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Investment offerings will encounter quantitative challenges at some point in their lifecycle. Those issues within the realm of due diligence encompass all measurable aspects that might signal problems from an investment management perspective. These issues should not immediately trigger alarm but rather serve as prompts for the crucial question: Why?
This answer often comes from a blend of quantitative and qualitative concerns. Quantitative analysis, in isolation, provides only a monochromatic glimpse, like sketching in black and white. A more robust analysis adopts a dual-pronged approach, combining qualitative and quantitative due diligence, which brings deeper comprehension of cause-and-effect dynamics within our profession.
Here are the three quantitative metrics that I focus on when evaluating an investment offering.
Asset base
The asset base of a fund, or assets under management (AUM), can fluctuate due to various factors, including market conditions, organizational or management matters, or prevailing headlines. Examining asset flow across different timeframes offers a more detailed narrative and indicates whether concerns are immediate or longer term in nature. Given the level of available capital, I primarily inquire about each fund's ability to adhere to its investment process. my team’s research communicates any looming concern as soon as it becomes apparent that the asset level might affect our client's investment. Significant inflows or outflows can disrupt investment management, whether due to capital constraints, liquidity issues, or a scarcity of viable investment opportunities for the manager to deploy capital.
Performance
I consider investment performance in isolation as, at most, something to get interested in the fund. Short-term successes or failures should not overly influence one’s judgment of quality. Consistent with my team’s "process over prediction" philosophy, we initially evaluate performance over three- and five-year periods, which offer a more tempered assessment. We also scrutinize performance across multiple calendar years and rolling three-year periods. The three-year performance metric in particular helps smooth out any abrupt changes observed in annual performance. We compare a fund's performance both against its benchmark and its peers to ensure the most comprehensive assessment possible.
This multi-timeframe analysis promotes objectivity. While this evaluation process may seem extensive, it's merely a starting point. Underperformance is not necessarily indicative of poor portfolio management. Instead, it prompts us to investigate the "why" and determine the best course of action within our client's best interest. We never want to discourage portfolio managers from adhering to their investment process.
Consider a portfolio management team with a rigorous buy-and-hold process that undertakes extensive due diligence, adding only a few new companies to its equity portfolio over many years. It may experience significant drawdowns if its holdings don't include a given year's hottest stocks. But if the fund consistently executes its investment process over longer periods, generating excess returns over the benchmark, we should not harshly judge the team for adhering to their investment philosophy, even if it doesn't align with short-term trends.
Fees
Management fees detract from client wealth and opting for funds with lower fees means more money remains in the client's account. We compare a fund's management fee to its peers to inform our clients about that fee relative to the broader universe comparable investments. When a management fee exceeds the average fee among peers by 30% or more, we consider it a minor concern and communicate this to our clients, ensuring they are aware of potential cost savings through alternative offerings.
Asset base, performance, and fees are all critical metrics, but our evaluation goes beyond these purely quantitative factors. We understand that investment management is not merely about numbers, but also strategy, philosophy, and adaptability. Our approach emphasizes process over prediction and encourages us to ask the vital question of "why" when confronted with challenges.
Ultimately, our goal is to act in the best interests of our clients. We aim to provide them with a well-informed, responsible, and nuanced perspective on their investments. This approach allows us to confidently navigate the complexities of the financial landscape and support our clients in achieving their financial goals.
Peter Girard, manager, is a member of the Due Diligence Group and the Capital Markets Team at Innovest. The Due Diligence Group is responsible for sourcing investment managers, as well as monitoring recommended products and strategies. Additionally, this group utilizes both quantitative and qualitative analysis while evaluating performance, understanding return attribution, and meeting with management teams. Peter also supports the Capital Markets Team by providing research on the capital markets and performing asset allocation studies. In addition to his due diligence and capital markets responsibilities, Peter focuses his efforts on projects for Innovest’s nonprofit, family, and individual clients.
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Advisor Perspectives welcomes guest contributions. The views presented here do not necessarily represent those of Advisor Perspectives.