Qual­i­ties you should look for in a fund man­ager

Tal­ented peo­ple, a con­sis­tent in­vest­ment process, an eth­i­cal par­ent com­pany, a fair price for ser­vice and, yes, good per­for­mance should be the main con­sid­er­a­tions when choos­ing a fund man­ager. Laura du Preez re­ports

Weekend Argus (Saturday Edition) - - GOODPOSTER -

You should look for five things when choos­ing a fund man­ager to man­age your in­vest­ments, and past per­for­mance is prob­a­bly the least im­por­tant (see “Past re­turns are of less im­por­tance”, right). This is ac­cord­ing to David O’Leary, head of fund re­search in South Africa at Morn­ingstar, which rates do­mes­tic and global funds.

O’Leary says that, although good per­for­mance is a key con­sid­er­a­tion, it is of­ten not very fruit­ful, and you should look for at least four other char­ac­ter­is­tics in an as­set man­age­ment busi­ness: tal­ented peo­ple, a con­sis­tent in­vest­ment process, an eth­i­cal par­ent com­pany and a good price for ser­vice.

1. THE RIGHT PEO­PLE

O’Leary says that when he as­sesses how tal­ented the peo­ple who man­age funds at an as­set man­ager are, he checks not only whether the com­pany has em­ployed good- qual­ity peo­ple with the right ex­pe­ri­ence, but also if they are the right fit for the as­set man­ager.

He also asks how they are in­cen­tivised and whether they, per­son­ally, in­vest in the funds they man­age.

Typ­i­cally, a fund man­ager earns a salary and a bonus, and, ide­ally, the bonus is aligned with the longterm per­for­mance of the in­vest­ments, O’Leary says.

In­cen­tives are mis­aligned when the bonuses of in­vest­ment pro­fes­sion­als are tied to the size of new in­vest­ments in the fund (sales) or to the prof­itabil­ity of the as­set man­ager, O’Leary says.

Com­pa­nies that align bonuses to sales typ­i­cally ar­gue that sales rise when per­for­mance is good, he says.

How­ever, the best way to in­cen­tivise fund man­agers to pro­duce good per­for­mance is for them to have a mean­ing­ful amount of their own money in­vested in the funds for which they are re­spon­si­ble.

Un­for­tu­nately, the United States is the only coun­try in which as­set man­agers are re­quired to dis­close if their in­vest­ment pro­fes­sion­als are in­vested in the funds they man­age.

Fund man­agers of­ten say, when they select shares for their funds, that they look for com­pa­nies where the man­age­ment has in­vested in its own shares – known as hav­ing “skin in the game”, O’Leary says.

In­vestors should ask fund man­agers how much skin they have in the game, he says. If in­vestors and fi­nan­cial ad­vis­ers al­ways ask for this in­for­ma­tion, dis­clos­ing their own in­vest­ments in the fund will be­come a cost of be­ing in the po­si­tion of an in­vest­ment pro­fes­sional.

Morn­ingstar has found that there is a di­rect cor­re­la­tion be­tween how much money a fund man­ager has in­vested in the fund that he or she man­ages, how well a fund per­forms and how long a fund man­ager stays with an as­set man­ager, he says.

The higher the amount in­vested, the bet­ter the per­for­mance and the longer the man­ager stays with the com­pany, O’Leary says.

Ac­cord­ing to re­search done in 2010, out of all the do­mes­tic eq­uity funds in the US, where man­agers had at least US$1 mil­lion of their own money in­vested in a fund, the av­er­age fund had a five-year re­turn that ranked bet­ter than 61 per­cent of its peers, O’Leary says.

2. CON­SIS­TENT PROCESS

There is not one right way for a fund man­ager to earn re­turns for you, O’Leary says, but man­agers that pro­vide good re­turns have an in­vest­ment process that they can de­fine, and they stick to it.

A fund man­ager should be able to ex­plain his or her in­vest­ment process to you in a way that you can un­der­stand, and you should see ev­i­dence of that process in the fund’s hold­ings, he says.

If you don’t un­der­stand the man­ager’s in­vest­ment process, don’t just take a leap of faith and hope that the man­ager knows what he or she is do­ing, O’Leary says.

