money manager due diligence scott thoma, cfa. the challenge > 7,000 separately managed account...

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"

How Do You Conduct Manager Screens? 4 P's

Performance

Performance

Performance

Performance

How Do You Conduct Manager Screens? 4 P's

Performance Historical Risk-adjusted Star rankings

People

Philosophy

Portfolio

Universe (7,000+ Funds)

Mutual Fund Selection Process

Target Universe

Identify managers with records of performance success

Judge whether success is repeatable

Selection

Evaluate factors leading to success

Removal

•Change in thesis•Better alternative

List of Approved Managers•Investment thesis

•Team discussion

People Process Portfolio characteristics

Rolling period performance Risk-adjusted performance Performance Attribution

Manager Initiation - RFI Process

Personnel - Changes in structure, coverage, resources

Process

Portfolio structure & philosophy

Ownership

Qualitative Analysis

Level of experience

Key decision makers

Resources

Performance and financial incentives

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?

Investors Chase Performance

Source: Ned Davis Research, Inc.

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 PercentileSource: Morningstar

Portfolio…Or Collection of Funds

Source: Morningstar

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

Understanding Fund Differences

International Fund Performance Differences Emerging markets allocations

Currency hedging

Importance of Understanding Fund Differences

Source: Morningstar

96%

75%

86%

-500 bps -800 bps -1000 bps or Worse

Periods of Relative Underperformance vs. S&P500 Rolling 1-Year PeriodsTop 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

Even Top Managers Endure Tough Times

55%

31%21%

-100 bps -300 bps -500 bps or Worse

Periods of Relative Underperformance vs. S&P500 Rolling 3-Year PeriodsTop 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

Even Top Managers Endure Tough Times

Even Top Managers Endure Tough Times

% whose Rolling 1-Year Performance Fell into the Bottom of the RankingsTop Quartile Managers Q1 1998–Q4 2007

100% 96%

71%

Bottom Half Bottom Quartile Bottom Decile

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

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

84%

54%

24%

Bottom Half Bottom Quartile Bottom Decile

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

Detailed Performance Review

Peer review Attribution analysis Drift

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)

Issues With Star Rankings

Portfolio/Style Bias

Short-term Performance Bias

Share Class Bias

Category Changes

Manager Changes

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

Regulatory Issues

Fiduciary Standard

Target date funds

12b-1

The Challenge

Number of options

Evaluating performance

Urge to "do something"

Time / resources

The Opportunity

Standard process for evaluation

Better decision making process

Better portfolios

Better client experience

Questions / Comments?