If your job is to evaluate fund managers, the CFA Institute published a book on manager selection.
The task of manager selection involves more than simply picking active managers with a goal to outperform benchmarks. Investors must practice due diligence when selecting index managers as well as active portfolio managers. Investors want managers who are highly skilled, diligent, and persistent, but they also want managers whose interests are aligned with their own. And investors need to do more than identify skillful managers; they need to determine the appropriate weights to give these managers.
Before hiring your first fund manager, you must know that your portfolio will outperform doing so.
Investors need to develop their views on active management prior to crafting an investment policy statement. The IPS [Investment Policy Statement] specifies acceptable investments and types of managers in addition to overall investment goals. To justify hiring active managers, the investor must believe the following:
- Some portfolio managers have the skill to deliver superior performance.
- The investor has the skill to identify managers who will deliver superior performance in the future.
- The investor can build a portfolio of managers to effectively deliver asset class exposure as specified in the IPS and capture superior performance after costs.
Should you hire and fire a fund manager on a whim?
Manager selection should be an ongoing process. Change should be guided by prompts and policies, not by ad hoc decisions or a reaction to changing objectives, benchmarks, or allocation goals. Despite uncertain manager alphas and imperfect selection ability, if investors can identify in advance managers who deliver added value net of fees, they can yield higher profits than if they invested in index funds. Investors who prove able to identify managers with positive alpha (for example, those who have a probability greater than 50%) earn superior performance over long-term horizons.
It is very tempting for investors to fire managers who have recently underperformed and hire managers who have recently outperformed. Unfortunately, the primary benefit of this action is that investors no longer need to look at the fired, poorly performing manager’s numbers on the next quarterly investment report. For most investors, this process leads to a destruction of value over time.
Study the book before you write your investment policy statement.
Post by Marcelino Pantoja