How to strike a balance between art & science in selection

This essay appeared in Citywire Selector on September 8, 2016. 

 For part one, please click here.


The greatest threat to the future role of professional fund investors is not robots or regulators; it is information overload. There are tens of thousands of unique funds available for investment.

Each of those funds has thousands of points of information to be collected and analysed – both quantitative and qualitative. That’s a lot of information and, to complicate matters further, much of it is constantly changing.

The job of a fund investor is complex. Success – both in selecting a solid fund and avoiding an eventual downfall – depends upon the ability to capture and efficiently deal with information about managers in real time.

It is about separating important information from noise and reality from promotional fluff. Monitoring changes is important because the drivers of funds’ stability and potential alpha are constantly changing.

If a fund selector were a chemist, most of his/her time and focus would be on the part of the periodic table where instability reigns.

Art and science

With the rising complexity of fund investing, it is clear why the potential of automated fund selection processes have gained interest in recent years.

But between an analogue world in which fund investors must print out reams of fund information in the form of Word documents and the fantasy world of fully-automated robo-selectors devoid of human insight, there is a third way.

No robot has the ability to replicate the skills needed to do fund analysis and selection. As long as there are human fund managers, the industry needs highly trained and insightful professional fund investors with sufficient skill and experience to separate exceptional managers from the pack and protect the interests of end-clients assets.

Fund investing is a balance of science and art. Good fund selection ‘science’ is only possible through the rigorous collection and organisation of information about a fund’s investment process, personnel, risk management, portfolio positioning, etc.

It cannot be limited to publicly-available factsheets and pitch books – fund investors need to take a deep dive into the specifics. For detailed information to be useful, it must be complete, accurate and timely.

The science of the fund investing leads to strength in both initial analysis and the ongoing monitoring of funds. It is the structure and the systematic rigor with which a fund analyst performs due diligence.

The art of fund selection is driven by the careful exploration in the nuances of information – it is aggregating sources of information and reading ‘between the lines’.

It is about isolating the specifics about a manager and his/her investment process that will lead to alpha or the potential of a blow up. It is about judging the human elements of investing – gauging skill, insight and the nature of risk-taking.

Handling heavy lifting

Technology will not replace professional fund investors. Technology as a tool has the potential to expand the depth and thoughtfulness of how fund investors analyse and compare funds.

Foremost, this is through using technology more effectively for the low value-add ‘heavy lifting’ of collection and organising increasingly massive amounts of detailed and evolving information. It can make the process more efficient.

In many cases, the information used to make major decisions by fund investors is collected directly from asset management companies through proprietarily issued DDQs. While the information is vital, the process for fund investors is both time consuming and resource intensive. It has the potential to overload a fund investor.

As a key step to improving the process, well thought-out and universally-accepted standards for the format of due diligence information will make the work of professional fund investors more efficient and impactful.

The Association of Professional Fund Investors (APFI) is leading an effort to promote best practices in due diligence information gathering through DDQs (Due Diligence Questionnaires). APFI believes that fund investors will benefit from more timely and better quality information from asset managers.

The information that is common to the inquiries of 90% of investors through proprietary DDQs should be made available broadly to all professional fund investors in a common format regardless of size of assets under advisement or location.

Maintaining fund investors’ independence of thought and decision-making processes is inviolable. Bolstering the ‘science’ of fund investing through standards and smart technology will enable fund investors to make better decisions.