Selecting Investment Managers: Key Considerations For Success

Selecting an investment manager is a complex and detailed process that involves more than just analysing investment returns. It requires evaluating the manager's investment philosophy, process, personnel, and portfolio. The decision has important financial consequences, as the chosen manager will be entrusted with helping investors achieve their investment objectives.

When selecting an investment manager, it is essential to conduct due diligence, which involves understanding how the investment results were achieved and assessing the likelihood of the manager continuing to follow the same process. Due diligence also entails evaluating the firm's integrity, operations, personnel, and vehicle structure and terms.

Various factors should be considered when selecting an investment manager, including performance, philosophy, process, and people. While past performance is often a key consideration for investors, it is important to assess the manager's consistency in applying their investment philosophy and process and whether they have the right people to implement their strategies effectively.

The selection process must be thorough, methodical, and detailed, addressing any potential red flags to ensure the chosen investment manager is capable of delivering superior returns and aligned with the investor's objectives.

Understand the different types of investment professionals

There are several types of investment professionals, each with their own specialisations and skill sets. Understanding these differences is crucial when selecting an investment manager. Here are the main types:

• Certified Financial Planner (CFP): CFPs focus on financial planning and analysis. They help clients map out their income, expenses, and future cash needs, such as college expenses and insurance. Once these basic financial plans are in place, the next step is investing liquid assets. While some CFPs may offer investment services, it is often a small component of their overall service offering.
• Financial Advisor (FA): Financial Advisors is a generic term, often used by professionals who were previously known as stockbrokers. Today, FAs typically work as part of teams and offer financial products to clients rather than selecting individual stocks. They may also provide some financial planning services. FAs often outsource portfolio management to a money management arm of their brokerage firm or an independent Registered Investment Advisor.
• Portfolio Manager (PM): Portfolio Managers focus on investing in securities, such as stocks or bonds. They aim to generate strong investment returns while managing risk. Portfolio Managers are registered with states or the SEC as Registered Investment Advisors. They manage various types of investment vehicles, including mutual funds, hedge funds, and individual accounts. Portfolio Managers are the ideal choice for implementing investment strategies and maximising returns and risk trade-offs.

When selecting an investment professional, it is essential to understand your specific needs and goals. If you require comprehensive financial planning, a CFP may be the best option. On the other hand, if you already have a basic financial plan in place and are looking to invest your assets, a Portfolio Manager would be more suitable. It is also important to consider the level of assets you have; for example, hiring a Portfolio Manager is typically recommended for individuals with over $100,000 in assets.

Determine which type of investment professional you need

The first step in selecting an investment manager is to understand the various types of investment professionals and the services they offer. The three main types of investment professionals are Certified Financial Planners (CFPs), Financial Advisors (FAs), and Portfolio Managers (PMs). CFPs specialise in financial planning and analysis, helping clients map out their income, expenses, and future financial needs. FAs, a more generic term, often provide financial planning services and may outsource portfolio management to a money management arm of their brokerage firm or an independent Registered Investment Advisor. PMs focus on investing securities and seek to generate strong investment returns while maintaining appropriate levels of risk.

The next step is to determine what kind of investment professional you should be seeking. This depends on where you are in your financial planning process. If you are just starting to think about retirement planning, budgeting, insurance needs, or tax-efficient estate planning, a CFP is a logical first step. Once you have established a basic financial plan and set aside assets for investment, you will need a PM to specialise in growing those assets. Hiring a PM is most appropriate if you have over $100,000 in assets.

Understanding the role of investment managers

It is important to recognise that most investors do not hold securities directly but rather invest through intermediaries such as mutual funds, hedge funds, or exchange-traded funds (ETFs). In these cases, a professional investment manager is entrusted with helping investors achieve their investment objectives. The selection of an appropriate investment manager is a complex and detailed process that involves evaluating both quantitative and qualitative factors.

Evaluating investment managers

When evaluating an investment manager, it is important to consider the four 'Ps': people, philosophy, process, and performance. People refers to having the right individuals with the necessary experience to implement the investment philosophy and process. Philosophy is how an investment manager thinks about investments and drives their investment decisions. Process refers to how the investment philosophy is implemented in client portfolios, and consistency in the investment process is key to replicating past performance. Performance is the outcome of the other three Ps and should be evaluated over a long enough timeframe, preferably through the investment cycle.

