Higher inflation, higher market volatility and more variable nominal interest rates are important opportunities for active managers who can prove their value with differentiated and customer-focused products. But with active management under continuous supervision, investment managers are surprised by more difficult questions from an increasingly sophisticated allocator market. Are you ready for your next beauty show?
The Evolution of the Conversation Between Beneficiaries and Managers
I recently met with the management selection experts Evan Frazier and Joe Wiggins. During our conversation, they shared the difficult questions that investment consultants and asset allocators now ask potential managers. Frazier, CFA, CAIA, is a senior research analyst at Marquette Associates in Chicago and Wiggins is director of research at St.James’s Place in London and author of a popular blog on investor behavior.
These are four of the most productive and challenging questions, along with the motivation behind them.
If you had to run your strategy systematically like an algorithm, how would you do it?
Wiggins looks at three main aspects when evaluating a portfolio manager:
- The manager’s beliefs about the markets and their competitive advantage,
- The manager’s decision-making process and its consistency with his judgment, and
- The results generated by these beliefs and processes.
- This question focuses on the manager’s process. The manager’s response reveals how much they have thought about the best use of their human energy and how much they have adopted technology to do the things that can be done systematically.
What are the mistakes you have made throughout the history of the strategy or your mandate? How did you react?
“Every PM likes to talk, and they can talk — about the winners they’ve had,” Frazier notes. “But I think it’s useful to know when things may not have worked out.”
The beneficiaries want to hear, and ideally see evidence, that the manager has reflected on his mistakes without simply blaming bad luck. They want to understand what lessons have been learned and how this knowledge is applied to achieve better results in the future. Showing humility, responsibility and objectivity is very useful for sophisticated investors these days.
Assuming that recent performance is not necessarily a good indicator of your actual skill level, how do you measure the success of your decision-making?
This is one of Wiggins’ favorite questions from a results standpoint. He is not looking for a precise answer. He wants to know if the fund manager has thought about this issue because it provides an overview of the philosophy and approach underlying his strategy.
“If they considered that the performance of incumbents was all I needed to know to assess whether someone had skills or not, I’d be incredibly skeptical,” he says.
This goes to the heart of our behavioral Alpha benchmark: it goes beyond historical returns and the effects of luck to measure a portfolio manager’s demonstrated competence in a variety of types of investment decisions.
