Manager selection, in the world of funds-of-funds, is absolutely critical, and made no easier by the fact that first-class fund managers are very much a limited resource for which there is stiff competition, which, despite the recent rise in passive investing, is still growing.
So where to begin the selection process? As good a place as any would be with the vital task of screening a managers’ track record to filter out any element of luck in an apparently-impressive investment history. A lot of work ought to be undertaken, on a quantitative basis, to eliminate the good fortune of having been in the right sector at the right time. The real strength of a manager is quite separate from chance or luck. Such biases need to be stripped out of the record.
The only bias that ought to be left is the bias of skill.
When satisfied that the trading record stands up independently of transient factors, the next big question is whether or not it can be repeated. This is a qualitative assessment – how confident can you be that the successful past will appear once more in the future, in a different environment?
In this regard, experience is a key factor. Having used the quantitative tools, you need to back this up with a strong qualitative view.
Central to this qualitative view is to try to establish a strong conviction about the manager in question. This can come only from actual knowledge of that manager, with face-to-face meetings to take a view on, among other things, the stability of the firm at team level and to judge what it is – if anything – that makes this manager and this strategy different from the others.
Once a manager has been selected, then, in a sense, the hard work has only just begun. The manager will have been fitted into an overall investment process in which the fund-of-funds will have, first, taken a view of the macro-economic picture as it is likely to affect their strategies.
This, in turn, will lead to decisions as to the right asset mixture, which, likewise, will then tend to dictate the type of asset manager needed to give effect to this strategy.
Having been selected, the manager will need to be monitored, not merely in terms of performance – hugely important though that is – but in relation to the overall condition of the manager. Strong convictions about a manager arise from actually knowing them, which, again, is where face-to-face meetings have such a vital role to play.
Such a relationship should allow you to become aware of changes at the firm level that may have an adverse effect on performance some way down the line. It is good practice during the process of engaging a manager to establish who is really in charge of the team, regardless of titles. Who is the key person?
Firms routinely put three or four people forward as the “leadership team”, and if one of them should leave, they can plausibly claim this is not a major problem. More generally, firms tend to portray all personnel changes in a positive light. In-depth knowledge of the team can help you to see through this in those cases where a positive interpretation is unjustified.
In parallel, good, hands-on knowledge of a team can alert you when a manager moves out of their natural investment environment and starts operating in unfamiliar territory. Even if this is initially successful, it ought still to be a red flag.
The manager should be asked why they are not sticking to what they know, to their tried and tested sources of alpha returns.
Then, of course, there is under-performance – and over-performance. Either could spell trouble.
If you know managers very well, you should not be surprised by their performance. If you notice a departure from an established pattern, you need to ask why. It’s a qualitative assessment to see if something has changed or is it a mark-to-market loss or gain?
Should you have faith in a manager, under-performance may demonstrate that the manager is ahead of events, meaning there is the chance to buy cheaply. By contrast, over-performance may mean they are taking on more risk.
Manager selection is not, of course, an end in itself. The objective is to pull together managers and strategies to generate, over the long term, the best returns for clients.
In summary, we are looking for an original, confident investment manager, one that does not simply buy the sell-side story but is able to think laterally and make connections, for example between current news stories and possible investment trends. That is a real skill, and one for which, as mentioned at the start, there is a lot of competition.
However, the market, in general, is currently heavily reliant on quantitative investment techniques, meaning those seeking out such a manager are, to an extent, bucking the trend. Painstaking selection procedures coupled with a clear idea of what makes a good manager are essential preconditions for making the right choices in this vital area.
Christophe Jaubert, is head of Investments at Mediolanum Asset Management