Examining the Investment Memos Produced by Asset Owners

A report published by Addepar, “Investment memos and decision-making,” begins with this paragraph:

Investment memos are the foundation of most investment processes.  Yet despite their importance, there’s practically no published research in either academia or industry on best practices in crafting or using investment memos.  Our findings illustrate new methods and processes in the crafting and use of memos.

The focus of the report is on the internal memos produced by institutional asset owners, specifically those assessing private funds.  Other asset classes and fund structures may require different content, and there are many kinds of analyses and recommendations produced by advisors, securities analysts, and other investment professionals that fall outside of the scope of the Addepar report.  However, the themes and principles addressed apply equally to that broader spectrum of situations and documents, making it a worthwhile reference for professionals and organizations beyond the primary audience.

A foundational belief of the work of The Investment Ecosystem is that success in investment roles depends on “analysis plus communication,” and that the importance of the communication component of that equation is generally unappreciated by most investment professionals and organizations.  (The Investment Ecosystem will be introducing a new course, tentatively titled “Communication Skills for the Investment Professionals,” later this year.)  The Addepar report, authored by Barbara McEvilley, Ashby Monk, and Dane Rook, is a welcome review of an influential but largely unexamined branch of the industry’s communication tree.

Valuable windows

As the authors indicate, investment memos “serve as valuable windows into the inner workings of an organization’s decision-making,” exhibiting the assumptions, logic, and processes that come into play when investments are being selected.  The corpus of memos provides evidence of the lived beliefs of an organization (which may or may not comfortably align with the stated ones).

Given the tools now in hand to analyze large numbers of documents, organizations have the ability to make better judgments about the quality of their decision making and to look for patterns of success or failure in the selection process (applying the capabilities described in the last posting, “The Dawning Era of Qualitative Analysis,” in a different way.)

Structure and process

Of the 54 organizations surveyed by the authors, 97% “have a formal investment memo template and process.”  The common template includes the “proposed investment, people involved (both internally and externally), prospective deal terms, associated risks, performance benchmarks, and an opportunity’s fit within the investor’s broader strategy or portfolio.”

In addition, the Addepar report outlines steps in the process of producing memos, including screening (using a draft as a gate “to avoid wasted time and effort”); writing the complete memo; critiquing it within the organization (which may involve red-teaming the opportunity); rating the key components of the investment, often according to a specific scoring discipline; and approving it within the decision rules of the governance structure.

After the fact, there are three more (potential) steps.  The storing of the information (and the future accessibility of it) can vary greatly, depending on the sophistication of the technology environment.  Also variable is the subsequent learning that comes from the decision process.  As indicated by the authors, the majority of organizations surveyed do not “have structured processes for ex-post analysis of memos . . . which is noteworthy in that it reveals how much value is not being captured in current memo processes.”  Finally, there are ideas for improving the production of memos, including suggestions about which elements could be refined (the actual writing of a memo is a common pain point).  Plus, the authors indicate that at some organizations the governance, oversight, and approval of memos should be reexamined because the pieces don’t seem to fit together as they should.

Typical shortcomings

The primary purpose of the Addepar report is descriptive, identifying how things are done now and providing some areas to address going forward — as well as issuing a general call to action.

Here are some additional ideas about the composition of reports from The Investment Ecosystem’s online due diligence course and workshops within organizations conducted by it:

Structure.  In addition to the required elements that an organization agrees should be in an investment memo, there is the question of length.  Some long memos can be well-crafted and illuminating, but many are long and boring and not very revelatory.  The tendency is for the authors to tell everything they know, which impedes effective communication.  Editing for readability and clarity is essential.

Documentation and discovery.  The due diligence process often gets bogged down with the collection of information to the point that little real discovery about the manager is occurring.  Memos provide the evidence of that — and suffer from that lopsided allocation of attention.  Documentation is necessary as a part of the due diligence process, but that doesn’t mean it all needs to be part of an investment memo, where it can bury the most important information (the identification of the differentiated attributes of the firm in question and the discoveries during due diligence that support those conclusions).

Narrative dominance.  The major problem with investment memos is that they largely reflect the narrative of the manager about its qualitative attributes instead of the conclusions of the allocator.  The reflected narrative dominates sections of most memos and there’s not a clear divide between “what they say” (that is, the manager) and “what we think” (from the allocator) about what the manager says.  The members of an approval body often can’t tell that large sections of what they read in a memo is mere reporting of the manager’s story rather than an independent analysis of it.

The need to sell the idea.  All asset management firms are messy and have things that they need to improve, but you wouldn’t know it from reading most investment memos.  The lack of discovery of that mess during due diligence is compounded by the need for those working on an idea to sell it within their own organization.  The best organizations are unafraid of voicing shortcomings and of taking a realistic, balanced view of a manager — warts and all — and coming to an informed decision.  Within many other organizations, too much talk about the kinds of challenges and gaps and needs that an asset manager has will scuttle a recommendation’s chances.  Unrealistic expectations of perfection on the part of managers impedes sound selection practices.

Sunk costs and rubber stamps.  There is nothing worse that doing a great deal of work and having it derailed by what you think is bad information, political maneuvering, or a flawed process within an organization.  But the opposite kinds of problems may be more prevalent.  Because of the amount of work that can go into due diligence and memo writing, a recommendation can take on a life of its own.  The sunk costs of time and resources can distort what should be objective decision making.  And by the time something comes up for final approval, it can be a fait accompli, rendering the approval process meaningless.

The Addepar research is an important step in drawing attention to the critical role investment memos play and the need to vet — and work to improve — their quality and effectiveness (something that The Investment Ecosystem has done on behalf of a number of asset owners).