Tarot cards, Ouija boards, horoscopes or animal entrails? This hodgepodge of attempts to read the future all have the same chance of success. Slim to none! But investors keep trying to predict tomorrow in hopes of being able to prepare for it and thrive. Thanks to the internet these days there is even more information at our fingertips to separate investors from their money. The complex changes of the past few years have deluged us with so much information that it is hard to know what is truly meaningful.
However, when it comes to evaluating investment managers, both the ones clients currently have and the ones they are considering, there should be no hocus pocus. The focus must be on the four P’s: process, people, philosophy and performance. The most important lesson to learn from looking at the four P’s is that performance is simply the outcome of the analysis. If everything else is done correctly in the evaluation of a manager: the right people are in place; they have an enduring investment philosophy; and a sound investment process, then performance will take care of itself. Of course, at the end of the day, advisors are in business to generate superior long term investment results for their clients. Performance, however, is not the starting point in evaluating investment managers. It really begins with:
- Process: the process aspect defines a firm’s investment approach and management style or in essence how and why they select securities. Does the firm have a proven strategy? Does the strategy have a certain discipline associated with it? Does the firm have a disciplined approach to managing the level of risk in the portfolios? Discipline reflects the consistent application of a sound investment process.
- People: the people aspect is the most difficult but ultimately the most important to gauge. The people issue is fundamental to the culture and discipline within a firm: how are people compensated and how do they interact on both an internal and external level? The quality of people in an organization tells everything about the overall depth and stability of a firm. Changes in people often lead to changes in investment strategy or tactics and integrating new players into a firm is generally a challenge. Therefore consistency in approach and in staff is an essential element. Nonetheless, a long term orientation does not mean that only 10 or 20 year old firms should be considered. New firms having a team with a sound investment process and continuity have merits as well.
- Philosophy: a firm’s investment philosophy has to have an enduring character. If the philosophy cannot be explained in about three sentences it is probably too complicated. Long term results and the philosophy or the culture of the firm are intrinsic to delivering the desired results. What is the firm trying to produce? Does the philosophy focus on producing results for the clients? Is the firm composed of people who strive to achieve good results for clients, rather than a firm whose people are simply focused on preserving revenues?
- Performance: everything comes down to the residual which is performance. Solid performance is vital because clients know that performance is delivered as a result of the decisions made by the people who drive the process and enact their philosophy. Above all clients are interested in consistency when it comes to performance. They are not looking to hire a “hot” firm whose one correct bet allowed performance to soar for a couple of years. They want competitive returns and a long-term track record. They are looking for a long-term track record but that does not mean they should ignore new startups. Investors must have a reasonable basis for believing a firm’s record is representative of what it could do in the future.
Breadth in ability, knowledge and experience are other traits that superior firms share. Also of importance is the money manager’s size and linage. As firms grow, management at times does not put the client first. Larger size means more people, which in turn means more overhead expenses thus putting pressure on the firm’s bottom line. Managers of growing investment firms sometimes respond to income pressures by taking actions to preserve revenue. These steps can conflict with the best interests of clients. The focus of the firm can shift as these maturation issues emerge causing increased employee dissatisfaction and personnel turnover.
Consider a small innovative firm that evolves from a team of investors into a large, established firm that is in the “investment management business.” As the organization grows and its dependence on its long term clients decreases, loyalty to these clients can erode. Loyalty is a key for an investment management firm. Loyalty must be to the clients and their long term needs. Loyalty is a powerful business concept because it keeps the focus of the firm on what is important to the client.
A firm’s primary focus has to be on serving clients. Everything else will take care of itself. Substance in the investment management business is, quite simply, generating superior long term results for clients. Problems arise when firms are stretched financially and focus more on the form rather than the substance of making money for clients. By focusing on the fundamentals, the need for hodgepodge methodologies is eliminated in favour of a rational approach to investing.