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Our Research Journey

Published: September 19, 2019 by Peter Foster, Fundhouse

Starting a fund research service was not obvious to us when we started rating funds for investors in 2013. What we hadn’t realised at the time was that as a team we had inadvertently built up quite specific expertise through working within fund management businesses, which would later form the basis of our fund research service.

While our careers started within fund managers, when Fundhouse started in 2007 they became our clients rather than our employers. We provided specialist consulting to these businesses, and this allowed us to take our initial experience and extend our knowledge, as “insiders”, to a much broader range of business examples – equities, property, hedge funds, fund of funds and asset/liability matching just some of the examples. This was a formative period for us, which allowed us to observe both the good and bad aspects of the industry and, in retrospect, was essential in developing a more critical eye when evaluating funds.

Over time the requests from these clients started centering around the evaluation of their investment propositions. As an external party we were able to be quite constructive with investment teams who were either struggling or looking to build new capabilities. This role was in essence the first iteration of the fund research process we employ today.

It took a specific client request for us to connect the dots in 2013 and see what direction we needed to take long term. Fortunately, we had the presence of mind to recognise the opportunity when it presented itself. The opportunity to provide informed and objective fund research services required one major change in our business: to switch off our legacy consulting activities to fund managers. Essentially, we would be “jumping the fence” onto the end investors’ side, to bat for them exclusively as our long-term business pursuit.

The first year was daunting. We were required to initiate coverage on over 100 funds, local and offshore. This entailed the formal development of our research process, and being blank slate, allowed us the opportunity to build around the experience we had developed so that our research process took guidance from the combined expertise of the team over their working careers. This resulted in a few key points which we believe set us apart from our peers and allow us to consistently apply our experience in a meaningful way to this day.

  • We are naturally skeptical of fund managers. Despite the fact (or you could say, due to the fact) we started our careers within fund managers, we became naturally skeptical the more we became immersed in it. While the industry pursues a noble cause, quite often the nobility loses out to the cruder demands of business profits, financial success and the agency problem, at the expense of the client. The numbers also don’t lie – the majority of investment managers do not add value, and so it pays us to be naturally skeptical as a point of departure.
  • Broad industry knowledge allows us to connect the dots within each business. We see the product of investment performance being driven by a complex set of organisational, cultural and behavioural traits in which we are now well versed. The ability to evaluate each of these traits, and then to string them together, allows us to build a composite view of a fund from the buyer’s perspective. Rather than being led by the industries vast marketing efforts, we have the depth through our research to understand the underlying drivers and how they may enable or disable investment performance looking ahead.
  • We are open and transparent with investment managers in our views. This may sound quite trivial, but in our estimation it is quite unique globally. Having to confront someone who is a) a specialist in what they do and b) financially reliant on what they do, can be a difficult position to be in. Once we have arrived at a provisional assessment of a fund, we provide the manager with the opportunity to test us, as we have tested them. This two-way assessment allows the truth to come out, with all ambiguity and noise removed from the process. There is nothing like a fund manager refuting your findings to test your conviction! However, the depth of the research work we do equips us to have this meaningful debate, even if the views are negative, or if we agree to disagree with the manager in question.
  • We provide a significant number of negative views on funds. Technically this is in line with industry performance statistics and value add, but it is much harder to do in practice than on paper. Firstly, the fund research industry globally relies on the income they earn from fund managers to pay the bills – often a veiled marketing expense for the fund research conducted. This conflict leads to biased outcomes, to the detriment of the end investor. In 2013, when we distanced ourselves from working for investment managers and moved over to the client side, this created a strong platform for us to retain our objectivity. It is simply not possible to provide objective advice if you need to make judgement calls on the hand that feeds you. The ability for our process to be able to deliver a large number of negative outcomes on fund views is a necessity, or we would not be doing our job.

Early on in this journey, a key decision we needed to take was whether we make our findings public or not. Clearly performing a great deal of research and providing this only to the select few would have enabled us to have a simpler business. However, we opted for the alternative, where we provide our research to a wider range of clients in various formats. Why would we do this?

At the heart of why we decided to focus our business on serving the end investor was a desire to bridge the information gap which existed between the investment manager and the end investor. Particularly in the retail investment industry, this information asymmetry we often found to be quite one sided, where the end investor and their financial advisers had limited access to the inner workings of the industry, or the ability to pick apart the relative merits of each fund they were considering for clients. By performing detailed research on a wide range of funds and ensuring that this research found its way to independently minded advisers and investors, we could help solve the information gap and create a competitive edge for our clients.

To date we have approximately 230 South African funds under full time coverage. Just 25% achieve our top Tier 1 rating, while almost 40% of all funds covered are negatively rated to date. For these funds, each takes a minimum of 50 man-hours at inception to initiate coverage, and a significant amount of ongoing monitoring, review and manager engagement to ensure we are fully up to speed with each fund and business. Through our UK office, we directly cover a similar amount, a focused subset of the global investment universe.

There have been common learnings across both markets which we have taken back into our research process to ensure we utilise this new information in the future. To highlight a few of these where the results may be surprising:

  • The strongest performance indicator is culture. The very best investment businesses tend to exhibit extremely strong organisational culture. In a human capital industry with a long-term product at its heart, the continuity of your personnel and the way in which they work together is a make or break factor in making sure that what is promised today is delivered tomorrow, regardless of who is in charge. In South Africa, businesses with a strong culture are few and far between. Generally, privately held partnership type businesses fare best in our reviews.
  • We live in hope with the ‘boutiques’. By most accounts these smaller asset managers are yet to break through into the mainstream where they can start to add value to a wider range of investors. For the most part they are held back by not taking their businesses seriously enough, not investing ahead of the curve, and stretching their capabilities beyond their means. There is currently a huge void between the few large managers at the top, and the long tail of managers looking after smaller assets.
  • The weakest funds are characterised by poor organisational culture, the agency problem (manager is not an owner), divisive teams, high staff turnover, weak investment leadership and high fees. They survive through the lack of broad and deep competition, and captive clients who don’t hold their managers to account.

Looking ahead we are excited in continuing this role on behalf of our clients. As our research insight develops, we are also cognisant of learning from our mistakes. As a human capital business, we are acutely aware of our own behavioural biases, and much of the way we operate is designed to counteract the impact these can have on decision making.

Our objectives remain the same: to bat exclusively for the client; bridge the information gap; more money into better funds; lower the cost of investing and to improve the quality of decision making for a better financial future for our clients.

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