Things to Remember When Selecting an Active Fund Manager

These are simply some musings on active manager research; seemingly random, but hopefully linked by a common thread:

– The more PhDs in a team, the greater likelihood that a fund will blow up. This is tongue-in-cheek comment, but underlying it there is an important point about complexity. It is perfectly acceptable not to invest in a strategy because you don’t understand it. Furthermore, academic pedigree can easily make investors unnecessarily complacent about the robustness of a fund.

– Fund groups will always find some room in their strategy for you, capacity limits are more flexible than you think.  Incentives matter – you should never be reliant on an asset manager to tell you when they have reached capacity in a fund (particularly if they are listed) and, if you are waiting for them to tell you, it is probably too late.

– Although the majority of active managers underperform the market, the majority of slide decks produced by active managers will show them outperforming. The slicing and dicing of performance numbers is a constant wonder.

– Just because a Brinson attribution report shows a positive ‘selection effect’, it doesn’t mean there is ‘alpha’ – it is probably just a style bias. The term ‘alpha’ is banded around with abandon when discussing fund manager performance often without any clarity about what that actually means. Perhaps the most common is stock / sector decomposition – which tells you nothing about style / factor skews.

– The majority of excess return in fixed income strategies comes from assuming additional credit risk. Another attribution problem – this time for credit – is the persistent overweighting of credit risk (relative to the benchmark). Attribution for credit managers is fiendishly difficult but is an investment grade manager permanently overweight high yield skilful?

– Unless you believe that many fund managers can time the market (they can’t), then performance consistency is an example of luck or the derivative of a persistent style bias. It is rarely skill.  I still don’t understand the obsession with short-term performance consistency in the industry – the focus on this does much more harm than good in promoting the right type of active management.

– You will never really know the inner workings of the team running the fund you are researching. No matter the quality of your due diligence, your understanding of the characters, relationships and motivations within an external team will always be partial.

– Diversity for many (UK) asset managers means hiring white men from both Oxford and Cambridge. There is too much virtue signalling and not enough action on diversity in the industry.

– Ego / arrogance is not a necessary or positive trait for a fund manager. I often hear people absolve certain fund managers for being ferociously arrogant on the basis that they need to have high levels of confidence to ‘bet against the market’. This is nonsense – good fund managers will be wrong (a lot) and need both humility and a willingness to learn; believing that their views are unimpeachable or that they are infallible is the obverse of this.

– At least 90% of equity managers say they are buying quality companies (barriers to entry etc…) that are undervalued.  This should tell you something.

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