Money Manager Due Diligence Scott Thoma, CFA
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Money Manager Due Diligence
Scott Thoma, CFA
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The Challenge
> 7,000 Separately Managed Account Options
> 7,000 Distinct Mutual Funds (> 25,000 when incorporating share classes)
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The Challenge
Investors judge on short-term performance
Fiduciary duty?
Urge to "do something"
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How Do You Conduct Manager Screens? 4 P's
Performance
Performance
Performance
Performance
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How Do You Conduct Manager Screens? 4 P's
Performance Historical Risk-adjusted Star rankings
People
Philosophy
Portfolio
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Universe (7,000+ Funds)
Mutual Fund Selection Process
Target Universe
Identify managers with records of performance success
Judge whether success is repeatable
Selection
Evaluate factors leading to success
Removal
•Change in thesis•Better alternative
List of Approved Managers•Investment thesis
•Team discussion
People Process Portfolio characteristics
Rolling period performance Risk-adjusted performance Performance Attribution
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Manager Initiation - RFI Process
Personnel - Changes in structure, coverage, resources
Process
Portfolio structure & philosophy
Ownership
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Qualitative Analysis
Level of experience
Key decision makers
Resources
Performance and financial incentives
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Qualitative Questions
How does the portfolio management team identify attractive investment ideas?
How does the investment team build the mutual fund portfolio?
Does the investment process make sense?
Is the overall investment process repeatable?
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Investors Chase Performance
Source: Ned Davis Research, Inc.
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Rolling Period Analysis – Fund A
Morningstar Rankings (end of 2008) 1-Yr: 97th Percentile 3-Yr: 96th Percentile 5-Yr: 91st Percentile
Rolling Period Return Analysis Fund outperformed its benchmark and peers in
88% and 99% of 5-year rolling periods, respectively.
Outperformed its benchmark and peers in 76% and 86% of 3-year periods, respectively.
10-Yr Morningstar Ranking: 9th PercentileSource: Morningstar
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Portfolio…Or Collection of Funds
Source: Morningstar
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Differences in Styles Leads to Differences in Performance
Fall/Winter 2008
Deep Value Underperforms
Eclectic & Conservative Managers Outperformed
Spring/Summer 2009
Deep Value Outperforms
High Quality Underperforms
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Understanding Fund Differences
International Fund Performance Differences Emerging markets allocations
Currency hedging
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Importance of Understanding Fund Differences
Source: Morningstar
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96%
75%
86%
-500 bps -800 bps -1000 bps or Worse
Periods of Relative Underperformance vs. S&P500 Rolling 1-Year PeriodsTop Quartile Managers Q1 1998–Q4 2007
Past performance does not guarantee future results. Universe—Large-Cap domestic equity; 164 large-cap managers whose 10 year average annualized performance ranked in the top quartile from January 1, 1998– December 31, 2008 were analyzed.Source: Factest, PSN and AllianceBernstein
Even Top Managers Endure Tough Times
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55%
31%21%
-100 bps -300 bps -500 bps or Worse
Periods of Relative Underperformance vs. S&P500 Rolling 3-Year PeriodsTop Quartile Managers Q1 1998–Q4 2007
Past performance does not guarantee future results. Universe—Large-Cap domestic equity; 164 large-cap managers whose 10 year average annualized performance ranked in the top quartile from January 1, 1998– December 31, 2008 were analyzed.Source: Factest, PSN and AllianceBernstein
Even Top Managers Endure Tough Times
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Even Top Managers Endure Tough Times
% whose Rolling 1-Year Performance Fell into the Bottom of the RankingsTop Quartile Managers Q1 1998–Q4 2007
100% 96%
71%
Bottom Half Bottom Quartile Bottom Decile
Past performance does not guarantee future results. Universe—Large-Cap domestic equity; 164 large-cap managers whose 10 year average annualized performance ranked in the top quartile from January 1, 1998– December 31, 2008 were analyzed.Source: Factest, PSN and AllianceBernstein
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Consistent Performance Is Elusive: Even Top Managers Endure Tough Times% whose Rolling 3-Year Performance Fell into the Bottom of the Rankings
Top Quartile Managers Q1 1998–Q4 2007
84%
54%
24%
Bottom Half Bottom Quartile Bottom Decile
Past performance does not guarantee future results. Universe—Large-Cap domestic equity; 164 large-cap managers whose 10 year average annualized performance ranked in the top quartile from January 1, 1998– December 31, 2008 were analyzed.Source: Factest, PSN and AllianceBernstein
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Detailed Performance Review
Peer review Attribution analysis Drift
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Drivers for Removal
A significant negative change to the fund's portfolio management team
A significant change to the fund's investment process
Investment style or investment process drift
A better alternative within the same asset class
Underperformance (relative to style and process)
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Issues With Star Rankings
Portfolio/Style Bias
Short-term Performance Bias
Share Class Bias
Category Changes
Manager Changes
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Issues With Star Rankings
Not predictive of future performance
“In short, the star rating is a backward-looking measure of past performance. What it is not is a forward-looking measure of fundamentals.”
- Russell Kinnel, Morningstar
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Regulatory Issues
Fiduciary Standard
Target date funds
12b-1
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The Challenge
Number of options
Evaluating performance
Urge to "do something"
Time / resources
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The Opportunity
Standard process for evaluation
Better decision making process
Better portfolios
Better client experience
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Questions / Comments?