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How to find a brilliant investment manager

Cape Town - The key to finding a great investment manager is to focus on that something extra that differentiates them from the rest, rather than focusing on the 99.5% they will have in common with most other competent managers, according to Matthew de Wet, head of investments at Nedgroup Investments.

"As the global economic environment presents many challenges for investors, it is crucial for this decision to be made wisely," he said.

He provides the following tips:  

Dig deeper
 
When you interact with an asset management firm, this is often in the form of a standardised and rather formal "due diligence" presentation which will extensively detail the investment philosophy and process of the company.

These presentations are usually predictable and include references to any combination of the following: an organogram on group structure, value investing, margin of safety, detailed research, Warren Buffett quotes, committee meetings, experienced employees - the list goes on.

These meetings are usually passive -  in other words, you listen to what the manager thinks you want to hear.

They will rarely provide unique insights into the firm or its people.

In summary, these meetings can only take care of 99.5% of the hygiene factors.

To find the elusive 0.5%, deeper research is required. You need to corroborate inferences and find supporting evidence.

At best, this takes significant time and effort. At wors,t it is impossible if managers are unwilling or unable to provide what is required.

Get under the bonnet

One of the surest ways a manager can allow you to really get "under the bonnet" is by writing regular, comprehensive, well thought out investment commentaries.

Going back through the annals and comparing what they were saying - and then how that manifested in portfolio positioning and ultimately results - can hugely enhance your understanding.

A manager's honesty about performance when it is not good can be especially insightful.
 
Unfortunately, the vast majority of managers miss out on this opportunity to allow their investors to really understand what they do in practice.

This is a pity because the better the client understands the manager, the more likely he is to remain invested through the inevitable periods of underperformance.

Ask open-ended questions

If you ask managers to explain certain things about their business and beliefs – without the use of any supporting material – it can also enable a deeper understanding.

Asking open-ended questions and giving managers the space to answer as they see fit can give you a perspective that would otherwise be missed in a formal presentation.

For example, asking the question: "Why will this business still be around in 20 years’ time?" will give a sense of what the manager thinks are the most important factors (and the relative importance of each) for creating and maintaining a successful investment management business.

Different businesses provide very different answers, and there is no right or wrong one.

But you should be able to make a judgement on how much thought and effort has gone into creating structures that can stand the test of time.

Responsibility

Also, take note of whether managers talk naturally and easily about their responsibility to investors.

There is a direct correlation between how seriously a manager takes their responsibility to clients, and eventual client outcomes.  

Or ask something along the lines of: "What is risk and how do you construct portfolios to be robust in any of the (many possible) outcomes?"

The answer to this will give insight into how every aspect of their process and philosophy pulls together in execution.

The very best managers show a healthy respect for what they do, don’t and can’t know, and have clearly thought out mechanisms to protect their portfolios against these unknowns.

Another way to garner insight is to ask not about a particular stock, but rather about an industry in which a particular company operates.

Industry dynamics can be critical to the investment outcome, and these types of questions will enable you to see how deep the research has gone.

Do they understand the capital cycle and where in the cycle an industry currently finds itself?

Sources of information

A manager who can reference industry periodicals or interactions with customers, service providers, competitors and industry experts will be easily distinguishable.

Recognition and respect of one’s peer group is often the hardest earned and most deserved.

Consider track records in context

Establish if the track record is worth paying any attention to at all.

Are the same people implementing the same process and philosophy under the same conditions? More often than not, the answer is "no" and the track record should be disregarded.

Perhaps the most challenging aspect of finding an outstanding investment manager is not so much about figuring out whether or not they have a reliable approach that has been well implemented.

With enough effort, this is achievable. The difficult part is figuring out whether they will be able to repeat what they have done in the past over the next market cycle.

And you won’t find the answer to this question in the 99.5% presentation.

You will need to find it by digging deeper.


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