Structured for success
What does it take to be a successful investment management firm over the long term and how do investors know when they’ve found one? A lot of research has been done on this very subject. Turns out there are some very specific attributes that successful investment managers share. Measure those that you deal with against the following checklist before deciding if they’re worthy stewards of your money.
Successful investment approach attributes
Unfortunately for investors, a lot of closet indexers out there are charging higher fees for active management when in fact they just mirror their benchmarks.
True active managers base investment decisions on specialized analysis and overlap little with their indices. Investments with the highest active share have been found to outperform their benchmarks by almost 4% annually.1
Low turnover is a good sign that the people managing your money have conviction in the businesses they’ve chosen and the temperament to cope with stock market swings. With a long-term outlook and a commitment to staying the course, they approach investing as buying businesses for the long term rather than just renting stocks.
Ultimately this impacts your bottom line as underperforming investments have been proven more likely to have higher portfolio turnover.2
Investment managers that concentrate their holdings in their best ideas outperformed the market by 4% to 10% annually without added risk.3
No surprise considering the benefits of diversification weaken significantly with increases in the number of holdings.
Lower fees allow for higher returns. End of story. They’re unavoidable but you need to pay attention to them because these costs eat away at your nest egg.
Invests based on business fundamentals
Using computer algorithms to guide investment selections simply doesn’t work over time. You want an investment manager that views stocks as long-term ownership interests in businesses because investments focused on stock selection have posted better returns than those that made market-timing calls.4
Successful structural attributes
Investment-led firms are guided by professionals with a background in investing whereas the emphasis of sales- and marketing-led firms is on asset gathering and creating products that will sell whether or not they’re in the best interest of investors.
Be warned: several well-known investment managers spend more on marketing than all the other costs of managing your money.5
Publicly traded investment managers must balance the needs of their clients with the demands of their shareholders resulting in an inevitable clash. With no public shareholders to appease, privately held investment managers can align their interests with those of their investors for a mutually beneficial partnership. They have a better chance of avoiding the pressure that leads public companies to focus on increasing assets over managing money.6
While bigger assets benefit investment managers that stand to profit from the fees applied to those assets, the story is less positive for investors. The smaller the investment, the more flexibility it has to buy substantial stakes in smaller businesses. Investment performance has been found to be inversely correlated with the level of assets under management.7
If experience didn’t matter, there’d be more market-made millionaires. Experience provides the discipline and skill needed to filter out noise and position an investment for long-term outperformance to the tune of 1.5% per quarter on average.8
Invests alongside its investors
If you’re at a dinner party and notice the host hasn’t eaten any of the food they’ve prepared, you’d probably be wary of trying it yourself. By the same logic, why trust an investment manager with your personal savings if they don’t have the confidence to put their own money in the same product?
Money talks. Investment managers with a minimum of $1 million in their products have outperformed the majority of their peers over a five-year timeframe.9
- M. Cremers, M. Ferreira, P. Matos, L. Starks, “The mutual fund industry worldwide: explicit and closet indexing, fees, and performance”. Social Science Research Network, 2013.
- S. Wu, “Interaction between mutual fund performance and portfolio turnover”. Journal of Emerging Issues in Economics, Finance and Banking, 2014.
- R. Cohen, C. Polk, B. Silli, “Best Ideas”. Social Science Research Network, 2010.
- M. Cremers & A. Petajisto, “How Active is Your Fund Manager?” Yale School of Management, 2006.
- Louis Lowenstein, The Investor’s Dilemma. New Jersey: John Wiley & Sons, 2008.
- R. Brown and T. Lee, “The science and art of manager selection”. Manager Research at Barclays, 2012.
- J. Chen, H. Hong, M. Huang J. Kubik, “Does fund size erode mutual fund performance? The role of liquidity and organization”. The American Economic Review, 2004.
- E. Kempf, A. Manconi, O. Spalt, “The value of experience and the origins of skill for mutual fund managers”. Social Science Research Network, 2013.
- Morningstar Research Inc. “Want Fund Managers on Your Side? Pick Those That Walk the Line”, January 2011.