Baseball and investing have this in common: everyone takes notice of the outperformers. But like baseball, seasons of great performance may tell only part of the story. With investments, manager results or “batting average,” can provide additional insight into an investment’s returns. Equally important may be how that manager deals with risk, especially for a more volatile asset class like emerging markets, which has recently experienced a resurgence.
Batting Average Tells a Bigger Story
Batting average is a straightforward, intuitive measure of consistency. The metric represents the periods of a manager’s outperformance divided by the total number of periods. The resulting percentage is a fund’s batting average. For example, if the batting average is 0.250, the manager outperformed 25 percent of the time.
The higher the number, the more consistent the manager has been in outperforming the benchmark over time. You can calculate a manager’s average this way:
In baseball, Ty Cobb is the all-time career batting average leader at .366. In the investment world, success four out of every 10 is likely considered mediocre, or worse for an active manager. For passive exchange-traded funds, you would expect a .000 (0%) batting average because those investments are designed to track their benchmarks, not beat them.
Applying Batting Average to Volatile Asset Classes
A strong batting average in a volatile asset class demonstrates whether a manager is taking advantage of all opportunities to add value. The relative inefficiencies in emerging markets and sudden reactions to political turmoil can make selecting the right manager difficult. However, using a manager’s batting average can help evaluate consistency in performance. It’s a more holistic view of a manager’s skill and may mean the difference between choosing an investment hall of famer versus a benchwarmer.
Why Add Batting Average to Performance Analysis?
Anyone who follows baseball knows that, in addition to Ty Cobb, Ted Williams and Lou Gehrig are three of the best who ever played the game. We consider them great hitters not only because of one impressive season, but because they consistently outperformed competitors even in the most difficult circumstances.
Investment managers are also valued for their ability to outperform competitors, or their respective benchmarks. Performance and track records can provide valuable information, but often they don’t tell the whole story. “Batting average” can measure how reliably a portfolio manager adds value, and help remove the bias that occurs when investment returns are influenced by a particularly strong or weak period.
Batting Average and Other Measures
A true fan realizes that batting average does not tell everything about a hitter. Do they take walks, drive in runs, or hit homers? Even batting averages have limitations. While they are valuable measures of consistency, the metric does not account for volatility or degree of returns, nor does it consider risks the manager has taken.
You may want to consider pairing it with other important statistics such as alpha, Sharpe and information ratios, and upside and downside capture. These statistics reflect the degree of outperformance, the relationship between the return achieved and the risk taken, and the capability to perform in up and down markets. Using these in conjunction with batting average may provide a more rounded view of a manager’s skills, combining the reliability and frequency of their returns with the risk they are willing to take to achieve them.
Characteristics Important for Emerging Markets
As we have discussed, outperformance alone should not be the deciding factor for choosing an emerging markets strategy. Investments that have a good batting average, but are also designed to manage risk, participate in upside market moves and protect against downside market moves are important, too.
Consider choosing an actively-managed portfolio because of the oversight active managers can provide. Emerging markets are a diverse group of countries with unique economic, political and cultural differences. The right active manager may take advantage of these inefficiencies.
Next, look for an active manager who has the structure and strategies in place to find opportunities, while still managing risks. We believe an active manager that primarily concentrates on company fundamentals in addition to macroeconomic factors can help with upside and downside capture. Plus, you want a manager with a repeatable process.
Emerging market managers should have access to a free flow of information and analytics so they can take advantage of timely investment decisions. We believe that comes from teamwork; and when it comes to emerging markets, you want all the bases covered.
Financial Professionals: Find out more about the international diversification emerging markets can provide your clients. Call us at 1-800-345-6488 to find out how.
International investing involves special risks, such as political instability and currency fluctuations. Investing in emerging markets may accentuate these risks.
Investment return and principal value of security investments will fluctuate. The value at the time of redemption may be more or less than the original cost. Past performance is no guarantee of future results.
Diversification does not assure a profit nor does it protect against loss of principal.
The opinions expressed are those of Sibil Sebastian and are no guarantee of the future performance of any American Century Investments fund.
This material has been prepared for educational purposes only. It is not intended to provide, and should not be relied upon for, investment, accounting, legal or tax advice.