Will your investment manager fail?
01 October 2007 | Investments | General | Investment Solutions
The investment-management industry has in recent times experienced tremendous growth, says Imtiaz Ahmed, chief investment officer at Investment Solutions."With the run of the equity market, South Africa has seen the launch of more than 24 start-up investment managers during the past three years. "To make things even more intricate, there has been a 90% increase in specialist equity institutional offerings and a 28% increase in equity unit trusts," says Ahmed.
This is to be expected, he says, as any market that has such a phenomenal growth phase will see a rise in products and service providers, and the investment-management industry is no exception.
"But this also begs the question: What happens if the markets go bust and these managers close down shop? The short answer is investors stand the chance of losing their investments, so they should do a lot of homework before handing over their money to any investment manager," says Ahmed.
He places strong value on research and says the primary driver of investment returns and financial security is research but, more importantly, acting on that research -- analysing the past, present and future scenarios.
Investment Solutions monitors over 600 investment professionals working at the 64 investment management companies and undertakes more than 260 investment-manager visits each year.
"This is important, as we need to know how these companies manage investments, the efficiency of their back offices and their checks and balances if we want to invest our clients' money with them. Assessing investment expertise during our due-diligence process is only one aspect; we are focusing increasingly on business sustainability, internal compliance and administration." says Ahmed.
Investors, he says, need to know who is managing their money and the levels of expertise. "At the average investment manager, 74% of the staff joined in the last three years and 51% in the last five years. On average, 80 to a 100 staff change jobs every year. So the team that managed your money last year may be drastically different from the team currently managing it, and have a drastically different skills set."
Ahmed says investors also need to know where they are in the manager cycle and if their manager will survive if the style cycle turns against it. In a boom cycle, investors tend to have a stronger appetite for risk and investment managers tend to achieve high alpha (outperformance of the benchmark) levels. During this time, many new investment managers appear.
"Then market volatility strikes, pressure builds and investors start to get nervous. Often, a market bust is followed by a negative market shake out. It is during this time that the less profitable investment managers close shop and the market consolidates. After a bust period, the markets begin to recover and the process starts over".
Ahmed says investors should also be aware of the business risks their investment manager faces. Is it exposed to overly high risks or does it have a balanced mix of high, medium and low risk exposures? In time of market busts, these exposures can cause havoc with investment managers that did not hedge themselves and their clients with balanced risk exposure.
"It is also important to know which stockbrokers investment managers use and the fees they pay these brokerages. This can have a huge effect on investment returns as broker fees can range from 0.17% to 0.22% on a single transaction and twice the charge when investment managers switch from one share to another".
This is a lot of information to dissect and to constantly update. The myriad choices and overwhelming number of variables make it a mammoth task for the individual investor. "Ironically for multi-managers, wider choice translates to better value for their clients as they are able to build a greater variety of products, provided their research processes are in place", says Ahmed.
He uses the example of the equity portfolio universe. "We start with a universe of 64 investment managers offering over 100 portfolios, do the research and the investment-manager visits, score each manager and its proficiencies and end up with a range of equity portfolios with less then five underlying managers that we will invest in. These portfolios are regularly revisited and investment managers removed and replaced if necessary.
"We do, however, take a longer-term view when allocating assets to managers and remove an investment manager from a portfolio primarily as a result of a change in process or key people.
"Occasionally, a manager is removed if its portfolio no longer enhances the characteristics of our portfolio. The value proposition of multi-management is in building diversified portfolios to reduce the risk of investing but still deliver top-quartile investment returns over the medium to longer term," says Ahmed.
