SQM Research Newsletter and Ratings Update - July 2021

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All About Peer Groups

by Rob da Silva, Head of Research

Let's talk about peer groups – they get more attention than maybe they deserve.
When reviewing a fund, it is common practice to compare that fund's performance (and a host of other metrics) against its peer group - usually the average (sometimes the median) of that group.
This type of comparison can turn up in several places:
  • Fund Rating reports
  • Asset consultant review reports on a managers/funds
  • Comparison websites, investing websites
  • Fund Manager Client reports to investors
  • Product promotional materials
A peer group comparison is often used as a shortcut to judging the merits of a fund. It's a simple formula – the higher up the ranks of the peer group, the better the fund. It has appeal because it is straightforward and intuitive,
Such comparisons have their place and provide helpful information when appropriately used…but they are not the be-all and end-all.
They tell you where a manager/product has been, but not necessarily where they are going. Remember ASIC's most used (probably) quotable quotes? (from ASIC RG53)
"Past performance is not a reliable indicator of future performance."
You can easily replace the words 'Past performance' with the words 'Peer group ranking', and the statement is equally valid.
I'm going to paraphrase a previous SQM newsletter (titled 'Why didn't I get an Upgrade?)' and say….
A peer group rank is volatile and uncertain and not a good stand-alone indicator of a manager's skill in the short term. Of course, we want performance in the long run – that's the name of the game. But, using performance rankings as a guide to who can deliver the best long-term results is a flawed strategy. There are many other factors that can/should be used to triangulate a manager's prospects. The table below shows the key categories that make up a 37-point scorecard we at SQM use to guide the rating outcome. Risk and return is the lowest weight of these categories, and peer group comparison is only one component of this section. The other categories are more important in coming up with an informed opinion and a confidence level about the manager's future prospects.
Nevertheless, we (and many other fund researchers) use peer group comparisons, so let's look under the hood a little.
What is a Peer Group?
Google the word peer, and the first thing you're likely to see is this: "A person of the same age, status, or ability as another specified person."
So, not exactly the definition we are looking for. But if you replace the word 'person' with 'fund', you get a better idea. A peer fund is one that shares a number of characteristics of a similar nature to a specified fund.
When it's people you’re comparing, those characteristics could be age, status, or ability. When its funds, it might be a variety of characteristics such as asset class, investing style, size, age, market cap, product type and so on.
From this perspective, there are many, many peer groups you could construct from a mix of characteristics. Often the perspective of the user (of the peer group analysis) can make a big difference. Here are three examples:
Fund Manager: often, a manager will see their peers as firms that invest in a similar fashion as they do. This doesn't just mean the same asset class, but also sharing other features within the investing process such as value v growth, quality v momentum, fundamental v quantitative, market cap (large v small), valuation methodologies, preferred sectors (industrials v resources) and so on.
Fund Researcher: fund researchers tend to focus on sector categories/peer groups being defined by asset class along with one or more other characteristics. For example, Australian Equities might be broken down into style (value v growth v neutral) and market cap (large v small). They can often be quite broad categories with many constituents. The entire category might be used as a peer group, or a selected sub-set might be chosen.
Financial Adviser: often look at peer groups through a very different lens. They might consider elements such as funds that their clients have shown interest in, competitors to funds they are already invested in, or other broad themes or interests they have, e.g., income, ESG, disruption, climate. These groupings may not necessarily be based on the same type of characteristics that fund managers or researchers might use. Consequently, their constituents may look very different. For example – an advisor may look at "income funds" as a broad category including any product that provides some acceptable income level regardless of asset class or style. This group would likely look very different to a fund manager or researcher derived category/peer listing.
So, having talked about the foibles of peer surveys and accepting that they are commonly used (and sometimes mis-used), let’s add a little detail.
The Unifying Characteristics of a Peer Group
A peer group is tied together by a set of shared (or at least similar) characteristics that are used to define the group. There is no such thing as a correct peer group - as we've said before, different users will have different views on the characteristics that are important. Ask 5 different professionals for their Australian Equities Large Cap peer group and you will get 5 different answers.
At SQM, we aim to determine peer groups that are designed to be practical and fit for purpose. Here is a (non-exhaustive) list of characteristics we use (I would suggest that many other researchers and asset consultants use something like this list):  
  • Asset Class - obviously!