Due diligence

Due diligence involves understanding how investment results were achieved and assessing the likelihood that the manager will continue to follow the same investment process. It includes evaluating the firm's integrity, operations, personnel, vehicle structure, and terms. Due diligence encompasses both quantitative and qualitative analysis.

Common pitfalls to avoid

It is important to avoid common pitfalls when selecting an investment manager. Many institutions hire managers who are in favour and fire them when they are out of favour, chasing performance and often harming the performance of their plan assets. Instead, focus on understanding a manager's intentions and track record of investment decisions to differentiate luck from skill over time.

Review their regulatory qualifications

When selecting an investment manager, it is important to conduct due diligence, which includes evaluating a firm's integrity, operations, and personnel. This involves reviewing their regulatory qualifications and ensuring they are qualified to provide investment advice and manage your investments. Here are four to six paragraphs elaborating on this point:

Regulatory qualifications are a critical aspect of the investment manager selection process. Investment managers are required to register with regulatory bodies and adhere to specific rules and guidelines. In the United States, for example, investment managers must be registered with the Securities and Exchange Commission (SEC) or state securities regulators. These regulatory bodies set standards for education, experience, and ethical conduct that investment managers must meet.

When reviewing an investment manager's regulatory qualifications, it is important to verify their registration status and ensure they are in good standing with the relevant regulatory body. This provides assurance that the investment manager has met the necessary educational and experiential requirements. Additionally, it is important to review their regulatory history to identify any disciplinary actions, complaints, or legal issues. This helps to mitigate the risk of working with an unethical or unqualified investment manager.

The regulatory qualifications also extend to the investment manager's licensing and certifications. Reputable investment managers often hold relevant professional certifications, such as the Chartered Financial Analyst (CFA) designation. This certification is a globally recognised standard for investment professionals and indicates a strong foundation in investment analysis and portfolio management. Other certifications to look for may include the Certified Financial Planner (CFP) or the Financial Risk Manager (FRM) designation, depending on the specific services you require.

Furthermore, investment managers are often required to adhere to specific codes of conduct and ethical standards. For example, the CFA Institute's Code of Ethics and Standards of Professional Conduct outlines principles that promote ethical behaviour and protect client interests. By reviewing an investment manager's commitment to these standards, you can gain confidence in their integrity and professionalism. It is also important to ensure that the investment manager has adequate compliance procedures in place to prevent conflicts of interest and ensure the protection of your assets.

Additionally, regulatory qualifications can provide insights into the investment manager's expertise and specialisation. Some investment managers may hold qualifications specific to certain industries or asset classes. For example, the Chartered Alternative Investment Analyst (CAIA) designation indicates a focus on alternative investments such as hedge funds, private equity, and real assets. If you are seeking investment opportunities in a specific area, ensuring that your investment manager has the relevant qualifications can enhance your confidence in their ability to provide informed advice and strategies.

By thoroughly reviewing an investment manager's regulatory qualifications, you can better assess their credibility, expertise, and commitment to ethical standards. This due diligence process is essential to making an informed decision and protecting your financial interests when selecting an investment manager.

Seek a professional who is readily accessible and understands your needs

When selecting an investment manager, it is important to seek a professional who is not only knowledgeable and experienced but also accessible and understanding of your needs. Here are some key considerations to keep in mind:

Understanding Your Needs

Before seeking an investment manager, it is crucial to assess your own needs and goals. Ask yourself: What are my financial objectives? What level of risk am I comfortable with? What time horizon am I working with? Do I need assistance with financial planning, or do I simply need guidance in adhering to my investment strategy? Being clear about your needs will help you find an investment manager who is well-suited to support you effectively.

Accessibility and Communication

Look for an investment manager who is readily accessible and responsive to your inquiries. Effective communication is essential, as it ensures that your questions are answered promptly and that you are kept informed about the status of your investments. Consider the frequency and methods of communication they offer, such as regular meetings, phone calls, or email updates. Ensure that their communication style aligns with your expectations and that they are willing to provide the level of interaction you require.

