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As a result, it is often difficult to discern between what is a marketing message and the reality that sits behind it. The lack of detailed information and access makes it difficult for advisers and investors alike to dig deeper and this is the gap we are aiming to fill through our research process.
Investing is a human capital business and at the heart of any successful investment process sits an individual or group of individuals who are required to make decisions. We spend a significant amount of time assessing each investment team and the way they interact with one another to build and manage a portfolio over time. In this article we take a look at some of the marketing led statements that are often put forward relating to the investment team and how we test whether there is substance behind the flash.
The number of years’ experience of the investment team is a statistic often quoted by asset managers when marketing a particular fund. Does it matter or is it just marketing?
As part of our research process, we need to evaluate the experience levels of the team. Effectively what we are interested in testing is who influences the portfolio and are they qualified to do so? We are looking for a team comprising individuals with sufficient relevant experience to carry out the necessary research and manage the investment process.
Experience is important, but the devil is often in the detail. The word relevant is something that the simple marketing statistic often hides. A few extreme examples help illustrate the point:
- The key portfolio manager has 20 years investment experience but has only managed a portfolio for a year;
- The investment team has 100 years of experience, but 90 of the years’ experience is as financial sector analysts while the fund is a general equity fund. Can they build portfolios to effectively include industrial and resource counters?
- Of the 100 years, 40 years’ experience has been working in the operations team of an asset manager, rather than analysing stocks.
The level of analysis we do is to consider the specific experience per team member for their entire career, and then assess whether the team’s combined experience is sufficient and appropriate to manage a portfolio under a specific mandate. “We have only lost two members of the team in the last five years”
The stability of an investment team can have a significant positive impact on the investment outcome. Our process analyses the staff turnover to ensure that we are able to attach the past investment actions taken to the current team. This gives insight into whether we can expect a similar investment outcome on a forward looking basis.
However, the broad statement of only losing a certain number of people needs to be assessed and understood. We need to have a view on who is part of the “core team” in order to gauge severity of turnover. If the two team members who have left in the past five years were crucial to the process, it doesn’t really matter whether turnover has been low by number because the impact on the future management of the portfolio could be very high.
In addition, a high level of turnover can’t be explained away by saying that only junior team members have left, so the impact is minimal. If often signals broader culture issues.
The simple question we are trying to answer in our research process is whether the team is large enough to cover all the effort required to implement the stated investment process?
For example, we want comfort that a team that adopts a detailed, fundamental, bottom up investment process has sufficient capacity to carry out the necessary research to enable that process.
There is no optimal size when it comes to an investment team. Having the breadth to cover the investment universe may be an advantage, but the evidence points to smaller teams outperforming larger teams over time as a general rule.
Let’s consider the example of a global equity portfolio with an investment universe that includes thousands of listed equities across developed and emerging markets. How do you compare a global team made up of three portfolio managers and 40 underlying analysts to a team of two individuals who rely on their Bloomberg terminal for their research?
The point is that there is a balance between there being sufficient capacity to implement the investment process while also having a cohesive team that is able to interact productively and make decisions.
The other variable that we assess is how much time the key investment professionals spend on non-investment work. This is especially relevant to boutiques where we often find that the founder and key investment individual are one and the same. The successful implementation of the process often relies heavily on that individual, but they are also the face of the business and spend half their time marketing the fund or running the business. The ability for an investment individual to focus on investments is often harder than one would think.
The depth and quality of analysis and research is often quoted as being a differentiator for an investment team. This may be, but at the end of the day someone needs to make a decision as to whether you buy or sell a particular investment. Excellent research can obviously help inform a decision, but the ability to make the final call is key. All the behavioural biases and the emotion come into play when you have to “pull the trigger”. In our research process, we aim to initially develop a clear understanding of how decisions are made and whether that makes sense given the process and the team dynamic. Is it an individual call or consensus based or does each member have a vote with majority rule?
The most difficult part for us is to work out whether a culture of debate and challenge exists within the team. Who tests the decisions made and provides sufficient challenge to the key decision makers? It is fairly common for an investment team to have one dominant individual driving investment decision making. The stereotype is one who is confident (overconfident?), wants to be proven right and doesn’t like to be challenged. Those personality traits generally have a long-term negative impact on investment performance. In our meetings with an investment team, there are often tell-tale signs as to whether challenge is welcomed. If a question is directed to a younger analyst in the team in the presence of the key portfolio manager, there are usually one of three outcomes:
- The portfolio manager jumps in and automatically responds to the question, overriding the junior analyst;
- The young analyst looks across at the portfolio manager before responding and then again once finished answering, as though they are looking for approval that they didn’t say the wrong thing; or
- The analyst responds directly to the question and is allowed to engage.
While not a perfect science, the outcome does provide clues to what culture exists within a team environment.
Another indicator of the culture in the team is whether there is an ability to admit mistakes and be comfortable doing so. Even the best portfolio managers in the world constantly make mistakes and how the decision maker reacts to those mistakes is key.
We are effectively looking to see if decision making is well balanced, whether debate is genuine and whether the decisionmakers have the Emotional Intelligence (or EQ) to reflect and learn from mistakes. In our opinion, these are primary drivers of the investment outcome which is why we spend so much time assessing individuals and the team despite it being so complex and challenging.