Investment principles II
Eileen Rowsome
Senior Investment Selection Analyst
A disciplined approach to manager selection can generate outperformance
Implementing investment views effectively is an important step in the multi asset investment process. The choice of investment product can lead to additional performance being achieved or indeed lost. This step is called manager selection.
What is manager selection?
Manager selection involves sourcing, researching, and monitoring fund managers who have the potential to deliver investment performance superior to an investment index or passive investment tracking an index over the long term. We call this superior performance, outperformance, or alpha.
At Davy, our research process focuses on four key areas of assessment; the firm in which the fund manager is based, the team that is contributing to, or directly managing the strategy in question, the philosophy and process employed and finally the quality of performance being generated. Within these areas a lot of focus is on examining the alignment of interests, the decision-making process and the repeatability of returns. From a returns or performance perspective, it is not always the case that the best performer is chosen, it is key to understand that the performance is understandable and repeatable, i.e., that there is evidence of skill, else it may just be down to luck.
Active managers can take a long-term perspective, aligned with client interests, and may not be persuaded to go with momentum or what is working in the short-term
What are the benefits of a disciplined approach?
Aside from the benefit of delivering superior performance, there are additional benefits, including:
- Diversification of exposures: By choosing complementary approaches across asset classes, positioning is not concentrated in companies, sectors or regions allowing for a broad range of opportunities to outperform.
- Forward looking: One of the pitfalls of indexed-based investing is its reliance on backward or point-in-time data. Bond indices are a good example of this, where most major indices are weighted towards the companies and countries with the largest debt load rather than those with the strongest ability to repay.
- Long-term focus: Active managers can take a long-term perspective, aligned with client interests, and may not be persuaded to go with momentum or what is working in the short-term.
What are the risks involved with manager selection?
Failing to deliver outperformance or indeed underperforming is the key risk and some of the key things to look out for include:
- Circumstances changing: Monitoring must be conducted with the utmost rigour and on a frequent basis in order to identify any adverse change to the investment team or process which could impact performance.
- Fees eroding returns: Performance should always be assessed net of fees charged to ensure fees paid are justified by the performance delivered. We expand upon this more in our investment principle relating to costs.
- Time horizon matters: At the outset, you need to set out an expectation to achieve outperformance and be patient for that time. Outperformance is not achieved in a linear fashion, further making the case for adding complementary approaches and diversification.
In conclusion, by conducting thorough due diligence on the component parts of a multi-asset portfolio, additional returns can be achieved. At Davy, we have a team of seven involved in manager selection, who combined have circa 100 years’ experience. A disciplined process, incorporating plenty of debate and discussion, helps us to identify what we feel are the best opportunities for our funds.
Warning: Past performance is not a reliable guide to future performance. The value of your investment may go down as well as up. These products may be affected by changes in currency exchange rates.
Warning: Forecasts are not a reliable indicator of future performance.
Warning: Davy Select is designed for investors who are comfortable making their own investment decisions, without financial advice; this is known as “execution-only”. Execution-Only is not for everyone. You should ensure that you fully understand any investment and the associated risks before making a decision to invest. Alternatively, Davy can arrange for you to open a different type of account, where we can advise you in relation to investment decisions, or where we can manage investments on your behalf. Forecasts are not a reliable guide to future performance.
Warning: This article does not constitute investment advice as it does not take into account the investment objectives, knowledge and experience or financial situation of any particular person or persons. Prospective investors are advised to make their own assessment of the information contained herein and obtain professional advice suitable to their own individual circumstances.
