After presenting at a conference last month, a sceptical audience member asked me: “When you retire, would you invest your money with a fund manager?” He expected me to say “no”, but I surprised him by saying: “Sure, I would happily allocate a portion of my funds to a great fund manager.”
Naturally this led to a follow up question: How do you decide who is a ‘great fund manager’?
Wholesale and retail investors alike have to grapple with this thorny question at some stage, so – as an investment professional who has spent almost two decades managing other people’s money – I thought it might be useful to provide a fund manager’s perspective.
In my experience, virtually all fund managers today have driven, ethical and smart people working for them. That’s almost a given – and in the unlikely event that your fund manager lacks any one of these qualities, you should replace them instantly.
The tricky bit however is how to choose between fund managers, when they all have driven, ethical and smart people working for them.
For me, there are three big questions that all investors should ask about a fund manager before they commit their hard earned cash into their custody:
- Does the fund manager cultivate a culture of ego or humility, team work or silos?
- Has the fund manager developed a rigorous approach to risk management? and
- Does the fund manager, without prompting, propose a business model that closely aligns their own interests with those of their investors?
Note, I say that these questions should be asked about the fund manager and not just asked to the fund manager. In other words, you need to observe, research and reach your own conclusions about the manager and not just accept the manager’s responses at face value.
1. Corporate Culture and Team Ethic
I heard a presenter say recently that corporate culture was a myth and that leaders who talked about managing a team culture were hallucinating. I couldn’t disagree more. Not only is corporate culture very real, it’s a highly reliable predictor of long term organisational performance.
One of my favourite business authors, Patrick Lencioni, puts it this way:
“If you could get all the people in an organisation rowing in the same direction, you can dominate any industry, in any market, against any competition, at any time.”
Patrick’s book, The Five Dysfunctions Of A Team, is in fact mandatory reading at EG for anyone looking to join our firm. I call it our “cultural bible” and, if you haven’t yet read it, it’s well worth the effort.
Corporate culture is the repository of an organisation’s unspoken rules: all the way from sharing information freely with other team members, to feeling safe to own up to mistakes, to feeling empowered to debate the CEO on a major investment decision. It matters immensely because:
- without a culture that actively fosters goodwill among team members, rivalries and factions ultimately lead to silos that inhibit the free flow of information – and information is the lifeblood of good decision making;
- without a culture that cultivates trust, team members are afraid to challenge and debate each other’s views when big investment decisions are being made – and debate is the heartbeat of good decision making;
- without a culture that promotes accountability and growth at the workplace, staff turnover will be high and this results in regular loss of corporate memory (experience) – and corporate memory is the oxygen of good decision making.
A team of smart, driven people who feel comfortable to debate each other will, over time, make better decisions than any single team member on their own. And yet too often, the biggest egos in the room hog the stage and squash debate.
CEOs, whether by choice or not, are the single most important influence on corporate culture. One of the key responsibilities of any corporate leader is to serve as a guardian of team culture – and, to borrow Churchill’s immortal words: the price of great corporate culture is eternal vigilance.
In my view, you cannot overstate the importance of corporate culture to long term organisational performance and I will have a lot more to say about this in my blogs in the weeks and months ahead.
2. Risk Management Process
The next key thing I look for when selecting a fund manager is the rigour of their process when it comes to identifying, measuring and pricing risk. After all, the main reason we decide to hire a fund manager in the first place is because they presumably have specialist expertise in dealing with certain types of risk.
The old adage in property applies to all risky investments: “you make your money in the buying”. So it is critically important that the fund manager has very well developed and well enforced routines to ensure: (1) cycle risk is consciously measured and factored into all key decisions; and (2) all the key risks associated with generating the base case returns are systematically identified and priced.
I’ve been hugely influenced by a book written by a US doctor (Atul Gawande) in 2009 called The Checklist Manifesto. The author was initially pilloried when he dared to suggest that surgeons could radically reduce post-operative infections and deaths if they adhered rigorously to a simple checklist of pre-operative and post-operative procedures. If checklists were good enough for pilots on take-off and landing he argued, then perhaps they were good enough for doctors too. After a trial in eight hospitals in eight different countries, simple checklists produced a remarkable 49% reduction in post-operative infections and a 47% reduction in post-operative deaths. Truly astonishing results – and surprise surprise – checklists have since been rolled out to a hospital near you.
What Atul Gawande’s book makes clear is: “Checklists seem able to defend anyone, even the experienced, against failure in many more tasks than we realised … And yet it somehow feels beneath us to use a checklist, an embarrassment. It runs counter to deeply held beliefs about how the truly great among us handle situations of high stakes and complexity. The truly great are daring. They improvise. They do not have protocols and checklists. Maybe our idea of heroism needs updating”. This applies to all smart people making important decisions: pilots, doctors and fund managers. Doctors operate on your body and fund managers operate on your life savings – both need to take extreme care when making decisions.
To be sure, all fund managers make mistakes – the difference is that great fund managers humbly catalogue the anatomy of their mistakes and promptly codify the lessons into their risk management process. In other words, they maintain and follow checklists.
And here’s a tip worth noting: if you want to find out whether a fund manager is only paying lip service to risk management (rather than routinely practising it), ask them when was the last time they changed it or adapted it. If a risk management system isn’t being continually tweaked, you can be sure that it is not being routinely used. A system that is actively being used by the fund manager is organic and continually evolving;
A static checklist is nothing more than marketing propaganda and should be treated with suspicion.
At EG, we take risk management so seriously that we’ve spent enormous amounts of time and money developing our own risk management software (PRISMSTM). We don’t allow any deals to be done unless a PRISMSTM assessment has been completed – and I’ll have a lot more to say about the essential elements of a risk management system in my future blogs.