Analysing Investment Managers—the Five P’s

One of the more useful frameworks the consulting community has come up with.

Philosophy

What is your edge? Perhaps the most difficult and illuminating question to ask a fund manager.

What persistent market anomaly are you attempting to arbitrage to generate alpha systematically?

Philosophy is important because it unites the managers in a common belief and reduces countless wasted hours arguing over basic investment approaches. Various philosophies can work with different people but if the team fundamentally differs in their belief in how markets work, there is likely to be a big problem.

Process

What processes has the manager in place to identify the above stocks and how do they become part of the portfolio? What is the decision-making process? Does accountability exist? With who?

How does the process handle risk in the portfolio construction phase?

Portfolio turnover identifies whether the managers are investors or traders, defined as a sales/ave fum, turnover above 100% indicates a trading strategy while investors like a limit around 40%. Implies a different role in idea generation and longevity.

The best processes are simple, clear and easy to follow, have accountability and lead to decisions. There is plenty of room for discussion and different views but the process should remain in place.

Where the process is unclear or a moveable feast issues can arise.

People

Who is involved in the decision-making process? How big is the team? Do they believe in the philosophy and implementing the process? Do they sing from the same hymn sheet? Can you identify the main investor(s)? the marketers? The fill-ins?

Has the team changed who? how many? How often? What is the correct size of the team?

Is there any change in ownership structure that would upset the people involved?

The whole area of incentives, ie bonuses, equity etc, is important, how are they constructed, fair, consistent, objective etc? because it is easy to lose good people due to the greed of others and start a downward spiral.

Is the structure of the firm built for funds management or is there another purpose and layers of people not involved in managing money, like admin, marketers, sales, middle/senior management? There is a theory that when the number of non-investment people exceeds the number of investment people, the culture of the firm changes for the worse.  

Price

What are the base fees, are there performance fees or other (undisclosed) fees?

Does the PF have a high watermark?

Is there significant leakage from advertised returns to investor returns?

Performance

What is a reasonable benchmark to measure the manager against given their investment philosophy (is there a style bias)?

Does the manager run with a lot of risk or too little?

How has the manager performed in bull and bear markets (is there an understandable bias or skew)? what is a reasonable timeframe to measure returns?

Does the fund behave how you would expect, that is, is under and outperformance understandable given the manager’s stated philosophy and process?

Is there enough information to conclude whether returns are due to skill, luck, risk or style bias?

Conclusion

Most fund managers fail due to a weakness in one of the above. Maybe even getting the first four right doesn’t lead to a great performance is a possibility. Snatching defeat from the jaws of victory, lol.

Ticking off all five gives you the understanding and confidence to back a manager.

Note: analysis of fund attribution is critical and available to various consultants, why not retail investors?

Finally, even if you don’t use a manager but DIY, there is a useful framework to assess yourself against, IMO. Of course, I come from a professional management background and the above is well accepted and standard, but this may be new material to some so I offer it up.

It is also not exhaustive ill put it in my journal and add anything I've forgotten over time.