Choosing the Best Fund Managers - Part I

At the Fourth Annual Manager Search and Selection Conference in May 2009 hosted by the New York Society of Security Analysts (NYSSA), the most impressive presentation of the event was given by David Judice, a Managing Director who is the Director of Traditional Strategies Research at Citi.  His team researches over 1,000 products (mutual funds, ETFs and separately managed accounts) for Global Wealth Management to help investors make proper investment decisions.

According to a chart from Dalbar: Quantitative Analysis of Investment Behavior (www.qaib.com), the average equity investor's annual return lags the S&P 500 Index by 7.5% annually from 1988-2007.  During the same period, the average fixed income investor's annual return is 6% less than the Lehman Aggregate Bond Index.  There are many factors that cause investors to underperform the indices:

• Too many mutual fund choices
• Chasing "hot" managers that have strong returns over the past 3 years
• Limited time for detailed analysis
• Current market conditions are not included when researching funds
• Changing fund managers at the wrong time
• Equating strong returns with good investing skills
• Mixing emotions into investment decisions

To create a portfolio of the best fund managers, Judice's team uses a 5 step process.  The investor sets objectives for desired returns, risk tolerance and time horizon.  Once that is known, the team reviews the market conditions for the best tactical and strategic asset allocations for the investor.  Manager research is done using qualitative and quantitative analysis to identify the "best of breed".  Then the team helps allocate capital to the different managers that fit the investor's needs.  The portfolio is monitored on an ongoing basis to maintain its suitability for the client.  The process is refreshed as an investor's objectives may change.

Strategic asset allocation considers long term goals and risk aversion.  Tactical asset allocation maximizes returns based on current market conditions.  Proprietary research is used to find investments that will have extra returns over the intermediate term (1-3 years) by identifying the best managers and investing styles.  For example, the relative value strategy outperforms prior to or during recessions.

When researching a manager, his team looks at the following factors:

• Personnel and Firm - Credentials and expertise of key professionals, ownership structure of the fund, how key professionals are compensated, any turnover, experience and success of the firm
• Investment Process - Investment idea generation, portfolio construction methodology, sector/industry concentration, any volatility guidelines, investment style consistency, performance
• Research - Depth of research analysts; industry expertise; databases, technology and analytical tools; number of companies covered
• Operations - Assets under management, growth or stable personnel, legal or regulatory issues, when the firm closes funds to new investors

Research has proven that there is some persistence in fund managers.  The managers in the top 25% tend to stay there.  Managers in the ninth and tenth deciles are 2.5 times more likely to disappear.