  • Sector - a more granular division of each asset class. There can be much variation here as there are multiple classification schemes available with material differences among them. We use the scheme developed by our data provider, which is widely used and recognised in the industry. It’s not perfect (no scheme is) but its widely known and widely accepted.
  • Structure – i.e., regulatory defined product categories such as managed funds, super funds, ETFs, investment bonds, pension products. We generally don't mix these products in a single peer group.
  • Size – i.e., total FUM in a product. Funds that are too small in size might not be in a viable competitive position.
  • Age – funds with too short of a track record may be excluded.
  • Pricing Frequency – there may be a case for separating daily priced products from monthly priced products. This aspect can also be a proxy indicator of portfolio liquidity.
  • Minimum Investment Size – helps separate retail from wholesale and institutional product
  • Headline Fund vs. White Labelled – to avoid duplication, it is best to focus on the main flagship headline fund and ignore the multiple other "copies" that may exist for white-labelling or platform purposes,
Sample Size
The final question is how many funds to include in the peer group; You can take the "kitchen sink" approach and throw every single thing in that category into a peer group. That risks leaving a lot of irrelevant 'junk' in that should be weeded out based on the criteria listed above.
Our approach is to take the broadest universe and apply a set of appropriate selection criteria (which is most, and sometimes all, of those listed above). From this filtered group (if it is large enough), we generally choose X number of funds from the largest (ranked by FUM) of the group. The number selected for the peer group (X) will vary depending on the size of the remaining filtered group and several other factors.
Why choose from the largest of the funds? Because regardless of the number of funds in the category, the sample will represent where most of the money is invested and, therefore, will represent the performance experience of many (if not most) of the investors. So, it is a practical and straightforward way to judge if a product has been competitive with the performance experience of the bulk of the money in that sector.
Let's look at an example to illustrate.
The SQM Fund Explorer database has 503 funds in the Australian Equities Large Cap asset class. Here is the filtering process:
I have done these calculations for several asset classes and drawn the same conclusion – the top 15 to 20 or so funds (ranked by FUM) will be a reasonable estimation of the FUM weighted return for a category AND will cover the experience of roughly half to two thirds (50 to 66%) of the money invested in that sector,
Sample Identity
By the way, we sometimes get asked by managers to reveal the constituents in a peer group. Our policy is not to reveal those details, so we respectfully decline those requests.
There are several reasons for this:
  • The peer group element is a small part of a 37-point checklist (amongst other things)
  • As we have discussed – no peer group is perfect. It is often in the eye of the beholder… and when SQM is writing a report as an opinion on a fund, that opinion includes the peer group.
  • Given the two points above, it is generally not productive to debate/argue about the peer group. It can in fact be counter-productive if it appears to be an attempt by a manager to influence the rating in a positive direction.
  • There may be a possibility that a manager publishes peer group details out of context, or in an inappropriate manner or, more troubling, in a selective manner. These are not proper uses for peer groups hence we prefer to “guard their identities”.
However, we are always happy to discuss the process of determining a peer group in order to provide appropriate transparency to the users of our research. Which is what this note is all about.
Now that you know all this – ask your favourite researcher, fund manager, platform, or whomever, how they triangulate their peer groups.
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Important Note:
There is some great reading in our archives – check it out at:
For further information:
Rob da Silva - Head of Research, SQM Research
Tel: (02) 9220 4606

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Tel: (02) 9220 4666

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Tel: 0414 847 511

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Please see below for descriptions of each star rating, whose purpose is to act as a guide for dealer group research teams and investment committee:
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3.75 stars - Favourable. Consider for APL inclusion.
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The rating contained in this document is issued by SQM Research Pty Ltd ABN 93 122 592 036. SQM Research is an investment research firm that undertakes research on investment products exclusively for its wholesale proprietary review and star rating system. The SQM Research star rating system is of a general nature and does not take into account the particular circumstances or needs of any specific person. The rating may be subject to Only licensed financial advisers may use the SQM Research star rating system in determining whether an investment is appropriate to a person’s particular circumstances or needs. You should read the product disclosure sta licensed financial adviser before making an investment decision in relation to this investment product. SQM Research receives a fee from the Fund Manager for the research and rating of the managed investment.
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