“I’d
like you to underperform your benchmark by a consistent 200
basis points for the next six months.”
Imagine making this statement at your next fund
manager meeting. It’s likely that those sitting across the table would look at
you quizzically and ask you to repeat the instruction.
You’d say again—stressing this time—that you’d
like your manager to underperform their benchmark by 200 basis points
for the next six months. After all, if they are as skilful as they (and their
fees) would have you believe, this should be no problem.
It’s probable that your manager would start
reeling off the quarters of outperformance they’ve had and assure you that
these returns are a better indicator of skill.
“OK, great,” you would counter. “Can I accompany
you to your next training session? When this week are you analysing your
performance? Who is responsible for pouring over your daily trade data and who
poses the tough questions on your selling discipline?”
Cue more quizzical looks.
“Because,” you would then say, “if your returns
are down to skill rather than luck, I want the best coaching team
available—like Serena Williams, Lewis Hamilton, or the New York Yankees employ.
We can’t afford for you to lose your edge.”
At this point, very few fund managers would throw
open their office door and lead you to the nerve centre where all this happens.
Most of them would smile nervously and ask if you’d like to hit the bar or have
a round of golf instead.
Egos and mediocrity are the problem. If your fund
manager maintains you are remunerating him for his superior skill, but refuses
to take advice or training to maintain or improve his performance, he might
find that luck soon runs out.
And do you want your assets to crash out of the
major leagues with him?
“She
can improve a lot. Her game at the net can improve and the
transition from the baseline to the net can be improved a lot. Her swing volley
can be better; she sometimes is hesitating to move forward… it’s just to name a
few.”
This is Serena Williams’ coach, Patrick
Mouratoglou, discussing how she could improve her game. It was not when she was
struggling to perform a season or two ago, but in a CNN interview in March of
this year after she had just won the Australian Open. She went on to win the
French Open and Wimbledon, and is poised to take the Grand Slam at the US Open.
“Serena Williams’ game involves roughly 85% skill
and 15% luck,” says Lawrence Evans, co-founder of Salomon Partners, a fund
management coaching and performance analysis firm. “Being a fund manager
involves 90% skill and 10% luck.”
“Our industry puts too much emphasis on people believing they are geniuses or have some kind of sixth sense. That is all rubbish.”Williams has an undeniable gift for tennis, but
instead of relying on her natural ability, she is driven to excel. She trains
at least five days a week and whether she has just slammed her opponent 6-0,
6-0, or been slammed herself, she returns to the training court the next day to
work.
Very few people are natural fund managers.
Securities selection is not a skill we are born with, most people believe. It
is something we work at. With that in mind, how many of these investors—who rely
more on skill than luck—can boast a regime like Williams’? Very few. And
unfortunately for investors, there is usually just one thing to blame: Ego.
“Our industry puts too much emphasis on people
believing they are geniuses or have some kind of sixth sense. That is all
rubbish,” says Fredrik Martinsson, righthand man to the CIO at Danish pension
ATP. “There are some brilliant people, but what makes them is the
interconnection between protocol and details—their process.”
For Martinsson, there are four important P’s: people, protocol, process, and a platform from which to conduct it all. “The most important P is people,” he says, “but only if they are devoted to the others.”
The cult of “star fund managers” is not only
unhelpful, but rarely actually true, according to Morningstar’s UK Director of
Manager Research Jeremy Beckwith. “There is a small number of managers who have
been around 10 years [at the same fund] and really good firms are hard to
find,” he says. “We give positive ratings to fewer than 10% of firms.”
No firm is consistently brilliant, according to
Beckwith, but the underlying factors of people and process are key to being
better than average. “The process gives the outcome,” says Evans at Salomon,
who also should be credited with the question in this article’s opening. He and
his partners, including former Goldman Sachs Asset Management international
business head and behavioural finance expert Paul Craven, pose exactly this
question to leading international fund managers.
The answers they receive indicate whether they are
dealing with someone who wants to be the best or someone who believes they have
already hit their groove and are happy with it.
“We meet a lot of rock stars,” says Evans, “but we
have found that having a massive ego is not a trait of a genuinely skilled
investor. We have pitched to managers with huge egos and have been asked to
leave, but we are lucky to coach some of the best portfolio managers in the
business.”
Evans believes a
“folklore of finance” says success should be measured by the alpha created—and
that needs to change. “Are you meeting your clients’ objectives on a long-term
basis?” should be at the heart of every decision a manager makes, says Evans.
Despite many outwardly saying this is the case, actions speak louder than
words.
Beckwith has
spent years meeting fund managers and evaluating their performance. Yet few
people have delivered and shown real skill. Those who do have similar
characteristics. “They are passionate and single-minded about investing,” he says.
“They show humility and realise that at least one-third of their decisions are
going to be wrong. The successful ones want to learn when they are wrong and
when to cut their losses.”
