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Money Manager Due Diligence Scott Thoma, CFA

Money Manager Due Diligence Scott Thoma, CFA. The Challenge. > 7,000 Separately Managed Account Options > 7,000 Distinct Mutual Funds (> 25,000 when incorporating share classes). The Challenge . Investors judge on short-term performance Fiduciary duty? Urge to "do something".

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Money Manager Due Diligence Scott Thoma, CFA

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  1. Money Manager Due DiligenceScott Thoma, CFA

  2. The Challenge • > 7,000 Separately Managed Account Options • > 7,000 Distinct Mutual Funds (> 25,000 when incorporating share classes)

  3. The Challenge • Investors judge on short-term performance • Fiduciary duty? • Urge to "do something"

  4. How Do You Conduct Manager Screens? • 4 P's • Performance • Performance • Performance • Performance

  5. How Do You Conduct Manager Screens? • 4 P's • Performance • Historical • Risk-adjusted • Star rankings • People • Philosophy • Portfolio

  6. Mutual Fund Selection Process Universe (7,000+ Funds) Target Universe Identify managers with records of performance success Rolling period performance Risk-adjusted performance Performance Attribution Evaluate factors leading to success People Process Portfolio characteristics Judge whether success is repeatable Selection Removal List of Approved Managers • Investment thesis • Team discussion • Change in thesis • Better alternative

  7. Manager Initiation - RFI Process • Personnel • Changes in structure, coverage, resources • Process • Portfolio structure & philosophy • Ownership

  8. Qualitative Analysis • Level of experience • Key decision makers • Resources • Performance and financial incentives

  9. Qualitative Questions • How does the portfolio management team identify attractive investment ideas? • How does the investment team build the mutual fund portfolio? • Does the investment process make sense? • Is the overall investment process repeatable?

  10. Investors Chase Performance Source: Ned Davis Research, Inc.

  11. Rolling Period Analysis – Fund A • Morningstar Rankings (end of 2008) • 1-Yr: 97th Percentile • 3-Yr: 96th Percentile • 5-Yr: 91st Percentile • Rolling Period Return Analysis • Fund outperformed its benchmark and peers in 88% and 99% of 5-year rolling periods, respectively. • Outperformed its benchmark and peers in 76% and 86% of 3-year periods, respectively. • 10-Yr Morningstar Ranking: 9th Percentile Source: Morningstar

  12. Portfolio…Or Collection of Funds Source: Morningstar

  13. Differences in Styles Leads to Differences in Performance Fall/Winter 2008 Deep Value Underperforms Eclectic & Conservative Managers Outperformed Spring/Summer 2009 Deep Value Outperforms High Quality Underperforms

  14. Understanding Fund Differences International Fund Performance Differences • Emerging markets allocations • Currency hedging

  15. Importance of Understanding Fund Differences Source: Morningstar

  16. Even Top Managers Endure Tough Times Periods of Relative Underperformance vs. S&P500 Rolling 1-Year Periods Top Quartile Managers Q1 1998–Q4 2007 Past performance does not guarantee future results. Universe—Large-Cap domestic equity; 164 large-cap managers whose 10 year average annualized performance ranked in the top quartile from January 1, 1998– December 31, 2008 were analyzed. Source: Factest, PSN and AllianceBernstein

  17. Even Top Managers Endure Tough Times Periods of Relative Underperformance vs. S&P500 Rolling 3-Year Periods Top Quartile Managers Q1 1998–Q4 2007 Past performance does not guarantee future results. Universe—Large-Cap domestic equity; 164 large-cap managers whose 10 year average annualized performance ranked in the top quartile from January 1, 1998– December 31, 2008 were analyzed. Source: Factest, PSN and AllianceBernstein

  18. Even Top Managers Endure Tough Times % whose Rolling 1-Year Performance Fell into the Bottom of the Rankings Top Quartile Managers Q1 1998–Q4 2007 Past performance does not guarantee future results. Universe—Large-Cap domestic equity; 164 large-cap managers whose 10 year average annualized performance ranked in the top quartile from January 1, 1998– December 31, 2008 were analyzed. Source: Factest, PSN and AllianceBernstein

  19. Consistent Performance Is Elusive:Even Top Managers Endure Tough Times % whose Rolling 3-Year Performance Fell into the Bottom of the Rankings Top Quartile Managers Q1 1998–Q4 2007 Past performance does not guarantee future results. Universe—Large-Cap domestic equity; 164 large-cap managers whose 10 year average annualized performance ranked in the top quartile from January 1, 1998– December 31, 2008 were analyzed. Source: Factest, PSN and AllianceBernstein

  20. Detailed Performance Review • Peer review • Attribution analysis • Drift

  21. Drivers for Removal • A significant negative change to the fund's portfolio management team • A significant change to the fund's investment process • Investment style or investment process drift • A better alternative within the same asset class • Underperformance (relative to style and process)

  22. Issues With Star Rankings • Portfolio/Style Bias • Short-term Performance Bias • Share Class Bias • Category Changes • Manager Changes

  23. Issues With Star Rankings • Not predictive of future performance “In short, the star rating is a backward-looking measure of past performance. What it is not is a forward-looking measure of fundamentals.” - Russell Kinnel, Morningstar

  24. Regulatory Issues • Fiduciary Standard • Target date funds • 12b-1

  25. The Challenge • Number of options • Evaluating performance • Urge to "do something" • Time / resources

  26. The Opportunity • Standard process for evaluation • Better decision making process • Better portfolios • Better client experience

  27. Questions / Comments?

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