Successful investing requires a contrarian mindset; anything else is, at best, a recipe for mediocrity. This is especially true for an investment committee, the core of an advisory firm’s decision-making process. Five prominent advisors – Harold Evensky, John Hill, Steve Cassaday, Steve Kaye and Berk Nowak – are embracing unconventional approaches to ensure that their investment committees operate in the most effective ways possible.
The five advisors were panelists in a discussion I moderated at the recent RIA Investment Advisor Summit in Dallas, Texas. The conference’s attendees were selected on an invitation-only basis, and funding came from a small group of sponsors, including investment-product providers and technology vendors. The resulting environment afforded the opportunity for in-depth discussions in small groups on a variety of important topics.
All five panelists are principals at independent investment advisory firms, with assets under management ranging from $750 million to $2 billion and client relationships typically between $1 million and $10 million.
Evensky is the president and founder of the Florida-based Evensky & Katz. Hill is the chief investment officer of the Maryland-based Pinnacle Advisory Group. Cassaday is the president and CEO of Virginia-based Cassaday & Co. Kaye is the president of New Jersey-based AEPG Wealth Strategies. Nowak is a partner with New York-based Highmount Capital.
Embracing the unconventional
Investment committees are where opinions, ideas and facts get translated into policy decisions about asset allocation and fund selection. An investment committee’s work is undeniably the central element that determines whether client goals are met.
Each panelist’s firm had a unique approach to structuring its investment committee, and those differences revealed some best practices that can maximize the likelihood of good results for your firm. Here are five ideas you can put to work:
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Listen outside the box. All five panelists devote significant portions of their investment committee meetings to discussing the economy, but they pull input from diverse sources. A number subscribe to expensive consulting services like Ned Davis, Ed Yardeni, ISI International Strategy, Cumberland and Jim Grant and use research from investment managers like GMO. Evensky said he relies extensively on institutional research from firms like J.P. Morgan and Goldman Sachs, which provide him with access because of the relationships he has with those firms.
But Cassaday has a different approach. “We ignore them all completely,” he said, ”because when you have equally credentialed experts speaking every day with diametrically opposed perspectives on the same topic, it just calls the whole thing into question.”
If consulting and research firms “were accountable for their recommendations and policy decisions and got paid based on that, they'd be broke,” Cassaday said. Instead, he said, he invests the money he would have paid for those services into his internal staff.
Cassaday uses one other interesting tactic. He speaks directly to the managers at major fund companies like Fidelity to get their views. Often he goes to fixed-income managers to get their views on the equity markets. “The credit guys are usually smarter than the equity guys,” he said. “They are usually the guys that really understand balance sheets and come from accounting backgrounds. And the value of a company … is almost always represented by balance sheets.”
Cassaday said many advisors simply spend too much time trying to understand the economic picture. “Advisors are spending all this time contemplating all these things which are frankly unknowable,” he said, “when at the end of the day what they probably should be doing is remaining fully diversified, fully invested and going with skilled managers who have demonstratively shown that they can pick and anticipate things in advance.”
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A CFA may not matter. All panelists have certified financial planners on their staff, but there was disagreement over whether a chartered financial analyst adds value to an investment committee. Hill, who has CFAs on his staff, said the certification program ensures that graduates have solid quantitative skills and intelligence. Kaye has three CFAs on his investment committee and likes the fact that they offer a different perspective than his planners. But he also said that situations arise in which his CFAs hold low regard for what his planners have to say.
Nowak relies most heavily on CFAs, with seven on his staff. That is largely because his firm uses alternative investment products, like hedge funds, and because his client base is internationally diversified, which makes tax and investment planning more complex.
Evensky has a couple of CFAs on his staff, but he said the certificate was “incidental” to the CFP program, which is more relevant to his needs. Cassaday also downplayed the significance of the CFA program for his needs – he has none on his staff. He said the curriculum is not relevant to a portfolio of mutual funds and exchange-traded funds. The Certified Investment Management Analyst® (CIMA) designation, he said, is more relevant to portfolio construction and selecting mutual fund managers.
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Learn from mistakes. Two of the panelists have systems in place that allow them to identify and learn from mistakes and situations that deviate from their investment committee policies.
Cassaday has something he calls the “mistake book.” Whenever something “blows up” or just doesn’t go as planned, he documents it in that book. There are probably 100 pages of things he’s done wrong, he said. “To be a good investor, you have to have really good memory, and most investors don't have good memories,” he said. “Having a mistake book for us has been something that has helped us not to redo the same errors over and over again.”
Evensky said that the “single most valuable tool” for his investment committee is what he calls the “exception report.” To monitor his managers, he establishes benchmarks and criteria: For example, he monitors the duration, expenses and turnover for his funds. If the reported values deviate by more than a pre-defined tolerance, they show up as exceptions. He reviews the data monthly and takes action when one manager has too many exceptions. The report “highlights anything out of the ordinary so that we can focus on it,” he said.
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Ask the right questions. The panelists who use active managers devote significant resources to selecting and monitoring them. A key component of that process is the interview, which is reviewed by the investment committee.
Cassaday said he’s developed a standard list of questions he asks managers. Some of these, he said, are trick questions: How are you compensated? Are you compensated based on assets under management or on performance versus a benchmark? Why wouldn't you leave and start a hedge fund? Tell us what your “golden handcuffs” are. Who do you admire in the business?
Evensky said that the first question he asks is, “What is your philosophy?” He looks for a good story and carefully reads the managers’ quarterly letters. “We are looking for a manager who says, “Boy, I blew it last quarter. This is what I've learned, as opposed to someone who is just BS, BS.” Evensky asks how managers make their philosophy work in the real world.
Kaye said he also relies on attribution analysis to evaluate why managers over- or underperform. “When you have anomalies in performance that are skewing the track record up or down,” he said, “we really can't just look at performance. We really have to tear the performance apart and do deep attribution analysis.”
One point on which everyone agreed
When it came to creating an open and collaborative work environment, there was no disagreement among the panelists.
Evensky said that any member of his firm can bring an idea to the investment committee. “There is a wide range of input in terms of what we ultimately implement in our portfolios,” he said.
Nowak said he has an open weekly meeting, even though there are only five voting members on his investment committee. “We really try to design a structure where ideas can be presented, and not just a balloon floated and someone walking away,” he said. “If someone has an idea, we want them to champion that idea, evaluate it through and through and make sure that it is something that could work in a client's portfolio.”
Hill echoed those sentiments. “What works for us is having a wide-open team,” he said. “There are no closed doors.”
“Watch out for groupthink in your committees,” Kaye said. “Manage to the mission, not to the trend. Keep total portfolio objectives in mind, always — meaning, don't operate in a vacuum. Think ahead and have contingency plans. We focus on the probabilities, but sometimes the unlikely possibilities happen.
“Everyone needs to have a voice,” Kaye said.
Read more articles by Robert Huebscher
