Success Factors for a Buy-side Analyst

As a member of the New York Society of Security Analysts, I was invited last week to listen to a panel talk about the buy-side and how to succeed in it.  There were four speakers:  Subrata Ghose, CFA, Lauren Lambert, CFA, Stanley Lee, CFA and Thierry Wizman.  Their points can be boiled down as follows.

Ghose is an equity research analyst at Lord, Abbet & Co.  To be successful, he must:

• Simplify his research for the portfolio manager to make decisions
• Be objective
• Have conviction in his opinions
• Be quantitative
• Talk to the entire supply chain of the company (vendors and clients)
• Not hide when wrong

Lambert is a portfolio manager at AllianceBernstein and former Director of Research for Non-US equities at Bessemer Trust.  She added the following points:

• Be excellent with clients
• Do not be too narrow i.e. do not just follow your stocks
• Learn about other asset classes

Lee is a portfolio manager for Neuberger Berman and runs the (David) Greene Group All Cap Intrinsic Value strategy.  His items were:

• Have conviction in your stocks
• Understand the industry and economic environment
• Have good ideas that make money
• Sell ideas in a simple manner

Wizman is the Director of Research at Artha Capital.    His notes were not targeted towards success factors but more of the difference between buy-side and sell-side.  They were:

• Buy-side is exposed to many opinions from the sell-side.  The sell-side analyst is by himself.
• Buy-side can have conditional opinions or change opinions easily
• Buy-side has continuous exposure to a small audience.  Sell-side has a large audience.
• Buy-side becomes portfolio managers.  Sell-side becomes Directors of Research.

Notes from a Private Wealth Management Panel Presentation

Last night, I had the pleasure of attending an event sponsored by the New York Society of Security Analysts (NYSSA) on the State of Private Wealth Management.  The speakers were Hinton Crawford of TD Wealth Management; Chip Packard, Managing Director and Head of the Eastern Region for Deutsche Bank Private Wealth Management and Mason Salit, Head of the International Private Bank for HSBC.

They noted several trends in the private banking business.  Clients were interested currently in investment products that protect principal, are liquid, reduce risk, reduce tax burdens through Master Limited Partnerships and senior level tranches of structured products.  However, investors tend to have short term memories and the preferred products were different a couple of months ago.  Investors want simplicity, control, consolidated reporting, help with generational wealth transfer and philanthropy.  Returns were ranked seventh.  Private bankers are spending a lot of their time with legal, compliance and risk in the current environment.

Secondary Market for Private Equity

Private equity fund investors may want to sell their investments to raise cash, reduce their risk or re-balance their asset allocation.  These positions are similar to hedge fund investments.  They do not trade on a stock market daily and are hard to price.

At the 4th Annual Manager Search and Selection Conference at NYSSA in 2009, Nigel Dawn of UBS spoke about that year's state of affairs.  At the time, he was head of the Secondary Market Advisory team.  Historically, the spread between bid and ask prices was 8%.  In 2009, the spread was 20%.  Surprisingly enough, the growth was in private equity real estate funds.

The following year, David Tom, CFA, of the VCFA Group had a presentation about the secondary private equity market.  He deals with three types of investments:  limited partner interests in small and middle market buyout, venture capital, mezzanine and other private equity funds;  secondary direct private investments; and portfolios of private assets.  Secondary funds had $50 billion in assets under management with larger funds (anything over $500 million) holding 80% of the assets.  The secondary market is steadily growing.  In 2009, it was 4% of the total US private equity AUM and 3% of global AUM.  This is up from 1.5% and 1% in 2000 and 0.2% and 0.2% in 1990.  Historically, there has been a excess of secondary investment being sold on the market and not enough buyers.  The gap is much larger during crises such as the credit crisis of 2008 and the dot com meltdown in 2001.

Again, thanks to NYSSA for holding two great events.

Creating a Hedge Fund Portfolio

Earlier, I had written some articles regarding how investment advisors and consultants pick the best mutual fund managers for their portfolio.  Let us return to hedge funds and discuss how fund of hedge funds do the same.  Again, I will rely on presentations from NYSSA's Fourth and Fifth Annual Manager Search and Selection Conferences.  I have combined details from three experts over the two conferences.  They are:

• Ben Appen, CFA - founding partner at Magnitude Capital (Fourth)
• Jeff Moses, CFA - Lyrical Partners (Fifth)
• Robert Teeter - Ten-Sixty Asset Management (Fifth)

Magnitude Capital uses experienced hedge fund professionals to source investments.  The team includes senior employees from UBS, Deutsche Bank and D.E. Shaw who have extensive contact lists.  They use a six step process to make investment decisions:

1. Risk Management:  In addition to accounting for the common risks (i.e. credit, liquidity, etc.), Ben considers crisis risk management.  The credit crisis of 2008 saw a rapid decrease of available borrowing, illiquidity in certain products and cross asset selling.  Rob also asks if liquidity is needed for the whole or just part of the portfolio.
2. Strategy Analysis:  Ben and Rob invest in different strategies based on market conditions.  Jeff focuses on buying long/short managers at a discount to the Net Asset Value of the fund.
3. Sourcing:  Networking, hedge fund service providers, databases and conferences are used to find managers.  Rob noted that there was greater institutional demand for the largest hedge funds.
4. Evaluation and Due Diligence:  Both quantitative and qualitative methods are used.  In the former case, past returns, correlation of these returns with other investments and how they affect the current portfolio are analyzed.  The latter method includes meeting with managers, reference and background checks, reviewing the fund's operations, auditing financial statements and general administrative review.
5. Portfolio Construction:  Ben's firm has a proprietary "optimizer" to help make investment decisions.  It ranks the incremental value of each manager.  This rank plus the investment team's judgment creates the portfolio.
6. Monitoring:  Ben tracks market conditions, portfolios (using monthly risk reports) and managers (weekly estimates, monthly risk reports, quarterly meetings and quantitative analysis).  Jeff wants to have broad conversational openness with managers in addition to receiving detailed portfolio holdings.  Rob said that transparency was increasing but wondered if people were taking advantage of the situation.  He noted that knowing the holdings in a portfolio does not make people aware of all the risks.

