Is your investment manager’s strategy sustainable (part one)?

Luke Cummings

Considering the strategy of an investment manager, which is essentially their investment approach and process, is a crucial element when assessing a fund manager, and one which is often underemphasised. While returns can and will fluctuate over time - and hence chasing past returns is a poor manager selection approach – an investment manager’s strategy should remain relatively stable and has the added benefit of being (relatively) easily assessed. This assessment provides a good way of differentiating between fund managers, understanding what they have to offer and whether this is aligned to your needs as an investor.

Financial products are becoming increasingly sophisticated and although good fund managers are of great potential benefit to investors, simply placing blind faith in a manager to do what they say they will, even if they have been successful in doing so in the past is fraught with danger. Instead, investors should take the time to understand a manager’s proposed investment process and whether they have confidence that it is (and will continue to be) diligently applied.

You have probably seen the standard financial disclaimer that “prior results are no guarantee of future performance” but how many investors stop and think about the implications of this statement. We believe a lot of investors disregard this statement and don’t consider it important, when in fact it is a meaningful reminder of reality. The reality is that market conditions are dynamic and frequently change without warning, and these changes can greatly influence many managers’ returns, making their past returns somewhat irrelevant. Just because your manager has been profitable over the past 1, 2, 5 or even 10 years does not guarantee that they will continue to be so into the future. It is for this reason that investors who take the time to understand the investment strategy and the process an investment manager is using – and its relevance to the future - have a far better chance of success than those that assume the past will continue indefinitely. Even the most skilful of managers can come unstuck when their processes aren’t strong and disciplined.

To give you one example, in mid-January 2015 the Swiss National Bank un-pegged its currency from the Euro. Even though the probability of this happening seemed highly unlikely, the Everest Capital Global Fund lost almost all of its assets as a result of extremely large positions that were bearish on the Swiss currency. Unfortunately for them, the announcement made by the Swiss National Bank caused the Swiss Franc to rally hard against many of its fellow currencies, something Everest Capital didn’t want to happen and which, ultimately lead to its downfall.

Now this wasn’t a small fund. It had about $830 million in assets at the end of 2014 and it had been through 5 separate emerging market debt crises in its 24-year life, so their founders weren’t exactly without prior experience. However, they clearly had a process failing with an obviously excessive exposure to this one currency call. Their risk management processes were obviously inadequate and arguably, unacceptable. A sustainable funds management strategy needs to know how to manage downside risk and size positions accordingly. It doesn’t matter that the last few months have been good, if there is a risk of a big market move– the risk of that move needs to take precedence when sizing positions.

Of course, getting a money manager to reveal their investment process is sometimes harder than getting blood from a stone, as many are hesitant to reveal their intellectual property while others don’t have a disciplined process to meaningfully speak about! So, conducting comprehensive analysis on a manager’s strategy can be problematic and often requires a high degree of skill and suitable expertise. It is obviously important that the people come across as trustworthy, genuine and down to earth. However, having at least some knowledge of what the manager is trying to achieve - even at a basic level – can allow you to identify times or circumstances when a manager’s strategy may come under pressure, and can provide confidence in whether a disciplined and sensible process is being applied.

In tomorrow’s article (part 2 of this series) we will further discuss the implications of not understanding your investment manager’s strategy.


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