|Knowing Your Investment Manager
Probe beneath a manager’s performance: Is it likely to continue and will business and compliance risks derail the manager?
March 17, 2011
Why bother with active management at all? Why not simply invest in a series of cap-weighted asset class indices? That way you can satisfy your asset allocation strategy, save money (index funds are less expensive than actively managed funds) and align with modern portfolio theory (in which the aggregate market portfolio has a prime role). Indeed, that’s the natural starting point and departures need to be justified explicitly by one of three reasons:
These reasons vary from one country to another and from one asset class to another and over time: there’s no constant superiority of either active or passive. And even when you establish a reason for pursuing active management, you still need to access your preferred alternative, at a cost below the expected benefit.
Traditionally, finding a superior active manager has relied on “the four Ps”:
The latest development in manager research is to check on their compliance and operations. This tends to fall under three headings:
At Russell we give a firm an overall rating after an investigation of this sort. The rating has four categories:
That last category will typically relate to a small operation, like a boutique manager or a husband-and-wife operation.
We always tell the manager about our findings (not the whole report itself). Partly this is to ensure that we haven’t misunderstood something. But partly it also serves an educational function for the manager, who becomes aware of our evaluation standards or even worse, becomes aware of something in the firm that needs correction — often we’re there before the regulator gets there. And certainly from Russell’s perspective, if there are things to be fixed, no money over which Russell has discretionary placement authority will go to that manager until it’s fixed.
We find that regulators in the United States (U.S.), the United Kingdom’s (U.K.) Financial Services Authority, Australia’s Securities and Investments Commission, the Ontario Securities Commission (there isn’t a national system in Canada and not all provinces have equal capabilities) — investment firms under their jurisdiction are subject to a regulatory culture that we find helpful. It’s in emerging markets and emerging economies and with small firms everywhere, that you know the potential for problems is greatest.
The interesting thing, though, is that large American firms have operations there, so there’s the definite potential for issues in global operations.
With mergers and acquisitions, even in the U.S. you find firms with different systems: which one will the combined firm go with and how many experienced operations managers leave?
Perhaps this gives you a feeling for why these reviews are now supplementary to investment skills reviews, why they’re conducted by a different team with a different mind-set and why there’s an increasing demand for this sort of review.
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Don Ezra is co-chair, global consulting at Russell Investments and a 27-year Russell veteran and an award-winning author. Most recently he co-authored: The Retirement Plan Solution: the Reinvention of Defined Contribution (John Wiley, 2009).
Nothing contained in this material is intended to constitute legal, tax, securities or investment advice, nor an opinion regarding the appropriateness of any investment, nor a solicitation of any type. The general information contained in this publication should not be acted upon without obtaining specific legal, tax and investment advice from a licensed professional. USI-9045