I’ve previously written in detail about ways to become an entrepreneurial investor. One of those ways involves understanding best practices for picking winners. There are so many choices and options when it comes to funds, one must be careful not to get caught in a paralysis from analysis.
Claudia Roering, head of Fund Selection at Deutsche Asset Management, very succinctly sums up the goal in picking funds: “Fund selection is about creating alpha by selecting the best funds and managers that deliver excess returns over a complete business cycle.”
Alpha is essentially the risk-adjusted difference that a fund manager makes on the value of a fund.
There are four areas which I look at when considering fund managers:
Some questions to consider in evaluating the strength and consistency of a fund manager are: Who is in charge? What are the ownership levels of the principals? How stable is the team, how do they work together? A strong team approach lends itself to a measure of stability in that the loss of one individual would not drastically impact fund performance negatively.
Roering said that her team would “want to understand how the manager will perform in various market environments, and that comes down very much to the investment process, which is something we focus most of our analysis on. This is really the core of our qualitative due diligence.”
How disciplined is the team to implement their investment process? What is that investment process? Can it be easily defined? Why will their approach result in future outperformance in the near and long future?
Short-term performance is commonly evaluated and hastily acted upon. Selecting a fund which had high recent performance often leads to a pick which will underperform in the next period. Likewise, leaving a fund for a few months of underperformance, barring anything severe, is a waste of the due diligence which should have been put in to select the fund in the first place. Thus, the best strategy is to put in the effort upfront and develop a thorough understanding of a fund manager and invest in them for a prolonged period of time.
Products are about eligibility based on specific investment criteria, but these criteria must be determined by the overall strategy. Roering cites an example of this saying, “I’d be willing to accept a higher fee for an emerging markets debt fund than a developed bond fund. So it depends on the alpha potential of the asset class.”
Also, she says that “fund size varies with the strategy of the fund. For instance, a large cap strategy can comfortably manage several billion dollars in assets under management, while a small cap strategy will likely have problems finding opportunities for growth with billion-dollar assets.”
The bottom line is there is no magic bullet to any type of entrepreneurial investing. But, the more you understand about the process — and the inner workings of those with whom you’re investing — the wiser you become.