Why are some asset managers better than others?

Geoff Blount, CEO of Cannon Asset Managers, shares his observations of what makes a successful asset manager

Having been in the investment industry for a decade, and as previous Head of Manager Research at Investment Solutions, SA’s largest multi-manager, I have studied many investment managers and have observed several traits which typify the successful ones.

1. Consistent Philosophy and Process

A manager’s philosophy is just not a marketing blurb. It is the critical belief system that underpins everything a manager does and defines their “DNA”. The philosophy says that, based on my experience or academic research or empirical observations or a combination of all of these, I believe that if I buy shares or build a portfolio with these attributes, it will outperform over time. A sound philosophy should not change over time. The investment process is then designed to implement that belief system.

Amazingly, most managers in South Africa (and globally for that matter) spend a huge amount of time designing big and fancy processes, but fail dismally on the philosophy. That is like building a big fancy ship but with no anchor. Why are many managers so hard to differentiate – well they have vanilla, poorly-articulated belief systems at best, and none at worst. The philosophy is a key anchor for when a manager’s performance is tested. If is it good, they will remain convicted in what they do and not capitulate to the current investment fad when their approach is out of vogue.

Interestingly, if you look at the truly successful managers in the long term in SA, they have very clearly articulated, logical and intellectually-appealing philosophies and they never waiver from those.

The capitulation, or chasing of current fads, fashions or popular investment themes can only doom you to long-term mediocre performance. A great philosophy will lead to a consistent process from which the manager will never waiver. Clients know what they will always get from such a manager. However, with a manger with a weak or no philosophy will waiver over time, the client will get different things at different time.

2. Passionate People

You want your manager to eat, sleep and drink investing. It’s amazing how many “investment professionals” have no passion for what they do. It’s like backing an athlete who isn’t competitive. Look your manager in the eye and see how hungry he is. Managing portfolios is not a nine-to-five job. It is no good thinking that you can cease to think of investments outside of regular working hours. In a globalised environment, markets are operating around the clock and investment managers need to be constantly aware of new developments and trends.

Without a passion for the industry, a manager is unlikely to have the drive to be constantly informed. This may result in being reactive to market moves, rather than being proactive in anticipation of trends.

3. Owner Managed

As a rule, the managers that outperform in SA in the long term are owner managed. Owner managed business are good “asset managers”. Investment managers that have outside shareholders tend to be good “asset gatherers” i.e. they are good at creating profits for their shareholders.

Why the importance of this subtle difference from a client perspective? Well investment managers with outside shareholder have to meet external objectives like earnings growth for those shareholders. If their investment team does not, they will get fired. Hence, the business will do three things, firstly product proliferate (and defocus) to gather more assets to earn more revenue and secondly, manage their portfolios in a risk-controlled peer cognisant approach i.e. don’t be too far from the crowd as the client might fire you for being too different and take those revenue producing assets away and lastly, begin focussing on short term performance and rankings rather than taking truly long term bets that require patience to pay off.

An owner-managed business means the CIO (often the founder and owner) will not fire themselves if they go through a period of underperformance. It gives them the luxury of not compromising and changing the style and philosophy nor focussing on short term time frames, and they don’t product proliferate, i.e. they stay focussed.

Again it is no accident that owner-managed businesses in South Africa have been the long term outperformers. Cannon, Foord, Oasis and Allan Gray are examples of successful owner-managed asset managers.

The manager does not need to become fixated on short-term performance – so-called ‘quarter-itis’ – in order to appease shareholders. The manager is therefore free to invest in the best possible way, for long term results in line with the tenet of sound investment practice.

When the manager has no ownership of the company, there is a tendency to become an asset gatherer: to look for bulk. In the case of managers who have ownership of the company, the focus becomes one of asset management.

4. Sustainable and Profitable

The investment industry is littered with the remains of start-up managers which have opened with a flourish, only to close several years later. Many of these have been based on a single large client, or a very small number of large ones.

A diversified client base is far more desirable from a business point of view, as the loss of one client is less likely to disrupt the company. Ideally, one would look for a manager which has a host of clients from a range of industries.

5. Patient (deferred outperformance)

The wise investor has a long-term horizon and is not concerned with near-term performance. The whole business should be aligned with this thinking, in order to best serve the client’s needs. Both staff and shareholders need to share a similar focus to ensure that it is long term outperformance which is delivered.

Clients, for their part, need to buy into a manager’s investment process and philosophy without concentrating on performance as the sole means of assessing a manager. If the process and philosophy are sound and are followed with rigour and consistency, the performance inevitably follows.

6. Investment Team Remuneration Linked to Alpha

By linking the team’s remuneration to the alpha they generate, their interests are directly aligned with those of the client. While this does not guarantee top performance, it serves to manage unnecessary risk taking and the team will focus on its core responsibility.

7. Size

While some large managers are successful, size is a disadvantage. Take the example of a large South African asset manager which boasts that it has R100bn under management. That means that if they want to allocate 1% of their portfolio to a company, they have to buy R1bn in shares in that company. That means, for example, that they would have to buy 1/7 of Imperial. Clearly this really limits such a manager’s universe to the top 60 in SA in term of flexible stock picking.

That means larger managers have to be, sector and thematic rotators. Some can do this successfully but if you want a truly flexible stock picker, than you have to be smaller and more nimble.