If you would like to read more advanced articles that are thoughtful and insightful, please go to Hedge Fund Portfolio blog.

Choosing the Best Fund Managers - Part III

Continuing on the manager selection topic, there was another presentation by Richard Schaffer, CFA, of Chartwell Consulting LLC and Nathan Sonnenberg, CFA, CAIA, of Fortigent.  Both firms provide investment advice to family offices, endowments and foundations and high net worth investors.  A slice of the buy-side commonly referred to as private wealth / mini-institutional investors.  The process is similar to the institutional side discussed earlier.  Both firms are looking to construct a portfolio of managers that will provide the best returns with low volatility.  I will highlight the differences:

• Additional attributes of managers
• Success in a variety of market cycles
• Reasonable fees
• Tax efficient
• Manager introduction for private wealth is done through networking and industry conferences
• Close monitoring of trades for separate managed accounts

Schaffer is the Director of Research / Senior Partner at Chartwell where one of his duties is investment manager search and selection.  Sonnenberg is a Managing Director in charge of asset allocation and risk management.  He oversees equity manager search and selection.  

Choosing the Best Fund Managers - Part II

Let's continue David Judice's concepts on selecting funds for investors from the Fourth Annual Manager Search and Selection Conference hosted by NYSSA.  In the first article, we concentrated on picking the best investments and listed the factors analyzed.  Now, let's review the reasons for removing an investment from a mutual fund.  They may originate from the investor or manager side.

From the investor:

• Re-balancing portfolio
• Change in market conditions cause a change in tactical asset allocation
• Change in investment policy statement (i.e. investor's goals or risk tolerance)
• Opportunity cost (Is there a better investment to fit investor's goals?)

From the manager:

• Unexplainable and poor returns.  Every manager will have three year periods of underperformance.
• Returns,  high or low, that do not fit expectations.  This may mean the manager, investment process or risk profile of the fund has changed.
• Key investment personnel leaving
• Firm is giving less transparency, access or client service
• An unprecedented, large loss
• Having liquidity or capacity (i.e. fund has too much assets under management) issues
• Trading execution issues
• Taking on too many investment styles

The manager selection process usually results in buying market indices plus 1-2 active managers to outperform the benchmarks.

Many thanks to David, Citi and NYSSA.  This was a fantastic presentation.

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.

Clarification on Portfolio Strategies

Yesterday in my summation of a presentation at the Manager Search Conference at NYSSA. I wrote that a portfolio should hold two main strategies: style-based and flexible. I should clarify these two terms. Style-based means choosing a manager that is constrained in a specific market cap or region. Some examples would be managers in small cap value stocks, emerging markets debt or Japanese stocks. A flexible strategy would allow the manager to invest in the best opportunities that they can find. The more famous managers would be George Soros, Paul Tudor Jones and Ken Heebner.

Updated Concepts in Choosing Investment Managers

One of the more interesting presentations at the Manager Selection Conference at NYSSA mentioned in the previous post was regarding selecting the right investment managers for your portfolio.  I am only the messenger here.  The following is list of ideas from the brain of Thomas Latta, Managing Director and CFA.

The financial crisis of 2008/2009 brought an end to the concept that "beating the market" was good enough for investors. If the benchmark is down 50%, is it good news that a manager is only down 45%? This provided a wake-up call to traditional money managers. The challenge is to fix this error but not commit the old error of timing the market.

This can be done by having improved risk management processes, qualitative analysis of managers and building a portfolio from a mix of different strategies. Better risk management involves managers having strict selling criteria, diversification, tail risk management and close monitoring of active risks. When managers are rated, there is a premium on experience, diversity amongst the managers (in terms of training and process experience) and knowledge of behavioral finance i.e. the science of crowds. The portfolio should hold two main strategies: style-based and flexible. However, this increases the need to monitor at a total portfolio level.

The trend for the advisor is to choose funds with concentrated portfolios of 20-30 positions in either traditional or alternative asset funds. This allows the advisor to choose managers with more freedom in investment decisions, that can manage their Beta and have lower correlation with the market.

Another Type of Conference

I had the pleasure of attending a conference that was not sponsored by an investment bank. It was held by one of the CFA (Chartered Financial Analyst) Institute societies and was decidedly more low key. The accommodations were not at a posh hotel but at the society's offices. It was an open event; there were no gatekeepers. Anyone who would pay the fee could attend. There were also no breakout meetings scheduled. Everything was on a presentation basis, either by a single person or a moderated panel.

In general, there was an industry theme - how to find and select good fund managers. Experts from different financial firms such as Brown Brothers, Bank of America Merrill Lynch and Avenue Capital spoke for about an hour on various topics in Wealth Management, took questions from the audience and gave their views on the current state of the markets. It was an opportunity to sell their products as well.

Anyone interested in experiencing a conference without being in a buy side firm can go to one sponsored by their local CFA Institute society. You can go to www.nyssa.org to view a list of conferences to attend. Unfortunately, the food is not as good as an investment bank's industry conference.