Philosophy, People, Process, Risk, Research and Resources
The things discussed in these sections include:
Philosophy - What are the manager’s beliefs and investment philosophy? Is there anything unique about these? Can they be translated into outperformance (‘alpha’)? If so, in what type(s) of market is the fund likely to do well?
People - Who are the people running the fund? What are their experience and skills?
We also consider the wider team, such as the chief investment officer. How stable has the team been, for example, has there been much staff turnover?
How well are the managers incentivised - is their pay related to the medium and/or long-term performance of the fund? Do they have significant amounts of their own money invested in the fund?
Process - Is it clear, understandable, well thought out and consistent with the philosophy?
How does the manager research and select securities and/or funds? How do they put portfolios together and what are their sell disciplines?
Risk - How do the managers analyse risk? Which risk packages/systems do they use?
What risk control is in place, for example, are there any size limits in terms of asset classes that can be held or limits on individual holdings? Is there oversight by an independent risk team with a separate reporting line?
Research - What is the size and experience of the research team? Is external research bought in?
If so, what research and from whom? Is research quantitative in nature that is, using models and forecasts to decide on asset allocation and stock selection?
Or, is it fundamental - looking at the income statements and balance-sheets of potential investments as well as carrying out company visits?
Resources - What tools and packages do the team have at their disposal? Which other parts of the firm can the team draw on, for example, research teams, other asset class teams or a governance team?
These reviews are updated every six months and can support advisers in selecting the most suitable funds for their clients.
What’s next in terms of fund and manager research?
The industry has seen a growing interest and fund launches in the area of ESG (environmental, social and governance) investing over the last few years. This is where fund managers search out and include companies in their portfolio based on desired ESG characteristics.
We see no sign of this abating, for the following two reasons in particular:
- Empirical research into ESG investing has shown evidence of a positive effect on returns, or at least no performance penalty. Companies that behave responsibly and incorporate ESG principles into their business are usually better custodians of capital and, in turn, provide higher long-term returns (whereas the exclusionary screening of ‘bad’ sectors or industries we saw in the past generally has a negative effect on returns as managers may no longer be selecting the most ‘efficient’ investments)
- The fact that the MIFID II rules will soon require advisers to ask clients about their ESG preferences and take these into account when assessing the range of financial products to be recommended. Fund and portfolio recommendations will need to match each client’s individual ESG preferences
As a result of the second point, advisers will need access to ESG data and fund research to fulfil their requirements.
However, the amount and quality of ESG-related information reported by companies still vary considerably.