The fund man­ager should also be able to tell you the mar­ket con­di­tions un­der which the fund will per­form well and badly. If the fund’s per­for­mance is in­con­sis­tent with this ex­pec­ta­tion, the man­ager is not stick­ing to his or her process con­sis­tently, and this kind of be­hav­iour is likely to re­sult in the fund los­ing value, O’Leary says.

3. ETH­I­CAL PAR­ENT COM­PANY

You need to as­sess the char­ac­ter of the com­pany that pro­vides the fund in which you want to in­vest, to find out whether it will put you, the in­vestor, first, O’Leary says.

It is un­re­al­is­tic to ex­pect a com­pany not to want to make a profit, but it is im­por­tant to es­tab­lish where you, the in­vestor, fea­ture on the spec­trum be­tween sales­man­ship and ste­ward­ship.

A com­pany in­volved in sales­man­ship is in­ter­ested only in sell­ing ev­ery­thing and any­thing to any­one who will buy it, but a good stew­ard will of­fer worth­while in­vest­ments in which it has a com­pet­i­tive ad­van­tage, O’Leary says.

Com­pa­nies con­cerned only with sales have a habit of clos­ing funds when mar­kets are per­form­ing badly, and launch­ing gim­micky funds in a mar­ket that is do­ing well, he says.

To de­ter­mine if your fund man­ager’s par­ent com­pany is a good one, con­sider these four things:

◆ The cor­po­rate cul­ture. You need to get to the DNA of the firm, read its fi­nan­cial state­ments to un­der­stand its cul­ture and what makes it dif­fer­ent, he says.

O’Leary says that he lis­tens in on as­set man­agers’ dis­cus­sions with an­a­lysts to find out how they ex­plain their busi­ness to share­hold­ers, as well as their at­ti­tude to­wards in­vestors.

An­other fac­tor O’Leary con­sid­ers is the turnover of staff at an as­set man­ager. If it has a low turnover, you know that things are healthy be­neath the sur­face.

Read a com­pany’s com­mu­ni­ca­tions, its web­site and its fund fact sheets. If you don’t know much about the com­pany af­ter read­ing these, it tells you some­thing about the com­pany’s at­ti­tude to in­vestors and ad­vis­ers, or it may be be­cause the com­pany is dis­or­gan­ised, O’Leary says. Ei­ther way, you may not want to in­vest with it, he says.

◆ Whether the com­pany is in the news a lot be­cause it con­tra­venes reg­u­la­tions or is be­ing sued.

◆ The in­cen­tives of­fered to its in­vest­ment pro­fes­sion­als.

◆ The fees the man­ager charges. The lower the bet­ter, but they may not all be the low­est, O’Leary says. What you should de­ter­mine is whether the com­pany charges the high­est fees on all of its funds in their re­spec­tive sub-cat­e­gories and whether the com­pany’s to­tal ex­pense ra­tio shows that, over time, it passes on to in­vestors the economies of scale it achieves as its funds grow in size.

O’Leary says that, in the US and Canada, Morn­ingstar gives funds a ste­ward­ship grade based on its view of the funds’ par­ent com­pa­nies.

Re­search by Cor­nell and Bing­ham­ton univer­si­ties has found that funds that re­ceive good s t e ward s h i p grades ( A or B) de­liver per­for­mance that is, on av­er­age, 1.6 per­cent­age points higher than funds that are on the two low­est grades (E or F).

4. FAIR PRICE

The fees charged by a fund are of­ten the best pre­dic­tor of their fu­ture per­for­mance, be­cause the big­ger the fee, the greater the hur­dle to per­for­mance af­ter fees, O’Leary says.

Many South African unit trust funds charge com­pli­cated per­for­mance fees, he says. De­pend­ing on how the per­for­mance fee is struc­tured, the fund may not, as is com­monly ex­pected, pay well for good per­for­mance and pay noth­ing for bad per­for­mance. Of­ten, a fund has base fees that en­sure the man­ager is paid de­spite poor per­for­mance, O’Leary says.

Per­for­mance fee struc­tures may have un­in­tended con­se­quences, and you, as an in­vestor, may not know the type of be­hav­iour a fee is elic­it­ing. For ex­am­ple, he says, to earn a high fee, a man­ager may in­vest more con­ser­va­tively than it nor­mally would in or­der to pre­serve a good per­for­mance track record.

With a few ex­cep­tions, there is no need for per­for­mance fees if the fund man­ager is in­vested heav­ily in his or her fund, O’Leary says.

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