Best Practices for Manager Selection

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Welcome to Advisor To Go, brought to you by CIBC Asset Management, a podcast bringing advisors the latest financial insights and developments from our subject matter experts themselves. 

Phillip Lee, executive director, manager research, with total investment solutions at CIBC Asset Management.  

A great starting point for manager selection is to establish a clear understanding of the manager and their investment philosophy. There are many different investment approaches in the marketplace, each with their own performance patterns and characteristics. So having a great breadth of choice is fantastic for clients. So being appropriately informed of those choices is just as important.  

Part of being informed is identifying the specific purpose that you need the manager or strategy to fulfil within a client’s portfolio. In most cases, trying to beat a benchmark is top of mind. But it’s just as important if not more so to start with identifying any particular client needs such as a focus on income, or a preference for reduced volatility because a client may get anxious at certain points with market volatility. Being mindful of those needs is not always aligned with beating a market-cap-weighted benchmark, especially over short time frames.  

It’s also necessary to regularly reconfirm that initial understanding and the conviction in a manager that’s been identified, to ensure that there’s continued alignment with the client’s needs and expectations. And some of the things advisors can do is review the manager’s decisions, the resulting outcomes and, of course, benchmark comparisons are also a healthy check point.  

So, why is this important?  

The context for which the manager was selected is important because the philosophy the manager employs will be a significant determinant of the overall outcome, regardless of any specific decisions a manager may make at the individual stock level. So, for example, if a U.S. growth manager is beating the S&P 500 index over the past 10 years, those results are likely heavily influenced by the strategy itself of being growth leaning, regardless of how astute of a stock picker the manager is. And all active managers do have a preset philosophy in which they adhere to, in order to try and beat the benchmark or to try to deliver an outcome. Some might focus on buying stocks that are faster growing, such as the aforementioned growth manager, while others might focus on stocks that are just simply cheaper than the rest of the market, where the manager believes that there’s hidden value to be unlocked.  

And then there’s another group of managers who focus on quality, through an emphasis on characteristics such as higher returns on invested capital, or objective or qualitative assessments of business models that are harder to penetrate and break down.  

Additionally, there are strategies that are designed to meet specific client needs, such as a desire to have a portfolio that has lower volatility, but still participating on the upside over the long term.  

So, these preferences are very distinct and different from trying to beat the benchmark. Yet, all of these strategies and their variants have very specific uses and applications in a client portfolio. So, establishing those needs and objectives will help improve the chances of identifying a manager that consistently meets the client’s needs. 

Manager selection isn’t a set and forget exercise. Monitoring is a big part of that selection process. And monitoring coupled with the initial selection is what takes these actions and turns them into an investment process. Effective monitoring requires establishing a structure and having the discipline to execute on that structure.  

So, there are many facets to this, so I’ll only go through a few. But at the top level, watching for stability at a manager’s organization and their team is paramount to the probability of them delivering on the purpose and objective of the strategy. Of course, firms and teams are living and breathing entities, and change does happen over time. But here we’re focusing more on negative headlines or unusual and sudden departures of key staff, or negative business momentum. These are certainly potential red flags.  

But change isn’t always negative, in fact change to improve resourcing and investment decisions are all healthy and welcomed as part of the process to inform and improve outcomes.  

On the investment side of things, reviewing the consistency of holdings and the stated understanding of the philosophy and objective, assessing a manager’s buy and sell decisions, and assessing the timing and rationale for those decisions are all informative to help infer and confirm a manager’s skill level.  

Another but more time-consuming layer is staying on top of relevant market news, reading a manager’s regular commentary or insight pieces if available, and having active and timely interactions with the manager to discuss their decisions and views are also an important part of making an overall assessment and monitoring.  

So, through these actions, and using an objective decision process, we can assess if a manager’s results and the risks that have been taken are consistent with their investment philosophy, and the intended purpose of that strategy.  

So, what happens if expectations aren’t being met?  

Any observed inconsistencies or prolonged underperformance that is misaligned with the purpose and objective could warrant placing a manager under review, and if those anomalies and concerns are not satisfactorily addressed through further inquiry and improvements are not observed, it might be time to consider moving on from the manager and strategy.  

Our proprietary selection and oversight framework are reflected in an overall rating for a manager and strategy that is based on the application of a set of best practices rooted in a few key areas. I discussed organizational and team stability earlier, but it’s more than just observing stability. It’s trying to understand and identify the attributes that enable an organization and team to remain stable. So, here, testing for a manager’s culture, their drive for performance excellence, the degree of collaboration across the team, and investment accountability are all inputs that we believe foster stability. As I said, some change is healthy in order to combat complacency, but chronic and large-scale changes are a distraction at best.  

We also look for a robustness of the investment process and the consistency in its application. This encompasses areas such as maintaining a wide breadth of great investment ideas, and conducting high-quality fundamental research that is differentiated and informed with diverse viewpoints. What we found is successful managers often operate in a stable environment. But they also wrap it all together in a framework to make decisions and refine those decisions, as well as objectively reflecting on any missteps they may have made.  

We’ve also seen that successful managers have a healthy mix of weighting their bias conviction ideas appropriately, while managing behavioural biases and being mindful of the risks that they are taking, whether they’re intended or unintended. 

Manager selection should start first with identifying a purpose or client need, and I’ll caveat that I’m not a tax expert, so I’m speaking in generalities. But let’s use an example of a client who has daily living needs to be funded from their investment portfolio. For this client, a dividend yield strategy that is structured and deliberate about delivering a minimum level of dividend income could be more suitable than one that is focused on total return or capital appreciation as a primary investment objective. Because of the client’s needs for that dependable cash flow, a strategy that seeks to simply beat the broad market cap-weighted index would be pretty misaligned.  

So, having this purpose and client need appropriately scoped, it leads to a more fruitful and balanced discussion with the client during periods of underperformance. During these periods, it’s important to review objective historical data, and glean insights through potential meetings with the manager, if that’s available, or by reviewing what their latest comments and thoughts are. This analysis would allow advisors and their clients to form the most objective view of whether the manager or strategy are doing the job that they were identified and selected for and ultimately whether they are on purpose with meeting client needs.  

In the end, this informed understanding will help advisors and their clients reconfirm their conviction in the manager and avoid any knee-jerk reaction to terminate. We’ve seen that knee-jerk terminations can take the focus off client needs and, more broadly, negatively affect compounding returns and wealth creation.