Some ideas on how to choose a good fund manager

Ian de Lange of Seed Investments writes that with thousands of professional investment management firms around the world, selection becomes a difficult process. Multi managers have tried to identify key drivers of investment firms to help them with fund manager selection.

Russell investments, an international fund manager in investment funds, put out a recent presentation on their manager research process. This is something that they started in 1969 and so over the years have refined their methodology of selecting money management firms around the world.

Naturally in making selections, the idea is to try and identify the key success factors. Their original focus was on what they now term the old 4 P’s, being people, process / philosophy, portfolio and performance, which is typically used in due diligence processes.

While they have developed the New 4 P’s they still consider the old 4 P’s an important part of manager selection. I will cover the New P’s in a later article, but what most multi managers focus on is:

People: Because investment management is a people business, it is important to gain a good understanding of the teams and or individuals behind the business that are expected to generate the returns that clients expect.

One must understand who these people are, background, qualifications, and track records etc. Are they team driven, or does the business revolve around one person?

Process / philosophy: Having a defined investment philosophy is critical to long term sustainable results. Because philosophies can vary from firm to firm, a properly defined investment process will see that the philosophy is implemented. A multi manager should gain a clear understanding of the philosophy and processes involved and also how this matches up with the characteristics of the people in the organisation.

Portfolios: This is an important step that Russell Investments identified, which is to analyse the portfolios going back over time and to assess how these have matched the firms adopted philosophy. For example where a manager espouses a value philosophy but in the past had the bulk of the portfolio invested in growth shares, this could be indicative of an unclear investment process.

Performance: This is often mistakenly used as the first step in manager selection, but should come near the end. Clearly one should be looking for superior past performance, but its more important that all aspects of the due diligence line up. For example a value firm displaying 3 year poor outperformance against the market, may still be in the running if the past 3 years was a growth market, where value investors tend to underperform.

A presentation from global multi managers, Russell Investments, noted their New 4 P – as distinct from their old 4 P. They note that they developed their new 4 P’s as a complement to their original manager research approach. The New 4 P’s are passion, perspective, purpose and progress and they believe that these allow them to categorize the characteristics of firms that will enable an improvement in identifying superior investment managers.

Passion: This is a powerful emotion. They look for highly motivated and intensely competitive investment mangers focused on excellence if not perfection. Although passion is largely an intangible factor it can be identified in the communication that the firm puts out, the words that are used, the intensity of the people, low personnel turnover, etc.

An example of passionate behaviour is provided of a manager that for at least 20 years starts his day at 5:00am looking through data that his systems have been gathering overnight, before heading to the office. After a full day in the office doing classical fundamental research of speaking with company management, suppliers, competitors etc, he will after dinner be back at his home office until around midnight.

Although passion is not exclusively the domain of owner managed firms, it tends to be the case.

Perspective: Their view is that “managers with perspective know the limits of their capabilities and, generally possess strong sell disciplines.” They go on to cite an example of a firm that after a strong 2 year performance, called their clients and returned capital, given their inability to come up with new ideas in an expensive market. This behaviour indicated perspective in that the manager knew what his limitations were in a certain type of market.

Another example of perspective mentioned is on underperforming shares. Many managers faced with underperformers simply sell and move on, but managers with perspective spend more time analysing why they made certain decisions and attempt to learn from their mistakes.

These characteristics may not be easy to quantify but because there should be a low turnover of investment managers in a composite portfolio, it is important to make an evaluation on a strategic level.