Tailoring Strategies to Your Needs

The right investment manager will tailor their strategies to align with your specific needs and goals. They should demonstrate a clear understanding of your risk tolerance, time horizon, and financial objectives. Avoid managers who employ a one-size-fits-all approach, as your investment strategy should be customized to your unique circumstances. Ask them to explain how their proposed strategies align with your needs and request that they provide specific examples of how they have successfully helped clients in similar situations.

Flexibility and Adaptability

Seek an investment manager who exhibits flexibility and a willingness to adapt their strategies as your needs evolve. Over time, your financial situation, goals, and risk tolerance may change, and your investment manager should be able to adjust their approach accordingly. Discuss their process for reevaluating and modifying investment strategies to ensure that they can accommodate your changing needs effectively.

Emphasis on Client Service

Choose an investment manager who prioritizes client service and places your interests first. Ask about their typical client interaction and how they handle client concerns or complaints. Inquire about the level of personal attention you can expect and whether they have a dedicated team to support you. It is essential to feel confident that your investment manager is responsive to your needs and committed to helping you achieve your financial objectives.

Due Diligence and Track Record

Conduct thorough due diligence on prospective investment managers. Evaluate their track record, including the performance of their investment strategies over time. Request references from current or former clients to gain insights into their level of satisfaction. Assess the stability and longevity of their team, as well as their adherence to ethical standards and industry regulations. By performing comprehensive due diligence, you can increase your chances of selecting a reputable and reliable investment manager.

Review their performance

When reviewing an investment manager's performance, it is important to consider more than just the analysis of investment returns. This process, known as due diligence, involves understanding how the investment results were achieved and assessing the likelihood of the manager continuing to follow the same investment process that generated these returns. It also involves evaluating the integrity, operations, and personnel of the firm.

Quantitative Analysis

The quantitative analysis involves evaluating the investment manager's track record and performance over a long-term horizon, typically defined as two full market cycles. This allows investors to study how the manager's strategy behaves in various market environments and understand their risk/return profile. When analysing performance, it is important to look beyond snapshot trailing returns and instead focus on rolling periods, such as five-year periods, to minimise short-term performance bias. Additionally, it is crucial to compare the manager's performance to an appropriate peer group or benchmark to understand how they stack up against similar strategies.

Qualitative Analysis

The qualitative analysis includes investment due diligence and operational due diligence. Investment due diligence evaluates the manager's investment process, investment personnel, and portfolio construction. It is important to assess the manager's investment philosophy, which outlines their assumptions about the factors driving performance and their beliefs about exploiting these sources of return. The investment process should be consistent and appropriate for the philosophy, and the investment personnel should have sufficient expertise and experience. Operational due diligence, on the other hand, evaluates the manager's infrastructure, including the integrity of the firm, its operations, and personnel.

Ratios for Risk-Adjusted Performance

Various ratios can be used to determine the risk-adjusted return of an investment portfolio and assess the manager's performance. Examples include the Sharpe ratio, Roy's Safety-First Ratio, the Sortino ratio, the Treynor ratio, and the Information ratio. These ratios help investors calculate the excess return per unit of risk, taking into account different kinds of risk and return.

Understanding the Basics

It is also essential to understand the basics of investing and the complexities of the institutional investment business. This includes recognising the role of institutional clients, investment consultants, and investment firms, as well as the fiduciary duty owed to clients and beneficiaries. Additionally, behavioural finance and agency costs play a significant role in investment decisions and should be considered when reviewing an investment manager's performance.

Case Studies and Track Records

Reviewing case studies and track records of investment managers can provide insights into their decision-making process and performance during different market conditions. For example, understanding how a manager navigated through a bear market or a recession can give you confidence in their ability to preserve capital and make sound investment choices during challenging times.

Performance Appraisal

Performance appraisal involves evaluating the manager's risk exposures relative to a benchmark, which is known as style analysis. Returns-based style analysis (RBSA) estimates risk exposures from actual return series, while holdings-based style analysis (HBSA) estimates risk exposures from the actual securities held in the portfolio. These analyses help define the universe of suitable managers and assess their performance in different market environments.

In conclusion, reviewing an investment manager's performance involves a comprehensive evaluation of both quantitative and qualitative factors. By considering the above points, investors can make informed decisions about the suitability and potential of investment managers to meet their financial objectives.

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