【Financial Quantification】How to screen funds?

Fund Evaluation and Screening

1 Screening steps

1.1 Equity funds

(1) Build an alternative pool

• Priority is given to funds with a relatively stable stock allocation, so as to estimate the performance of the fund for a period of time in the future and its tracking of the benchmark stock index. Therefore, first of all, those fund products with large position changes and timing selection should be eliminated, because their positions cannot be controlled.
• Give priority to products with stable styles, and eliminate products whose investment styles have drifted within a certain inspection period.
• Because analyzing the style and performance of funds requires certain historical data, funds with a short duration also need to be eliminated. As for how long it is enough, it depends on the investigation period of the analysis and evaluation, which usually ranges from 1 to 5 years.
• Similar to fund products, short investment experience of fund managers will also lead to a lack of sufficient samples to evaluate and analyze their performance. Therefore, relevant fund managers and their managed products should be excluded.
• In addition to the above indicators, indicators such as risk, scale, and cost also need to be given sufficient attention.

(2) Quantitative analysis - building a core pool

• Indicators to measure the relative strengths of funds

  • After eliminating products that do not meet the requirements according to the above ideas, we have constructed a stock fund candidate pool. For the funds in the alternative pool, a certain number of products with high scores in each individual indicator and overall evaluation can be selected as the core pool products through quantitative methods for analysis, evaluation and scoring.

  • Quantitative analysis mainly uses various indicators to measure the relative strengths and weaknesses of funds. These indicators mainly include the historical profitability of fund products (annualized rate of return, Johnson Alpha), risk level (annualized Withdrawal), comprehensive performance indicators (Sharpe ratio, Tretter ratio, Sortino ratio, information ratio), performance stability (H index, skewness), etc. It should be noted that since the frequency of FOF rebalancing is often not too high, the fund's performance continuity and style stability are very important, and relevant factors also need to be carefully examined.

• factor study

  • For fund factors, to verify whether it really has a significant predictive ability for the future performance of the fund is called factor research. To put it bluntly, it is correlation.
  • The calculation is the Pearson correlation coefficient, called the IC coefficient
  • The calculation is the Spearman correlation coefficient, called RankIC coefficient.

  (3) Adjusting positions

  When adjusting the holdings of each fund, the following indicators are usually considered:

  1. Risk-benefit ratio: FOF fund managers will decide whether to increase or decrease the fund's holdings based on the risk-benefit ratio of each fund. If the risk-return of a fund is relatively high, the FOF fund manager may consider increasing the fund's position; conversely, if the risk-return of a fund is relatively low, the FOF fund manager may consider reducing the fund's position.
  2. Performance: FOF fund managers will also decide whether to increase or decrease the fund's holdings based on the performance of each fund. If a fund's performance is better, the FOF fund manager may consider increasing the fund's holdings; conversely, if a fund's performance is poor, the FOF fund manager may consider reducing the fund's holdings.
  3. Asset allocation ratio: FOF fund managers will also decide whether to increase or decrease the fund's holdings based on the asset allocation ratio of each fund. If a fund's asset allocation ratio is too high, the FOF fund manager may consider reducing the fund's holdings; conversely, if a fund's asset allocation ratio is too low, the FOF fund manager may consider increasing the fund's holdings.
  4. Market environment: FOF fund managers will also decide whether to increase or decrease the holdings of a foundation based on the market environment. For example, when the overall market falls, the FOF fund manager may increase the holdings of stock funds to reduce the risk of the entire FOF portfolio; and when the overall market rises, the FOF fund manager may reduce the holdings of stock funds to control the entire FOF portfolio risks of.

1.2 Other types of funds

pending upgrade

2 Adjusting positions

2.1 Consider the risk-benefit ratio

The risk-benefit ratio can usually be expressed by the following indicators.

(1) Sharpe Ratio (Sharpe ratio)

Defined as the ratio between the fund's annualized expected rate of return and annualized volatility, it is mostly used to evaluate stock, hybrid and bond funds. Its formula is:
$$SharpeRatio=\frac{R_p-R_f}{p_p}$$
, where $R_p$Indicates the annualized expected rate of return of the fund, $R_f$Indicates the risk-free rate, $p_p$Indicates the annualized volatility of the fund.

(2) Sortino Ratio (Sortino ratio)

Sortino Ratio is another metric used to assess the performance of stocks or other risky assets. It only calculates downside volatility and uses this part as the denominator to calculate performance. Its formula is:
$$SortinoRatio=\frac{R_p-R_f}{p_{downside}}$$
σ downside $p_{downside}$Indicates downside volatility.

(3) Information Ratio (information ratio)

Information Ratio is an indicator used to evaluate the performance of active management strategies relative to passive management strategies. The formula is
$$InformationRatio=\frac{R_a-R_b}{p_{a-b}}$$
Among them, $R_a-R_b$Indicates that the active management strategy exceeds the average return level of the passive management strategy; $p_{a-b}$Indicates the market volatility that needs to be borne when the corresponding excess return level rises.

