The tough questions to ask fund managers

This essay appeared in Citywire Selector on August 6, 2009.

I have interviewed more than a thousand investment managers in my career as an analyst. I can still remember the excited nervousness of the first – well, to be honest, the first 50 of these encounters.

Readers who have sat across the table from a manager with the task of assessing whether or not he or she has the acumen, character and talent to be the steward of investors’ money will know the feeling. It takes a while to feel at ease, and a while longer to be confident enough to ask the tough questions that matter.

The world is full of mediocrity and the asset management industry is a great place to observe this. The vast majority of managers fall deep in the belly of the bell curve. Nonetheless, with the help of a good marketing team, nearly every manager I have ever interacted with, from those I would consider best in class to those in the downright bad category, all have enough polish to present a convincing story to the man on the street.

Inexperienced or less talented research analysts and investment professionals who dabble in manager selection are particularly susceptible. They often have just enough perspective to provide conviction in their views about a given manager, but not enough to have an adequate level of scepticism to be effectively discerning.

Beyond all the data and detail that gets thoroughly checked during the due diligence and research process, there are a handful of less tangible attributes that must be assessed. In fact, these are the attributes that often separate the exceptional from the mediocre.

Judging the acumen, character, talent and other such very human attributes is both one of the most interesting parts of the job and the most intellectually difficult.

Of the hundreds of questions a research analyst might ask a manager, ‘What do you see that others do not?’ is one of the most thought provoking and pertinent. It reaches down to the very core of what active portfolio management holds as true – ‘Since you as a manager assume that the market is inefficient, where is that inefficiency and how are you taking advantage of it in your fund?’ A manager who is unable to answer that question should find it hard to justify his or her salary. But fund analysts are also well advised to ask hard questions of themselves and to seek out what others have missed, both in terms of new opportunities and to avoid pitfalls.

When your peers are all heading in the same direction, caught up in the latest trend or chasing after a ‘hot’ manager, questions like, ‘What can I see that others don’t?’ can provide some grounding, new insights and a way of keeping yourself in check.

Scepticism is a key characteristic of a successful analyst. Asking yourself tough questions now might just keep you from answering tougher questions later on from clients and your boss.