Time and time again, manager selection has proven to be important but enormously difficult. Vast numbers of investment professionals all around the world cumulatively spend countless hours trying to figure out which are the best managers to maximise the risk-adjusted returns on their clients’ hard-earned savings.
At Nedgroup Investments this is the very core of our business – known as our Best of Breed™ investment philosophy. But what does this mean when it comes to our process of selecting the managers who we think have a sustainable edge? It’s a considered, meticulous process that we have spent years refining.
The Best of Breed™ manager selection process
We perform in-depth qualitative analysis and due diligence to seek out the very best asset managers to partner with. Some of the key factors that we look for when selecting an investment manager include the following:
- Managers who own a reasonable stake in the business
- Co-investment alongside clients and alignment of interests
- Sensible philosophy and process
- Differentiating and sustainable “Edge”
- Valuation driven
- Focus on capital preservation
- Stewardship culture
- Willing to close funds when necessary to protect alpha generation capability
Having these characteristics does not guarantee that an asset manager will be successful, but research does show that these factors tend to characterise managers who have generated good returns for clients over the long term. Using recent performance to judge how a manager is expected to perform in the future is tricky. Just have a look at the chart below, which shows the returns for the various funds in the ASISA High Equity category:
The horizontal axis shows returns for the three years to 31 December 2015, while the vertical axis shows returns for the three years to 31 December 2018. Each marker in this chart shows the returns of a particular fund over these two periods. What is quite interesting is that the funds which produced extremely good returns in the first period then produced extremely poor returns in the following period and vice versa. This is shown in the two teal blocks in the chart above. If we exclude these outliers, the rest of the data set shows pretty much zero correlation in terms of performance persistency across the two periods (shown in the green block).
What does this mean?
Performance is only one element of the decision
Firstly, although performance is often the buzz word in conversation, we understand that whether we are appointing a new manager or re-evaulating an existing manager, performance will only ever be just one component of the overall decision. In fact, in the past we have replaced managers even after they have delivered above-average returns.
Overriding concerns for us in this scenario could be factors that may include:
- Deviation from investment philosophy and process
- Resignation of key individuals
- Culture degradation within the business
- Return signature of the portfolio changing significantly compared to when we initially appointed the manager
- Portfolio construction deemed unsuitable for investor base
An ongoing process of research
As part of our role as stewards of investors’ capital we are always on the lookout for high quality back-up managers and are continually performing due diligences on alternative managers to the primary Best of Breed™ managers that we have appointed. This holds true for our entire range, both local and offshore. It is worth mentioning at this point a few more additional reasons why we may dislike a particular asset management business:
- Managers with a regional or sector bias
- Specialised styles that are incongruent with our desired philosophy for managing money, quants-driven, momentum, risk parity, having too many in-house strategies, closet index trackers, smart-beta, or high-turnover strategies
- Previous blow-ups or where they have returned investor monies
- Very low AUM for the business or when their sustainability becomes highly uncertain
- Unimpressive, under-resourced or unstable teams (both investment and operational)
A trusted, integrated process
I’m sure that it is now abundantly clear that we will only appoint a new manager when we are completely confident of their ability to manage the portfolio for our clients over the long term. To put that in perspective many of our partnerships thus far have lasted more than 15 years!
As a team we remain heavily invested in the various funds across our range, so we also feel the pain alongside our clients during periods of underperformance. That’s just another reason why we work so hard at finding out as much relevant information as possible before making any decisions.
We thank our investors for their faith in the process and we pledge to continue earnestly trying to take actions in the best long-term interests of clients. Thus far our track record and numerous awards over the years show that we’ve got manager selection right more often than we’ve got it wrong – an outcome we can certainly be proud of.