We have all been
told that it’s good to be right. However, most important is to know whether you
were right for the right reasons, or right for the wrong reasons. Luck is very
easy to spot and impossible to control—just hit the roulette wheel to find that
out. Skill is a different matter.
“We ask a fund
manager: ‘How do you define skill?’” says Evans. “For the majority, ‘the
return’ is the answer. We ask: ‘Is it something you can control?’ most fund
managers say ‘yes’—but it isn’t. The return is the outcome. The skill is the
process. Fund managers get themselves into knots with this question.” Even the
best fund managers in the world win no more than 60% of the time, according to
Evans. “There’s a lot more luck involved than managers admit—and a lot of it
comes down to money. You can’t charge fees if you’re basing your outcomes on
luck.”
Former
sportsperson-turned-CIO Larissa Benbow draws many parallels between the worlds
of sport and finance, and identifies problems with the latter. “What tends to
happen in the investment community is that the industry becomes too focused on
the output (performance) and they start to ignore the inputs,” says Benbow. She
represented Great Britain on the international softball stage before taking
charge of a £10 billion corporate pension at high street bank HBOS. She left
the bank in 2015 and is about to announce her next investment role.
“In sports, if you want to be and remain the best—and improve—you have coaching and take advice. In our industry the same rules don’t seem to apply. The concept of training is new and some are sceptical.”“When this
happens, performance often suffers, leading to fund managers looking for
shortcuts to get it back on track—or they look for a fall guy to blame.”
The fall guy can be anything from the market, to
central bank actions, to poor liquidity, to other investors. Can you remember
the last time you heard Rory McIlroy blaming anything other than himself for
failing to make the cut?
“In sports, if you want to be and remain the
best—and improve—you have coaching and take advice,” says ATP’s Martinsson. “In
our industry the same rules don’t seem to apply. The concept of training is new
and some are sceptical.” Additionally, the majority of investors do not want to
reveal what they are doing to someone else—for whatever reasons—says the Dane.
“Believing that the learning or developing stops
or is reduced upon taking the role as fund manager is naïve,” says Benbow. “It
now becomes more critical than ever; and if they believe this is not the case
all they need to do is reflect on where Serena might be without her coaches.
Sure, she might be a good tennis player, but would she be the record-setting
champion she has become? Doubtful.”
If a fund manager was playing Williams at
Wimbledon, who would be in the supporters’ box? The player’s manager would be
the fund house’s CEO; the accountant would be its CFO; physical therapist and
personal trainer would be covered by the COO, with investors making up the
family and friends cheering and being filmed by TV crews. This just leaves the
position of coach, which is pivotal to Williams’ success. It would be empty for
most fund managers.
That tide may just be about to turn—at least for
the managers who want to consistently see their name engraved on the trophy.
“They realise that if you want to be number one, you can’t do it on your own,”
says Evans. “You need a sounding board, coach, and teacher rather than just
waking up and making trades.”
Continued from here.
It
all starts with data.
“In sport, no elite athlete competes or trains
without analysis and someone tracking their improvements,” says Rick Di Mascio,
fund manager-turned-analyst at Inalytics. “As soon as they step off the court,
pitch, or ground, their stats are waiting for them. It’s inconceivable that
anyone could compete without a coaching programme.”
At Inalytics,
Di Mascio has put together a programme with Shane Sutton, technical director of
British Cycling, to apply to fund management. Sutton was instrumental in
reshaping the Great British cycling team to become a world leader on the
international stage.
Both Inalytics and Salomon Partners, although with
different approaches, focus on the same method: collecting data, analysing and
learning from it, then working with a coach to update and maintain an edge. “We
have 1,000 portfolios and millions of investment decisions to look through,”
says Di Mascio.
A key point here
is that those doing the coaching are not—and never were—individually at the top
of their game. Sutton contributed to the Great Britain team that won 26 Olympic
medals, but won none himself.
“Why do the top four tennis players all have
dedicated trainers?” says Martinsson. “They have the best backhands and
forehands in the business—who is a trainer who has not won as many titles as
them to tell them how to play?”
It doesn’t matter, Martinsson argues.
“It’s not that we are the smartest people in the
world,” says Evans at Salomon Partners, “We’re not. It’s all about the
questions we ask. Most of the world prefers to tell.”
“Fund managers for the most part like to see
themselves as their own coach,” says ex-softballer Benbow, “but they fail to
have the objectivity that coaches provide to their key players.” Smart fund
managers have a great “team of coaches”, she says, which includes both their
internal teams who should be able to challenge and provide suggestions to the
fund manager without negative recourse, and coaches who operate external to the
organisation.
“These external parties could include outside
mentors or devil’s advocates who will provide a challenge to a manager’s status
quo,” says Benbow.
In this form as
the devil’s advocates, Inalytics and Salomon work with just a handful of fund
managers out of thousands. However, the growth of their businesses signals a
growing sense that managers are human beings rather than machines, each company
says.
