A high-risk tolerance and the ability to handle significant illiquidity are necessary to participate successfully in private equity markets
Best of the Breed: The Four Ps of Fund Manager Selection
Not all fund managers are built equal, just like not all markets are equal.
Investing is a complex process. Return generation can take many different forms across many different asset classes.
As to where they invest, stock pickers will typically focus on company valuations or companies that are likely to experience the strongest future growth, while bond managers will typically analyse interest rate risk, credit risk, coupon and maturity of instruments. Meanwhile, for the Seeking Alpha generation, a popular approach focuses on strategic asset allocation and fund manager selection as prescribed by the Yale University Endowment.
Besides having a robust asset allocation, fund manager selection is just as critical. It is all about picking the best of the breed of fund manager who can deliver a return that outperforms the market, matches a particular objective, and/or suits a particular role in the broader portfolio.
Not all fund managers are built equal, just like not all markets are equal. Alpha generation seems easier in some markets than others, as this may be due to market efficiency, number of participants, liquidity or level of alternative trading strategies in the market, such as algorithmic trading or high-frequency trading.
Following the Four Ps of Manager Selection
Generally, with fund manager selection, one should consider the 4 Ps: philosophy, process, people, and performance.
The philosophy of a manager may take different angles. A manager may focus on how they look at stocks or bonds, what their approach to valuation is, and/or when they invest. More broadly, it is important to consider what their holistic philosophy consists of in respect to capital preservation, willingness to take higher levels of risk for greater return, the manager’s stance on responsible investing and so on. Above all, coherence with your own philosophy for managing multi-asset portfolios is essential to ensure you are aligned.
Process addresses how robust a manager’s strategy is and whether their investment process has been tested. Ask yourself these four questions:
Can another manager come in and replicate their process to generate the same returns, should the key staff member be unavailable or no longer there?
Will there be a drift in the process if the market gets too volatile?
Is there a balance between qualitative and quantitative investment processes that is delivering returns?
What measures are in place to ensure the strategy can't be changed on a whim and will be adhered to?
The investment team broadly is also an important consideration. When reviewing options for fund managers, consider whether there is enough experience within the team. Ponder these three questions:
What is their track record?
How long have the team worked together?
What are the firm’s attrition rates?
Does the firm have a reputation for treating its employees well?
Performance helps tie the first three Ps together. It accounts for the length of the candidate’s track record, including whether that track record is proven, whether the fund has been managed through a time of volatility in the market, and how the fund has performed during that time. Consider:
Do the securities in the portfolio have high return correlations which are positively impacting the overall return of the portfolio?
Is the performance track record strong and over what market conditions have the strategy performed?
Is the strategy and track record able to be replicated in the forward market?
How has the manager performed against its peers and the market in general?
While not an exhaustive list, these four considerations are vital. They blend together to ensure you are thinking about how to drive value from an attractive risk-adjusted return portfolio. Reviewing candidates with these questions in mind will put the fund first, and help you lock in the best fund manager for the job.
This article was written by:
Ainsley Lee: an experienced investment manager specialising in multi asset portfolios, direct property portfolios and venture capital and;
Tong Hoe: who has over 30 years of wealth advisory and management experience in Singapore covering the South East Asia region.
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