When selecting an investment, most firms’ “research” consists solely of looking through computer-generated reports to find a strong performing investment that stays true to its stated asset class. However, the best way to find a successful investment is to screen for strong performance and then evaluate the portfolio managers and their processes to determine if the performance is repeatable.
When selecting investments for a retirement plan, we look for investment managers that have a disciplined bottom-up research process. Bottom-up research implies that the investment will generate its excess returns (alpha) from security selection and not sector allocation. Security selection and sector allocation are sometimes mistakenly viewed as interchangeable; however, security selection comes from individual equities whereas sector returns come from positioning within segments (healthcare and technology are both examples of segments) of the economy. Next, we look for investments that exhibit a “buy and hold” mentality. Excessive turnover, generally created by a buy and sell mentality, inflates an investment’s trading costs and generally helps contribute to underperformance. An investment should have strong returns relative to its benchmark. Excessive returns also need to be scrutinized as they could be an indication that an investment has strayed from its investment philosophy by taking on more risk and aggressively pursuing returns. Portfolio managers who stay true to an investment’s stated mandate are preferred.
Portfolios should have a succinct group of holdings. A compact portfolio is imperative so that managers can stay abreast of new developments and changes to each holding. The best way for a portfolio manager to gain knowledge of the financial industry is through experience, which is why it’s important to evaluate manager tenure. Manager tenure is also an important consideration when evaluating historical performance. Unless the investment has a disciplined process that makes the investment less dependent on the individual investment manager and more reliant on a team effort, it is a good idea to avoid new portfolio managers.
The investment philosophies and backgrounds of the analysts who support the managers are also important to consider. Portfolio managers cannot do their jobs without a competent support staff. Analysts can be dedicated (servicing only one investment) or centralized (servicing multiple investments). Uncovering what resources analysts and portfolio managers have at their discretion is another imperative step. Analysts and portfolio managers need to have access to the latest economic and financial data to provide the highest quality research.
Evaluating a portfolio manager’s skill is a process that many firms do not have the expertise, time, or desire to implement. Our Investment Services team is made up of highly credentialed analysts, who have, or are actively pursuing, the CFA designation. Our Investment Services team focuses 100 percent of its time researching and analyzing portfolio managers to provide the best recommendations to our clients. For more best practices concerning the selection of investment managers, contact our Investment Services team
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