The Champion Manager of the Year

If you evaluate asset managers and allocate assets to them, take The Basis Point Test and see how you score.

The champion manager

The 150th Open Championship concluded yesterday at St. Andrews.  As always, the awards ceremony included the announcement of “the champion golfer of the year,” one of the most recognizable phrases in all of sport.

Cameron Smith received that recognition by playing one of the greatest final rounds in major championship history.  No doubt his incredible performance will result in increased press attention, lucrative endorsement deals, and shorter odds at the betting window for coming events.  He was not an unknown before — his game is widely respected — but his “stock” has now been revalued.  That said, who knows whether the Open is a sign of even better things to come or the high point of his career?

Parallels to the investment game abound.  A portfolio manager who shoots the lights out for a period of time is sure to be featured in those publications that still make lists of the best performers in different categories for a year or even a quarter (although most of the evidence shows you’d be better off buying the laggards rather than the leaders).

There are also manager-of-the-year awards, which feed the industry’s marketing machine and lead to more assets for a manager so honored (and, in most cases, softer standards of due diligence, since the awards are viewed by many — consciously or unconsciously — as a stamp of approval).

The awards aren’t limited to managers; there are some for asset owners, fund selectors, advisory firms, etc.  We are drawn to rankings and our impressions are affected by them (or we wouldn’t pay attention).  That puts the onus on those evaluating managers and other providers to see past the aura surrounding them and judge what will endure after the magical moment has passed.

Mutual fund boards

At the end of the great paper, “Role of the Mutual Fund Director in the Oversight of the Risk Management Function,” issued by Deloitte and the Mutual Fund Directors Forum, is a footnote which includes this reminder:

The SEC has explicitly stated, “directors play a critical role in policing the potential conflicts of interest between a fund and its investment adviser” . . . indicating that “[t]o be truly effective, a fund board must be an independent force in fund affairs rather than a passive affiliate of management.”

It’s debatable whether that standard is met.  How many fund boards do independent due diligence on the firms managing the money of the funds (with the exception of details that are specifically required to be reviewed)?  Most don’t get past the manager’s narrative.

But that’s a deep topic best left for a future analysis.  What makes this piece “great” is the incredible number of questions throughout that directors “may find helpful” across four categories of risk (investment, operational, strategic, and regulatory).  While there are issues to discuss beyond the ones presented, fund directors who seek answers to those questions would be demonstrating a greater-than-average fiduciary effort.  (The same goes for other kinds of intermediaries.)

Material risk

Speaking of risk management, the CFA Institute Research Foundation has published a monograph by Richard Bookstaber and Dhruv Sharma, Managing Material Risk.  While the focus is on risk management for individuals, the ideas “extend to the range of asset owners.”

In sum, many of the standard tools for evaluating investment risk are poor reflections of the real world, and

the notion that we can optimize a portfolio is wishful thinking, as is the idea that we can look at the current situation in isolation and “set it and forget it” when it comes to portfolio construction for risk management.

Bookstaber points to

a systematic flaw in the risk models is being used to evaluate individuals’ investment portfolios:  assets erode in value more quickly than what is suggested by traditional models, and they take comparatively longer to recover.

And, “at the same time that current methods underestimate material risk in the market, they overestimate the long-term risk.”  His answer is to use agent-based modeling, which can reflect the vastly different goals and behaviors of the various market actors.  Within that framework, data on “leverage, illiquidity, concentration, and credit conditions” can better explain the cascades and contagion that occur and disrupt carefully-created plans.

Other reads

“Allocating to hybrid strategies is a multiple-choice decision,” Cara Lafond, Pensions & Investments.  The increased mixing and melding of private and public strategies within investment vehicles raises classification issues for asset owners; four options are outlined.

“Beyond Fama-French Factors: Alpha from Short-Term Signals,” David Blitz, et. al, SSRN.  The authors approach the analysis of short-term signals using different assumptions than others, and find that

a composite strategy comprising short-term reversal, short-term momentum, short-term analyst revisions, short-term risk, and monthly seasonality signals generates economically and statistically highly significant net alphas, at least when efficient trading rules are applied.

“Private Equity: Risks and Opportunities,” Frank Fabozzi, et. al, Portfolio Manager Research.  A timely recording of a panel discussion covering a wide range of research about private equity investments.

“What’s the deal with the God Bless America ETF?” Alex Steger and Alex Rosenberg, Citywire RIA.  A look at one of the latest thematic offerings, which carries the ticker symbol YALL:

Also, as was the case with the launch of Strive Asset Management a few weeks ago, you have this odd situation of a firm or fund being created with the expressed aim of being non-political and against all things mission based in finance, while being, you know, quite political and mission based.

“Defining and diligencing impact funds,” Ben Thornley and Jane Bieneman, top1000funds.  “A guide for more precise impact labeling and stronger impact management practices.”

“Capacity Constraints in Hedge Funds: The Relation Between Fund Performance and Cohort Size,” David Forsberg, et. al, Financial Analysts Journal.  The authors find that capacity concerns should not just focus on a given fund, but on the “cohort” of similar strategies, because

diseconomies of scale arise from capacity constraints related to the amount of AUM pursuing particular investment opportunities, which in turn was better identified under the cohort model as it incorporated the AUM of close competitors into the analysis.

“Trends to Watch,” DuDil.  This site specializes in identifying changes in company accounting policies that might otherwise fly under the radar.  Three trends are covered here:  changing behaviors related to employee stock compensation, companies tinkering with accounting assumptions because of inflation, and increased scrutiny from the IRS regarding transfer pricing.  (Plus, some stocks to watch.)

“The Five Distinct Signs that You Have a Toxic Workplace Culture,” Gustavo Razzetti, Fearless Culture.  And some tips on how to see them.

“Rating Morningstar’s Fund Ratings,” Jeffrey Ptak, Morningstar.  This self-analysis from the firm includes a good thumbnail of its four types of fund ratings, multi-dimensional looks at the performance of them, and “opportunities for improvement,” including:

The forward-looking Analyst Rating and Quantitative Rating have generally been successful sorting funds based on future performance versus a category average, with higher-rated funds succeeding more often than lower-rated funds, on average.  Nevertheless, Gold-, Silver-, and Bronze-rated funds have not outperformed their assigned benchmark indexes, on average.

“Agency Rule List,” Office of Information and Regulatory Affairs.  The current list of SEC proposed rules.

Coatue presentation deck, May 2022.

Big regret:  anchoring bias to the last 10 years.

A place for us

“Humans will be needed to look over the bots’ shoulders to ensure that the recommendations they make are sound.”  — From “Five New Financial Jobs of the Future” by Chris Kornelis in the Wall Street Journal.

Sector rotation

The allure of the sector rotation philosophy is based on the idea that you can catch the relative moves among them.  Easier said than  done, but this chart shows why it is an appealing concept.

A couple of years ago it was hard to give away energy stocks, especially because of the tsunami of interest in ESG factors.  On the flip side, tech could do no wrong and no price was too high for a piece of the future.  Then everything changed.

Will we take a trip back to (and below) the zero line, then slog around for years, like last time?

Postings

Recent pieces for paid subscribers:

“Finding the Right Talent.”  This posting starts not one but two series.  It is the first of four taking an investment perspective of the terrific book Talent, and it kicks off a months-long project on the nature of investment work.

“The Individualism-Collectivism Sweet Spot.”  There are certain attributes that define the culture of an organization.  Using asset management firms as an example, some thoughts about a central consideration.

All of the content published by The Investment Ecosystem is available in the archives.