Updated: Jun 10
State of the Industry series: Asset Allocator Talk I: Beyond the Obvious.
One of the most crucial decisions for investors when constructing a portfolio is choosing the underlying managers. While many investors evaluate a fund manager's track record quantitatively, it's important to remember that numbers don't tell the whole story. Investors should also look at qualitative evidence to identify a manager capable of executing a proposed strategy and achieving success in the future.
When selecting a fund manager, several important criteria must be considered. However, it is evident that the track record consistently remains at the top of investors' lists. Assessing the manager's past performance is often seen as the critical aspect of this selection process for most investors. There is also a widespread perception that a manager's track record is solely based on quantitative metrics, such as historical fund portfolio performance data and quartile breakpoints found in spreadsheets. This perception is fueled by a benchmark industry that heavily promotes these data.
However, constructing a future-proof investment portfolio requires investors to make informed decisions when selecting a fund manager. To achieve this, investors must thoroughly analyze both qualitative inputs and quantitative data to explore the various factors that shape an investment portfolio. Only by gaining a deep understanding of these factors can investors make informed decisions that help them build a successful investment portfolio and achieve their long-term financial goals. In contrast, a static, quantitative-based approach often fails to capture the full picture and may not provide the complete information investors need to make informed decisions.
Numbers alone are insufficient
Merely relying on numerical data to evaluate a manager's performance is not only insufficient but has also its limitations. With a low number of data in a fund, the dataset might be too limited to draw significant conclusions. A manager's track record is multifaceted and cannot be evaluated based solely on numerical data. Instead, a comprehensive approach that combines both quantitative and qualitative analysis is required. While numbers provide a useful starting point, they should be complemented with an understanding of the manager's investment philosophy, talent, and operational capabilities.
In addition, the market is constantly evolving, and past performance may not be indicative of future results. Therefore, it is important to consider the current market environment and ecosystem and how they may impact a manager's performance moving forward. Ultimately, a manager's track record should provide evidence of their ability to generate returns consistently and sustainably over time, rather than simply how much they have earned in the past.
Good fund managers are not irreplaceable
The departure of a manager or changes in the management team typically should not have a significant impact on a fund's performance, as there is usually a team of analysts and co-managers who assist with decision-making. However, it is crucial for investors to carefully assess the fund managers' background and investment approach, as they are responsible for managing investors' hard-earned money. Therefore, when selecting a fund, investors should also examine the fund managers' own track record in managing other funds, as well as their investment philosophy and objectives.
Fund management companies should strive to maintain a low or reasonable turnover of managers and their teams. This is important because it helps to establish a solid track record of fund management and performance. Ultimately, having a reliable and experienced team behind the scenes can also significantly improve the performance and stability of a fund, regardless of the appointed manager, giving investors a sense of security and peace of mind.
To do well in a poor market- Don't ignore the fees
After a series of successful performances in a bull market, fund managers may argue for their ability to repeat the same strategies and generate superior returns. Consequently, they may become highly sought after and tempted to significantly increase their assets under management. This can lead to a massive increase in staffing and office space, and the fund manager may also be forced to increase the number and volume of the underlying positions. However, by spreading their attention over several new positions often of second ranks, managers risk weakening their fundamentals
While performance is a key factor in selecting a fund, investors should not be convinced by this argument alone. On the contrary, they should carefully consider fees and expenses when choosing a fund. Expenses, including fees and operating expenses, have a significant impact on long-term investment returns. Even a one percentage point increase in annual fees can make a 10% difference over a decade.
A good manager may be worth a higher fee in a bull market, but investors should always consider an investment option in a full cycle of bull and bear markets. Therefore, fees should be carefully considered and monitored when selecting funds.
Bigger is not necessarily better
This is often related to the previous point. Bigger is not necessarily better. Research shows that as a fund grows, the gap between its performance and that of its index or benchmark tends to narrow. This is because as the fund size increases, its managers may be inclined to take larger but less performing positions, ignoring the smaller and less liquid positions that might perform well in the future. Boutique funds, with their smaller size, have more flexibility to make decisions that can make a big difference in performance.
A large fund often can't put 5% of its assets into a single position, however good the prospects are because there isn't enough liquidity in the assets. A smaller fund, on the other hand, may be able to make bigger, more concentrated bets on what the manager thinks are the best prospects. This can give them an advantage in performance, as they have more flexibility to invest in opportunities that larger funds may not be able to access
Think about the working culture
The imminent retirement of key decision-makers who have led the fund to success is a potential concern for investors, who may need to decide whether to stay invested or move their investments elsewhere. This decision is dependent on the specific needs of each investor, but two factors that can be helpful in making it are the role of junior analysts and the decision-making culture within the firm.
Investors who have had the privilege of working with the current managing partners since their days as junior analysts may have a better understanding of the manager's fundamentals, and be better positioned to evaluate whether the new management will be able to maintain the same level of performance as the previous team. Additionally, if decision-making within the firm is spread across multiple roles and individuals, the departure of a key partner may not significantly affect the firm's performance.
What truly distinguishes a successful fund is not the individual performance numbers, but the underlying decision-making team and culture.
Look forwards, not backwards
Instead of dwelling on past performance, it's important for investors to focus on the next 10 years and identify fund managers who have the potential to excel. While historical data can provide some insights, it's crucial to look beyond that and assess the fund's competitive edge. This involves evaluating the manager's ability to navigate through various market conditions, including both bull, bear and extreme market conditions.
Instead of relying on mathematical forecasting methods that simply extrapolate past events and trends in a linear fashion, the fund selection industry could benefit from adopting corporate foresight methods. This approach involves analyzing the manager's overall strategy, vision, and ability to adapt to changing market conditions, in order to better predict future performance and potential.
By adopting a forward-looking approach and considering a more comprehensive set of factors, investors can make better-informed decisions on which fund managers are most likely to succeed in the future. Using foresight analysis tools rather than simple forecasting methods can provide valuable insights into a manager's overall strategy, vision, and adaptability to changing market conditions. By taking a holistic view of a fund's competitive edge and its ability to navigate extreme market conditions, investors can successfully identify managers with the potential for long-term success