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

Luke Cummings

Yesterday, in part one of this series, we discussed the importance of conducting due diligence on the strategy and process your investment manager. Apart from the initial investigative work, it also helps to know whether the manager is doing something genuinely different from others. After all, if your fund manager is not doing anything different to other managers (and this is in reality very, very common) there is little reason to expect a result that is anything other than average over time.

Unfortunately, the average return over time and the profile of this return, usually leaves a lot to be desired with many managers making money slowly when times are good and then losing it quickly when things get rough. We don’t believe investors need or want to rely upon good market returns for them to achieve their objectives and hence we think providing an offer that is anything but ‘average’ is a highly desirable offering which is much better suited to the needs of most investors.

Of course, having a strategy that is uniquely different is only one consideration. Investors should also be concerned with the extent to which a manager deviates from their stated strategy (hint: the answer should be that they don’t). How would you identify this to be the case though if you aren’t already familiar with their stated strategy and process? Deviating from their normal process suggests that a manager is no longer confident that their existing process or strategy will work or it may simply be that the manager is seeing better returns being generated elsewhere and feels compelled to try and keep up. By way of example, Harvest Lane Asset Management deals heavily in the merger arbitrage space. If we were to start buying companies solely because they look cheap on a valuation basis then our investors should rightly be concerned.

Knowing your investment managers chosen strategy also enables you to set realistic expectations in regards to the investment timeframe needed for success and the likely pattern of returns. If a manager’s volatility or return profile suddenly changes, investors should understand why this has occurred. Is the manager suddenly becoming overconfident and taking too much risk? Is that what you as the investor signed up for? Has the manager’s luck run out as the market stops rewarding their style bias?

A typical trade in the M&A space averages around 4 months but in some instances, it will take considerably longer. Any individual trade can influence results over a short period of time, but over years the average and expected result is much more likely to be achieved with the law of greater numbers. As a result, our volatility of returns has historically been quite low – which means there are periods of time where our performance will appear stagnant as not much appears to be happening.

Investors familiar with this knowledge will not be surprised to see a few months where our unit price fails to make any meaningful changes, but then eventually and suddenly increases as reasonable expectations are fulfilled. We are not the type of manager that is likely to make huge returns, but nor are we likely to face steep losses. We personally believe a volatile return profile is difficult for many clients to stomach (and often more so than they realise) so we prefer to minimize volatility wherever we can. Our investors are generally aware of this as we are very upfront about it as we believe that setting realistic expectations from the outset will lead to a better ongoing relationship.

Unfortunately, our observation is that there are a great deal of investors who are less well informed for several reasons. Perhaps they don’t have the time or perhaps they just aren’t that interested or maybe they have fallen victim of the hard-selling tactics of the managers’ sales team. Some would argue that you’re paying a professional so that you don’t have to conduct this work yourself. In reality, flying blind and placing total trust in someone without doing some due diligence into their operations or their methods rarely pays off in the long run.

You wouldn’t think twice about conducting a building inspection before purchasing a property, or having a mechanic look over a car you’re about to purchase. Digging deeper into the strategy of a professional investment manager – and whether their strategy suits your desired return and risk profile – along with monitoring their ongoing performance is essential if you want to have the best chance of achieving your objectives.

Ultimately, it is your money.


Luke Cummings

Luke has 17 years of experience trading Australian and international equity markets on both a proprietary basis and on behalf of retail and wholesale clients. In 2006, Luke and his partners founded private client firm HC Securities in addition to...

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