(4) Omega Ratio

Omega Ratio is an asymmetric risk-adjusted performance measurement method, which has different weight coefficients when considering different losses and profits. Its formula is:
$${Oh}_R(x)=\frac{{\int }_x^{\infty }(1-F(R))dR}{{\int }_{-\infty }^{x}F(R)dR}$$
Where x is the threshold level; F® is the probability density function of achieving r% or greater gains; 1-F® corresponds to the realization of r% or less loss probability density functions.

2.2 Performance

If a fund's performance is good, you may consider increasing the fund's holdings; conversely, if a fund's performance is poor, you may consider reducing the fund's holdings. There are indicators for evaluating performance.

The indicators for evaluating fund performance can be divided into two categories: absolute return and relative return. A few commonly used indicators are listed below:

(1) Annualized Returns

Indicates the average value of the total rate of return achieved by the fund within a certain period of time, usually in years. The calculation formula is:
$$AnnualizedReturns={\left(1+Totalreturns\right)}^{365/\text{holding days}}-1$$

(2) Sharpe Ratio

It is an indicator of the ability to perform excess risk-adjusted excess returns. Simply put, the smaller the risk and the better the performance of the fund, the higher the Sharpe ratio. The calculation formula is
$$SharpeRatio=\frac{R_p-R_f}{p_p}$$

(3) Information Ratio

It is the most commonly used one of the performance evaluation indicators of actively managed funds, reflecting the measure of the relationship between the manager's creation of excess returns and his exposure to market volatility. The calculation formula is:
$$InformationRatio=\frac{R_a-R_b}{p_{a-b}}$$

(4) Maximum Drawdown

The maximum drawdown represents the maximum extent of losses that can be incurred within a certain period of time. We need to determine this data based on historical data. The calculation formula is as follows:
$$MaximumDrawdown=Max[\frac{Trough-Peak}{Peak}]$$

Among them, Trough is the difference between the asset value and the original value at the corresponding moment when the investment portfolio is obtained from the previous peak down to the lowest point, and Peak is the accumulated principal invested before the peak of the current round.

(5) Jensen's Alpha (Jensen Alpha)

Jensen's alpha coefficient is a measure of whether a certain security or combination has obtained excess returns relative to the market average, and evaluates how much error the security or combination has caused due to passive investment. It is calculated as follows:
$$Jense{n}^{\prime }salpha=Rp-[Rf+(Rm-Rf)\ast beta]$$

Among them, Rp represents the stock return actually obtained by investors, Rf represents the risk-free interest rate, and Rm represents the market average rate of return. Beta represents the systematic risk of a certain security or combination relative to the market average.

2.3 Asset allocation ratio

If a fund's asset allocation ratio is too high, you may consider reducing the fund's holdings; conversely, if a fund's asset allocation ratio is too low, you may consider increasing the fund's holdings.

2.4 Market environment

When the overall market falls, the holdings of stock funds may be increased to reduce the risk of the entire FOF portfolio; and when the overall market rises, the holdings of stock funds may be reduced to control the risk of the entire FOF portfolio.

3 Questions to consider

The investment strategy of FOF funds is usually to achieve diversification and diversification by allocating funds of different varieties and styles, so as to reduce overall risks and increase returns.

1. Set an appropriate risk-return ratio target: According to the investment strategy and management goals of FOF funds, set an ideal risk-return ratio target that suits you.
2. Clarify the time of investment: First of all, you need to clarify whether your investment is long-term or short-term. If it is long-term, you can pay more attention to long-term value and stable growth; if it is short-term, you can pay more attention to market trends.
3. Determine risk appetite: Determine risk appetite based on your own risk tolerance and financial situation. If you want to pursue high returns, you can choose some growth stock funds; if you are more risk-sensitive, you can choose some index or index-enhanced funds with larger scale and higher diversification.
4. Select the appropriate sub-fund portfolio: select and allocate sub-fund portfolios with different types, scales, industries, regions and other factors according to the objectives, and determine the proportion of each sub-fund in the total assets; To achieve a high degree of dispersion among assets as far as possible.
5. Dynamic adjustment of positions: In the actual operation process, it is necessary to monitor market changes and the performance of each sub-fund in a timely manner, and dynamically adjust different sub-funds according to the expected risk-return ratio target. For example, increase the position ratio of stock-type sub-funds when the market conditions are good, and increase the position ratio of bond-type sub-funds or money market-type sub-funds and other products with higher security when the market conditions are not good.
6. Periodic evaluation and correction: In practice, regular evaluation and correction of FOF funds is required. If it is found that the current position has deviated from the ideal state, it needs to be adjusted in time.

It should be noted that not all investors in FOF funds will use predictive models for stock selection or fund allocation. It pays more attention to factors such as the macroeconomic background, industry trends, and company financial conditions, and combines past experience and professional knowledge to judge whether stocks or derivatives are worth buying or selling, and dynamically adjusts according to the target.