Technology offers an assist with identifying elite asset managers

By C.J. Marwitz

Much has been written about Canadian pension funds moving toward in-house asset management. But despite such benefits as cost savings, as well as control over governance with in-house asset management, it’s not an easy task for pensions to make the switch. Finding expertise will become particularly challenging in the Canadian pension universe, where funds utilize investment strategies that include a multitude of diverse assets, according to a CIBCMellon paper, “In Search of New Value.” And pension managers are concerned: The report notes that nearly three quarters of pension managers “regard in-house expertise as one of the top three issues they have to confront in any shift to in-house asset management.”

In addition, pension systems and asset managers have not been immune from the effects of the so-called Great Resignation. Coupled with the baby boomer generation aging into retirement, it means recruiting and retaining investment professionals is more critical than ever. But identifying that talent isn’t as simple as it seems.

The work of many skillful investment professionals has helped Canadian pensions excel over the years, but even success can be dampened by outside factors. The first quarter of 2022 saw the median Canadian pension plan returning -6.4% for the quarter, according to the latest Northern Trust Canada Universe report. That’s due to increasing uncertainty in the markets, caused by Russia’s invasion of Ukraine, disruptions of supply chains due to pandemic lockdowns in China, as well as concerns over inflation, Northern Trust says.

Such events, of course, are no fault of investment professionals. But where there’s uncertainty, one way of dealing with it is to ask more of staff and professionals. “Across the spectrum of pension investment stakeholders,” notes the CIBCMellon report, “perhaps the most dependable constant will be rising expectations – for performance, efficiency, outcomes, compliance, timeliness, risk mitigation and a multitude of other factors.”

All this adds to the pressure on asset managers, whether in-house or out-sourced, to achieve the highest possible returns. That makes for increased scrutiny of investment skills.

A recent study from research and analysis firm Inalytics of portfolios managed for pensions and institutional investors identifies four components of investment skills, and one in particular that drove positive alpha in over three quarters of portfolios.

Inalytics has gathered data over a number of years, studying the behavior and decision-making of asset managers. Founder and CEO Rick Di Mascio sees several specific skills that set the most successful asset managers apart. Di Mascio, who previously was CIO of British Coal Pension Fund and a portfolio manager at Goldman Sachs Asset Management and Olympus Capital, participated in the following Q&A, which has been edited for brevity.

What constitutes investment skill? Could you talk about the four criteria for success that you’ve identified with elite asset managers?

Rick Di Mascio: The elite in any walk of life, whether it’s fund management or sport, are elite because of how they win, not because they win.  Winning is merely an outcome which can sometimes be achieved simply by being lucky.  It’s the ‘how’ that delivers repeatable results with a higher expectation of success.  Our data, experience and research show us that the elite exhibit the following characteristics:

1. Research process: A process to investigate investment opportunities and add the highest quality ideas to the portfolio.

2. Sizing: Allocate capital to the positions that generate the most alpha so that the portfolio efficiently captures the alpha being generated by the research process.

3. Rebalancing: Minimize the loss of alpha from poor selling decisions.

4. Investment horizon: Identify the long term positions that are ‘past their sell-by dates’ and sell them before they start to generate losses.

Which is the most important of the four skills?

Unquestionably research. This latest study demonstrates that 88 percent of outperforming managers have demonstrable research skills.

You have compiled a database of institutional investment transactions over many years. What trends or changes have you seen in asset managers’ investment skills?

We have been amassing this dataset set for nearly two decades. One change that has occurred over this period is in how the portfolios are constructed. Going back before the financial crisis, portfolios had typically well over 100 stocks, usually around 140 or 160, and were put together by a ‘top-down’ process of determining the best sectors or regions and selecting the best stocks in each.  This led inevitably to concerns around closet indexing and a lack of focus.

Moving on some 15 years or so, when we work on searches for equity managers we see that the portfolios are now completely different, with the average number of positions being less than 40, and in some cases, as low as 25 or even less. This shift makes complete sense, because if a manager has demonstrable research skills then they ought to be applied in a focused and disciplined way that is to the benefit of their clients.

Is there a better way for asset owners to recruit and manage asset managers?

As 88 percent of successful managers have demonstrable research skills, having a process that focuses on establishing whether a potential manager has a repeatable research process that introduces winning ideas to the portfolio is vital, and to have an ongoing process in place to monitor whether any changes are occurring in this process. Given how crucial the research process is to the generation of alpha, asset allocators need to use data science in the selection process to understand the how and why it adds value.

Based on what you’ve seen and learned, what words of advice can asset managers take to heart?

To use the phrase, “show [them] the money” with evidence that you do what you say and that it’s the source of the alpha.  After all, if you pick up a bottle of ketchup and read the label it tells you what’s in it, why shouldn’t fund management be the same?

C.J. Marwitz is a retirement industry editor at ALM.