On the hunt for the pick of the bunch
Jupiter’s John Chatfeild-Roberts says the fund of funds selection process “is both an art and a science”. Kira Nickerson talks to six fund strategists to find out what they like and dislike in a manager and how they distinguish long-term skill.
Chief executive, North Investment Partners
We are trying to construct a portfolio in much the same way as you would a team - putting funds in a position to do a certain job for various times in the market cycle. We look at several key areas, the most important of which is process. It has to make sense, be robust and repeatable, and be clearly articulated.
In assessing the manager of a fund we look at the depth of their experience. Have they helped run or evolve that process over time? Performance track record is a tool in manager selection, showing whether the application of the investment process has been rewarding.
A manager need not necessarily have been running a fund for a full three years, but must have been running money in that manner at least for some time. We do not necessarily rule out new managers, but we do have a bias towards those who have been running money for a considerable period.
We also study performance in the ongoing monitoring of fund managers, looking for consistency, and whether or not performance has been in line with our expectations.
Sometimes a manager will underperform at certain stages in the market cycle or environment, but we are less convinced when underperformance is unexpected, when the manager’s style or process would have been favoured. Inconsistent or unexpected outper formance is also cause for review, as it may indicate a deviation from style or process.
Groups play a role in our assessment as we look for anything that may detract or interfere with the application of a manager’s ability. All groups have a house style, which can affect the way in which managers are reviewed, how analysts are set up, and even where they are located. Not all investment groups are good at all areas.
Yes, financial stability of the group matters. We are looking at fund managers and how they are managed, and the more stable managers will stick with the more stable houses.
Joint head of multimanager,Thames River Capital
Inevitably, historical performance plays a role in capturing our attention to look at a certain fund. We also study performance to judge a manager’s ability to manage money and generate alpha. We then evaluate that manager’s capability and the degree to which they can repeat performance.
“New funds and new ideas are fine so long as there is something to hang our hat on, some form of record of the process or manager’s ability”
Performance, though, is just one ingredient; we also look to assess capa - city, the number of mandates they run, the quality of the team and the resources and culture of the group. The latter is important, but mostly in regard to the group being the right fit for the manager.
We also look at incentives. There has to be a strong tie-in for a manager to their performance; in our experience this can be highly motivating. With regard to capacity, we favour managers unencumbered by assets, or with fewer funds to run.
The funds do not necessarily have to be small per se, but small enough so the manager has the flexibility to impart their judgment.
When looking at the people and team behind a fund or manager, we are not exclusive. A team does not have to be a certain size; instead, we look at the depth and breadth of the available knowledge.
While we would question managers who have had a tough period, this has to be put into context. Every manager will go through a bad patch, but that is the beauty of multi-manager funds - they don’t all go through it at the same time. We gauge the relevance of the underperformance, such as a smallcap manager underperforming when large companies are outperforming.
We take a practical approach to assessing managers so would not rule out a new manager or new fund. In fact, by having a rigid three-year track record rule we could miss some of their most potent performance.
New funds and new ideas are fine so long as there is something we can hang our hat on, some form of past record of the process or manager’s ability.
Head of fund of funds, Standard Life Investments
We have a universe of more than 5,000 funds - on and offshore - that are eligible for sale in the UK with reporting status. Performance screens aimed at identifying consistency are run looking at a fund versus its peer group and index over three and five years.
If a fund does not have a long enough track record we will examine its performance quarter by quarter and we keep a close eye on new or forthcoming launches, which we have no problem supporting so long as they pass our due diligence or qualitative assessments.
All of this helps to narrow down the list to around 250 onshore and 300 offshore funds.
In the qualitative portion of our process, we look at the five Ps: philosophy, process, people, performance and price.
The first looks at understanding what a manager is trying to achieve and examining the process to ensure it is deliverable and repeatable.
We probably spend most of our time in this area of assessment, looking through port folios, relating what the holdings tell us, challenging the managers. For instance, I remember a manager telling me he selected companies based on quality management and yet when looking at his portfolio there were several examples that didn’t fit.
In analysing those responsible for a fund we look to ascertain who are the key drivers behind the philosophy, process and performance.
We meet all managers before we would ever invest. As part of this, at times we will even sit in on analyst meetings if they are key to the way in which a fund is managed. We also look to spend time with the co- or back-up manager to ensure something is in place in case something were to happen to the lead manager.