“Elite coaching is very valuable,” says Di Mascio.
“Elite players—this translates to fund managers and other walks of life too—are
naturally competitive and want to win. You have to deal with the human aspect,
or this is just a data dump. Managers have to understand their behaviour and
create coping strategies.”
Changing what you have always done is hard, especially
when you have made good money doing it. “Human behaviour makes us repeat the
past and stay the same,” says Evans. “We think that a good outcome is from our
skill whereas a bad one is through luck. This bias has done humans very well so
far, but most of us don’t understand ourselves—nor the best way to assess
ourselves.”
“Complacency is the fastest road to failure,” says
Benbow. “No fund manager can survive on the same set of processes and rules;
they need to be creatively thinking about the market and strategy to find
opportunities to exploit. Many managers are happy to muddle through with
average returns. Great managers, like great sports people, are constantly
evolving strategy.”
As far as the
actual investing goes, there are three activities in fund management, says
Salomon’s Evans: buying, selling, and sizing. The most efficient is buying. The
least efficient is selling, which is the most sentimental and judgemental—and
can be a material alpha enhancer.
Managers need rules for these activities, says
Evans.
“You start with a set of stocks and have to
implement a filtration device to get 2,000 to 50,” he explains. “Having skill
is asking and acknowledging this: What are your rules and how do you update
them given micro and macro changes? We ask questions and expect them to answer
them clearly. If they don’t, we challenge them. It can be very uncomfortable.”
This is the key to maintaining an edge, for Serena
as for a fund manager. The work is never complete.
“Our clients
must track marginal improvements,” says Di Mascio. “Managers cannot just
carry out the exercise and go back to working how they were. They need to look
at the detail of how their performance improved and continue to use it.”
A
Formula One (F1) car has between 150 and 200 onboard sensors. In
real time, the mechanics in the pit lane—and those back at base—can see how the
car changes in atmospheric and driving conditions, how the driver is executing
the ride, and how both end the race compared to how they started.
F1 team McLaren’s UK headquarters more closely
resemble Tony Stark’s laboratory in Iron Man than a car shed. Mechanics work
around the clock to create faster, more responsive cars, while a team of
personal trainers, nutritionists, and psychoanalysts are on hand to keep the
drivers in tip-top condition.
“A sportsperson’s support structure monitors
nutrition, sleep, warm-up, training, recovery, and analysis of the competition,
with on-field performance being a result of all these critical inputs,” says
Benbow. “With such structured focus on these elements the level of performance
becomes a result of the recipe. You do the work, you reap the rewards.”
“Thirty years ago, F1 drivers would swig on a bottle of Champagne before getting behind the wheel of their car. Asset management is like that now, but it will change as people realise it affects their lives and the industry will assume more responsibility.”And investors want that to come to their industry
soon.
Morningstar’s Beckwith believes fund management is
getting more professional and disciplined, but if everyone is getting better,
managers with a will to win have to find a relative advantage.
“If you don’t have anyone challenging what you did
yesterday, you won’t develop,” says ATP’s Martinsson. “Managers have to
consider alpha decay and that the edge they have now will be eaten away. You
need to be able to maintain it.”
“If you are ‘podium’ level at anything or elite in
any field,” says Di Mascio, “you should have confidence in your ability and a
thirst to maintain and improve it. You shouldn’t be afraid of being found out.”
But we are still far from adopting the idea in the mainstream, according to our
ex-athlete.
“The quality of managers’ coaches will undoubtedly
be one of the most important inputs into the quality and sustainability of
their returns,” Benbow says. “Despite this, as an investor, I believe that
fewer than 20% of managers have quality coaching teams. Insufficient importance
is placed on this role; in part this comes back to ego or arrogance. For some,
it may be cost and others the time taken to listen and debate views with
others.”
Equally, Evans
says Salomon Partners walks away from as many clients as it accepts: “If they
don’t understand that they will have to work at it—and work differently—there’s
no point.” Evans admits his product is not cheap, but says the company has data
to back up its claims of improved outcomes for the end client.
And these
ultimate clients have a responsibility or—dare we say it—a fiduciary duty to quiz
their managers, says Di Mascio.
“Generally, CIOs don’t ask,” he says. “It’s not
part of their due diligence. Fund managers are very good at describing their
investment processes and their track records, but there’s no proposed link
between them. What are their strengths and weaknesses? Investors should be
equipped with—and encouraged to ask for—these kinds of insights.”
“Thirty
years ago, F1 drivers would swig on a bottle of Champagne before getting behind
the wheel of their car,” says Evans. “Asset management is like that now, but it
will change as people realise it affects their lives and the industry will
assume more responsibility.” However, Evans accepts this story is going to take
many decades to play out.
“Behavioural
biases are hard habits to break. But over 10 years, people are becoming more
receptive,” he says. “We are no longer on the lunatic fringe.”