Traditionally, investment portfolios managed on a discretionary basis by investment managers were the most common assets held in trust.
Even today, with the rise of multi-jurisdictional trust companies whose assets under administration are perhaps more varied than the smaller local firms, investment portfolios are key assets. By delegating the management of these portfolios to experts, trustees can expect to preserve and enhance the value of the underlying portfolios.
Given the number and variety of investment managers in the Channel Islands and the UK alone, selecting the most suitable manager for each individual client presents trustees with a unique challenge that, if not managed properly, could place the trustee in breach of trust.
The evolution of investment manager selection
Driven by the participation of private equity investment in the industry, trust companies have become more professional and the selection of investment managers has followed suit. Instead of individual trust company directors selecting investment managers (in their capacity as trustees) on an ad hoc basis, the selection is now delegated either to investment consultants, an in-house gatekeeper or an investment committee made up of experienced, investment-qualifi ed trustees.
The Holy Grail
In each case, the ‘Holy Grail’ is to create a preferred manager list (PML) which identifi es core investment managers, each of whom should be suitable for the vast majority of portfolios. This allows the investment committee to deal with only 20 managers who they know very well, rather than 60 managers they know only quite well. It also means that when investment managers come to see the committee, the meeting is worthwhile and spent discussing specifi c portfolios, instead of ending up as nothing more than an expensive catch-up.
Perfecting your preferred manager list
Ascertaining which managers should form part of a PML requires time, effort and above all understanding. A good place to start is by dividing the list into different strategies so you have sub-lists – cautious, balanced, steady growth and equity risk – with fi ve managers in each.
It would be a mistake to simply fi ll these lists with the five best performers. Particularly in these volatile markets, it is unlikely that a top quartile manager will consistently perform in the top quartile over the long term. If performance is the sole reason for selection, when performance dips, as it inevitably will, the client will be disappointed. It is therefore imperative that other more qualitative aspects are taken into account, such as key man risk, investment process issues and, of course, fees. These aspects, taken together with investment performance, should give the investment committee a greater understanding of each manager and their investment philosophy. It should also justify (or not) their inclusion in the PML.
Match-making is key
The overriding aim of the PML is to ensure that each portfolio has the most suitable investment manager advising it. Some clients like their portfolio to mirror the FTSE 100. If this index increases 10% these clients would expect their portfolio to increase by a similar amount – they would be disappointed if their portfolio increased only 5%. But equally, they cannot complain if the index falls 10% and their portfolio falls by a similar amount. Investment managers who manage these types of portfolios are called ‘benchmark aware’ managers, but they do not suit all investors. For some, should the FTSE 100 be down 10% at year-end, they would be dismayed if their portfolio fell by 5%, let alone kept in line with the index’s fall.
Ensuring that the investment manager is well-suited to a particular client relies on two aspects. Having the optimum number of managers in the PML who can cover the broadest spectrum of investment philosophies and approaches. This requires having access to due diligence on different managers as well as meeting them on an ongoing basis.
And knowing the client, their risk appetite and their investment objectives. Should the client’s circumstances change, it is an indication that the selection of the investment managers should be revisited.
Embrace due diligence
All clients should be risk profi led. In conjunction with an investment policy statement, this provides broad guidelines to investment managers and notes any restrictions they should be aware of. These guidelines should in no way fetter the discretion of the investment managers – they are designed to help and assist them.
If the expectations of the client are misaligned with those of the investment manager, sooner or later the client will be disappointed and will seek to change manager. By undertaking both quantitative and qualitative due diligence on a number of managers and formulating a PML that is as broad as possible, kept up-to-date and amended when necessary, the investment committee should be able to select the most suitable investment manager for each client, justify that selection and avoid frustration at a later stage.
Source: Gold News