Fund manager selection: seeing the wood for the trees

18 February 2021 - by Lan Broad

Recently our CIO David Smith wrote an Investment Insights note on our overall approach to investment structuring here at IAM. One of the elements highlighted was the selection of fund managers and funds. With literally thousands of fund managers out there, it is essential to have a defined process on which to base decision making.

Once the strategic asset allocation guidelines, portfolio structure and sustainable framework has been established for a client, we think about how to build the regional and thematic equity exposure. We filter the universe to a peer group of comparable managers with a similar opportunity set and run quantitative screens to determine the best in class. Alongside this, we identify those with the best medium to long-term performance track records. Naturally, absolute returns are important but risk-adjusted returns matter just as much in portfolio construction (volatility, Sharpe ratio, drawdowns). We are left with a short list of funds that merit research in greater detail and to which we apply the next, arguably more important, filter, qualitative analysis.

Qualitative analysis is subjective by nature and an important part of the value-added process. It involves a deeper understanding of all aspects of a fund and the context in which it operates, including,

  • The philosophy of the fund: the principles of the fund, the drivers behind the portfolio>returns.
  • The team and its structure: the functions of each individual and the dynamics of team>cohesion. Whether the team is led by a single manager or co-managers? if the research analysts have a generalist approach or can specialise in a particular niche? How flat or vertical is the fund’s investment policy?
  • The company: the review of their core businesses and where they operate – all sizes are of interest, from boutique to large institutional asset managers. We are looking for the source of their edge, their information advantage or their original thinking. Some>teams are on one site to maximise the benefits of communication, some will have>teams on the ground all around the world to have better access to local markets.
  • The process: how the fund manager and his team select their holdings. Active fund managers will tend to select from a large universe and apply a process to build a>portfolio of their highest conviction stocks, ranging from 25 holdings in a concentrated>portfolio up to 100 for a highly diversified approach. Are they using their Active Share budget? – the extent to which their portfolio is different from the broad market. Do they favour a bottom-up process, starting with the prospects of individual companies, or a top-down one, seeking to identify macro and structural trends and the businesses best placed to benefit from them?
  • The portfolio positioning: a review of the style biases of the fund, including value/growth, large cap/mid cap/small caps, geographical and sectoral overweights/underweights, thematic trends etc.
  • The performance: is the performance of the fund in line with the characteristics expected throughout the market cycle? Does the fund perform consistently? How is the manager using and controlling his risk budget?

To understand these specific components for each fund, we focus on a dialogue with the fund>manager. The list above looks rather factual on the surface, but is complemented and enhanced by seeking the nuances and individual stories of each fund, and, furthermore, by following the evolution and implementation of its portfolio over time and throughout the market cycle.

The funds we select can be very different, there are, after all, no inherently good or bad styles.

We favour high conviction managers with a differentiated philosophy and process that is  applied in a consistent and reasonably predictable way. 

Our aim as investment advisers is to curate a complementary blend of managers which together contribute to an overall portfolio that is appropriately diversified, exposed to a broad range of opportunity sets and capable of outperforming the broad market on a risk-adjusted basis over the long run.

Last, but not least, an ESG overlay is firmly embedded throughout our process aware of the sustainable investment framework set for each client. Historically fund managers have been strong on governance factors, this is just prudent risk management after all, but increasingly we are expecting managers to have a defined process for addressing environmental and social factors. This is an evolving process and as signatories of the UN PRI, it is essential to us that the managers with whom we seek long term partnerships, show proper consideration for all stakeholders in our collective pursuit of sustainable and responsible long term investment goals that we believe complement and enhance the pursuit of purely financial returns.

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