Don’t look for the hottest manager

Published Oct 3, 2015

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Your financial adviser can do a lot for your financial well-being, but not if he or she is trying to identify the next hottest fund manager, the woman who introduced multi-management to South Africa 20 years ago, says.

Anne Cabot-Alletzhauser says an adviser offering to pick the best manager is like a multi-vitamin salesperson trying to convince you that multi-vitamins are the source of your physical well-being.

Cabot-Alletzhauser founded South Africa’s first multi-manager, Time Life, which later become mCubed and finally Momentum Multimanagers. Multi-managers blend investment managers and strategies to meet investors’ goals.

Cabot-Alletzhauser is now the head of the Alexander Forbes Research Institute and addressed the Financial Planning Institute’s recent Retirement and Investment Conference.

Good health is not about taking a little vitamin pill, but about diet, exercise, stress management and many other factors, she says.

In the same way, your financial health is less about identifying top-performing asset managers and more about having a holistic view of your finances and how you manage the financial trade-offs during your life as you grow and protect your wealth, Cabot-Alletzhauser says.

Financial advisers ignore research that highlights why it is impossible to identify in advance which managers will outperform in the future, she says.

This is not because managers are not talented, but because there are so many factors that stand between talented managers and their ability to translate their good insights into good performance, Cabot-Alletzhauser says. These factors include the structure of the market, mandate constraints on a portfolio and the fact that so many drivers of market returns are beyond a manager’s control, she says.

Top performance wasn’t always the big focus that it is today.

Cabot-Alletzhauser says that when she entered the investment industry at the end of the 1970s, the main focus of investing was on making sure wealthy investors had enough to live on.

But late in the 1970s mutual funds (unit trust funds) made it possible for ordinary people to invest, but they had no access to financial advisers and no idea how to pick a manager.

Past performance quickly became the key way in which people decided which manager to invest with, and this was “a travesty”, she says.

Cabot-Alletzhauser says research has shown that share-specific information drives only 30 percent of a share’s performance. The other 70 percent is driven by risk factors, such as the exposure to value, small-cap, or momentum shares (30 percent), and market sentiment (40 percent).

Managers who manage unit trusts regulated by the Collective Investments Schemes Control Act and that invest in line with the prudential investment guidelines under the Pension Funds Act have even less ability to influence the returns you can earn – only about 10 percent of the return, Cabot-Alletzhauser says.

When investors combine funds from different managers in a portfolio, each manager’s influence over the performance of that portfolio dwindles to about two percent, she says.

Cabot-Alletzhauser says when the market is driven by only a few shares, it is mathematically impossible for a portfolio to outperform, unless you hold a very high concentration of, for example, resources shares. But a fund manager may be prevented from having this high concentration by the fund’s mandate.

Many financial advisers advocate combining asset managers to give you diversification that protects you from poor performance by a single manager.

But unless the combination of managers is designed to be more robust, it can be a “random walk”, Cabot-Alletzhauser says.

If you choose two managers who earn returns from exposure to the same investment risks (risks that have the potential to deliver returns), you just double your bets and compound the effects of market ups and downs on that risk, she says.

When it comes to determining whether or not a manager has skill, head of global financial strategies at Credit Suisse, Michael Mauboussin, says it is useful to consider where on a continuum from luck to skill you would place various activities.

Gambling would be at the one extreme of this continuum, attributable entirely to luck, while a marathon runner would be at the other end, with his or her achievements attributable almost entirely to skill.

To determine where asset managers lie on the continuum, Cabot-Alletzhauser says you have to ask:

* Can one intentionally lose? A marathon runner could, but you could not intentionally lose at, for example, roulette. An asset manager could also not lose intentionally because there would always be some value to the investments held.

* Does practice improve outcomes? In marathon running it does, but not in gambling, or in asset management. It sometimes appears that experienced managers perform better, but their performance can also suddenly be poor.

* Do the outcomes tend to revert to the mean? If they do, as is the case with asset management, the luck element is high.

* Is there evidence of transitivity? This means that if A can beat B and B can beat C, then A should be able to beat C, but that doesn’t always happen in asset management, indicating that luck plays a part.

* Between a manager’s best idea and the ability to execute it, how many factors are out of their control? For example, whether there is a crisis somewhere in the world, or the market goes up or down.

Cabot-Alletzhauser says current thinking in asset management is that, rather than trying to pick a top-performing manager, investors should identify a goal they need to reach over time and find a manager that has the appropriate strategy to meet that goal.

However, in order to achieve goals-based investing, you have to understand how much risk can be taken, what you can spend on it, how you should take it and what return it will deliver, she says.

Financial advisers and retirement fund consultants should concern themselves with helping you to meet your goals, Cabot-Alletzhauser says.

However, the truth is that many people are not achieving their goals, including saving for an adequate pension in retirement. They are retiring on pensions that replace only 30 percent of their pre-retirement income. This, she says, is despite the fact that asset managers managing the assets of South African pension funds have been achieving real (after-inflation) returns of 10 percent a year over the past 15 years.

There are many reasons for this, ranging from the contributions made, the costs, the investment returns, the retirement age, the lack of preservation of savings when people change jobs, and adverse events in people’s lives.

This is where financial advisers can add much more value than they can by picking “the right” investment manager.

On our journey through life, our income is like a suitcase into which we can only fit a few things, Cabot-Alletzhauser says.

We cannot carry all that we need by way of the financial protection in the form of life cover, disability cover, short-term insurance, medical scheme cover and so on, as well as the savings to accumulate wealth. Advisers should help you decide what to put in your financial suitcase and what you should leave out, she says.

They should also help you when you have a financial crisis or go into debt, Cabot-Alletzhauser says.

Some advisers give advice only on investment, but what is actually required is for advisers to assist you with all your financial decision-making to improve your financial well-being, she says.

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