Over the last three months I have written on a number of topics covering core philosophical decisions and beliefs ranging from the lifecycle of an SMSF to international trends on portfolio implementation and, most recently, dynamic asset allocation.
This month, I delve deeper and seek to provide a broad framework to assist you when evaluating the investment managers and professionals that are ultimately responsible for your clients’ investment outcomes. In the same way that structured implementation and effective asset allocation can add significant value, careful due diligence and a deep understanding of a manager is equally important.
As we all know, past returns are not a guarantee of future performance. Selecting managers from a list of top 10 performers will simply not achieve your clients’ outcomes or the increasing requirements of ASIC, in particular how an investment and/or investment strategy relates to a client’s individual circumstances (RG 175.287).
Funds under management – does size matter?
Depending on the investment strategy and asset class, fund size can be a important guide as to whether performance is sustainable and whether the manager is able to deliver on its objective and prior track record. When evaluating the impact of size, you need to carefully consider the capacity of a fund in a selected investable universe (such as small caps). Further, you should also try to understand if a manager’s appetite for risk has changed with success. It is not uncommon for new or boutique managers to outperform during their formative years. As they mature and grow bigger, they may drift closer to their benchmark and peer group average, as they seek to reduce volatility and mitigate ‘surprises’.
Investment philosophy and style – are they true to label?
Funds can fit, and are often placed, into a plethora of different style boxes. It is important to make your own evaluation on how you classify (within reason) a particular fund. The relevance of this is twofold. At a high level, you will find a fund can be classified differently by the various research houses, depending on their definition and view of certain practices. For example, if an Australian Shares fund occasionally shorts a small part of its portfolio to protect a position, would it be classified as hedge fund, an alternative investment or simply an Australian Share Fund? The answer is not always simple, but it is important to understand.
The second aspect relates to how closely they actually follow their mandate or philosophy. Has a manager switched ‘religions’ when their style is out of favour or have they drifted from their core beliefs when things haven’t gone to plan? Failure to stay true to label makes it difficult to predict future behaviour and to blend within a broader portfolio.
Culture, staff and ethics – do you trust how they operate?
Like any business you work with, it is important to understand the culture and ethics of a fund management business. In particular, how transparent are they with information and in their dealings with you? If a manager is reluctant or unwilling to share details of their portfolio, their systems or their investment process, it might be best to avoid them altogether. History has shown that ‘black box’ or opaque investment programs have rarely resulted in a positive outcome for clients.
In addition to transparency, the longevity of key personnel and low staff turnover within the investment team is paramount. A stable team, over a reasonable length of time, ensures a degree of consistency, shared internal knowledge and experience. It can demonstrate a commitment to the company and its values and beliefs. It is increasingly common to see investment teams own equity in their firms or to co-invest their own money on a mandatory basis to reinforce their alignment to client outcomes.
And finally, it can be beneficial to ask how the investment team is incentivised. There are a multitude of ways this might be structured. While there is not necessarily a right or wrong approach, it can identify if a team’s key performance metrics could lead to unnecessary risk taking or the opposite, a reduction in conviction.
Conclusion
Picking the right managers and funds can be challenging. However, spending the time to look beyond fund managers’ slick sales pitches and impressive marketing campaigns to really understand a manager and their business can avoid major disasters and create rewarding long-term partnerships.