Not everything comes down to price but we do look to ensure we use our buying power to get the best possible price for our clients as the better the price, the better our returns.
TIM GARDNER (L)
& ALAN THEIN (R)
Co-managers, Legal & General Investments
We give equal consideration to asset allocation and stock selection in constructing our portfolios. Both are solid sources of alpha, and we find having a diverse source of returns helps us to perform in different market conditions. In examining managers in which to invest, we take into account a wide range of factors, delving into all aspects of their investment process, trying to ascertain, for example, where the alpha in the performance comes from. Is it the manager or another member of the team who is providing most of the best ideas? Do they have a repeatable edge over their competitors? Are portfolios constructed effectively and is there a sensible approach to risk management?
We spend a lot of time talking to them in detail about the stocks held in their portfolio to determine whether there appears to be any differentiation from their peers in their thought process and ability to spot opportunities.
We do not have any set restrictions or exclusions when it comes to experience or track record as we always approach new funds on a case-by-case basis. However, one area we do not like is when we see managers thinking too much about asset-raising rather than performance, or an incentive structure that encourages this.
We spend a significant amount of time on the organisation itself when considering the merits of any of its investment strategies, as the overall management of a group will influence all aspects of the business.
We do not have a pre-determined preference for a large over a small firm, one based in Britain or overseas, or a well-established name over a boutique.
Instead, we look for positive characteristics such as strong vision and leadership, and a sound business plan. We like firms to espouse and display a culture of performance first, asset gathering second. We also pay close attention to a firm’s balance sheet dynamics.
Head of multi-asset investments, Rathbones
The first thing we do is to take a topdown decision - where do we want to invest?
Then, which part of that market or sub-class of the asset do I want? Structure is also an important consideration.
“You have to let good managers underperform in order for them to outperform; you have to let managers take risk. Style drift is of greater concern to us”
Do I want an investment trust or an open-ended fund?
If I were looking at smaller companies, I would perhaps look at a closed-ended fund, which could better handle liquidity issues.
My next consideration is investment style, such as growth, income, mixed asset or defensive.
After that, I look for a fund manager that fits in the above criteria, looking for managers who have performed in line with expectations for their investment style. It is about being able to find a predictable pattern of returns.
I need to know how a manager is going to behave in a certain environment. I cannot handle a manager who is too inconsistent in style.
We invest with the idea of a minimum holding period of three years, and we do not invest with any manager without seeing them first.
Underperformance by a manager doesn’t cause us too much concern, as we will have done enough work to understand why.
Besides, you have to let good managers underperform in order for them to outperform; you have to let them take risk. Style drift is of greater concern to us.
I do have some set biases in the managers or funds I favour. I prefer those who are experienced, who have been running money for a long time. I also prefer smaller funds, as big ones can become mediocre.
In looking at the group, it is all about culture over brand. We look to ascertain a group’s distribution strategy as we have an aversion to those pushing their funds hard to amass assets.
We will also examine who they marketing to and why.
Head of the Jupiter Independent Funds team
Selecting fund managers is part art, part science. Our starting point is to conduct quantitative portfolio and performance analysis to assess how the manager and fund is likely to behave in specific market environments.
Then we conduct interviews with those we have identified as being particularly interesting.
In some cases this will include managers who have been completely out of favour but who we feel could be approaching a recovery in performance.
During interviews we believe it is crucial to focus not only on the portfolio itself but also on the “soft” factors that may affect performance, such as the environment at home and work.
As well as assessing whether the culture at work is conducive to delivering strong performance, we will also look at the corporate background to ensure the company is financially sound and stable.
Building the portfolio is then about correctly assessing the environment and selecting the fund managers for your shortlist who you believe can perform best in such an environment, with a focus on the overall risk you may be taking and acting in a timely manner to change the portfolio.
We do not place artificial restrictions on ourselves with regard to the type or size of funds we invest in.
As investment is both an art and a science, if you try and turn it into too much of a scientific process, you run the risk of foregoing much of the alpha. We look at each individual fund and its potential inclusion in our portfolios on its own merit.
The trick is to identify the best fund managers, work out in which conditions they tend to do well (and when they will do badly), invest in their funds at the right time, and finally, take your profits at the correct time as well. Timing your entry and exit is very important.
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