs
(03) 9829 8892
0407 966 632

Notes to editors:

• Aviva Australia is a group of two specialist financial services companies: Navigator and Norwich Union Life Australia Ltd. Portfolio Partners, the Australian funds management arm of Aviva plc, is a sister company. Through these companies we provide products and services in the areas of wealth creation, wealth management and wealth protection for more than 300,000 customers throughout Australia.

• Globally, Aviva Australia is part of Aviva plc, the world’s seventh largest insurance group, the largest insurer in the UK and one of the top five life companies in Europe. Aviva was formed in May 2000 through the global merger of CGU plc and Norwich Union plc.

• Aviva is the world’s seventh-largest insurance group and the biggest in the UK. It is a leading provider of life and pensions products to Europe and has substantial businesses elsewhere around the world. Its main activities are long-term savings, fund management and general insurance. It has premium income and investment sales from continuing operations of A$68.32 billion, and more than A$488 billion of assets under management (as at 1 July 2003). The group has more than 59,000 employees and 25 million customers worldwide.

• The information in this document reflects Norwich Union Life Australia Limited's ('NULAL')/Navigator Australia Limited's ('Navigator')/NULIS Nominees (Australia) Limited's ('NULIS') understanding of existing legislation, proposed legislation, rulings etc as at the date of issue. In some cases the information has been provided to us by third parties. While it is believed the information is accurate and reliable, this is not guaranteed in any way. The information is not, nor is it intended to be, comprehensive or a substitute for professional advice on specific circumstances. The securities advice or information given in this document is of a general nature and has not taken into account the investment objectives, financial situation or particular needs of any particular person. Before making an investment decision on the basis of the advice above, a prospective investor needs to consider, with or without the assistance of a professional adviser whether the advice is appropriate in the light of their particular investment needs, objectives and financial circumstances.

• Applications to invest in a financial product issued by NULAL/Navigator/NULIS or any of its related entities must be made by completing the application form attached to the applicable Product Disclosure Statement ("PDS"). A PDS is available from Aviva or your financial adviser. Investors should consider the PDS before making an investment decision or deciding to continue to hold a product.

Rating methodology

The aim of Navigator’s research arm is to provide a valuable and reliable service to financial planners by identifying and monitoring quality managers and funds. As part of this service, Navigator Research reviews each asset class on an annual basis and produces individual managed fund ratings based on the characteristics, performance and risk of those funds. Ratings are formulated under a rigorous program of comprehensive fund manager visits, quantitative assessment of performance data and an extensive peer review process.

The assessment criteria allocates 60% of the rating to qualitative factors related to the fund manager and investment process, and 40% of the rating to quantitative performance and risk factors. Qualitative factors are weighted more heavily as Navigator Research believes that positive quantitative results are more likely to be achieved if the fund manager, investment process, investment team and the fund itself all exhibit strong features.

The sector review is conducted annually and the ratings are updated monthly. Each month the additional performance is incorporated into the quantitative calculations and any significant changes to the investment team or process are reflected in the qualitative factors.

Rating definitions

The final ratings are based on a 5-star system, with any fund rated 3 stars or higher considered to be ‘investment grade’. The definition of each rating is as follows:

*****	A superior quality fund indicating a very strong fund manager, investment process and performance history.
****	A very good quality fund indicating a strong fund manager, investment process and performance history.
***	A good quality fund indicating a capable fund manager, investment process and/or performance history.
**	A poor quality fund indicating a weak fund manager, investment process and/or performance history.
*	A very poor quality fund indicating a very weak fund manager, investment process and/or performance history.
Hold	The fund is under review and new investments should not be made into the fund until a new rating is issued.
Not Rated	The fund is monitored by Navigator Research but has not been assigned a star rating, generally due to an insufficient performance history or it being a multi-manager fund.