PAM Guide to Wealth Management

Changing private asset managers

Under-performance should not be the only cause of concern. Significant out-performance may also be a sign that the original risk parameters have been breached. It is important to be able to identify where a portfolio return is deviating from that of its benchmark and whether this is a result of individual stock selection, or because the asset allocation has changed so the portfolio no longer reflects its benchmark.

If there is short-term under-performance, you need to understand why this has happened. If the manager has stuck to the agreed mandate, then there may be a strong argument in favour of retaining the manager. But you still need to understand why there has been short-term under-performance. Is it solely because market conditions have worked against the manager's investment process? If so, then you should consider persevering with the manager. If it is because the manager has made mistakes in stock selection or asset allocation, you may want to remain invested for longer than the short term. For example, if you chose the manager because you agreed with his investment approach and he had a strong track record, you may want to allow him at least a few months longer, if not a year, to improve performance, dependent on your time horizon.

Be aware that private asset managers can change their personal and corporate approach over time and this should be raised as one of the items to be discussed at review meetings. Always be prepared to ask yourself whether the manager is the best one for you going forward.

But even if a private asset manager has consistently retained the same philosophy and process, continued under-performance has to be monitored and eventually some action will have to be taken.

Where you should have more concern is if the manager has delivered under-performance, while changing his investment process, or has taken on more risk than was agreed. In this case, you need to discover why the manager has made these changes and this may lead to you replacing him.

Among the factors that should be considered when reviewing the style consistency of a manager is the type of stocks he is holding in his portfolio. For example, is he moving from growth to value stocks, is he increasing his exposure to small cap stocks, is his exposure different from the index to a greater extent than in the past, has the turnover of stocks become higher, has the quality of companies being bought changed and are the weightings to a few sectors becoming a greater proportion of the total?

It is important to say at this point that you may not want every manager to stick rigidly to his investment style. Some managers excel by having the ability to change sectors, style and cap size according to the market conditions. In such cases, you may decide to allow these managers to go where they believe they will obtain maximum returns. Of course, if they get their calls wrong, they may significantly under-perform and you may lose money.

Another point to consider is that in constructing a portfolio, it is advisable to select managers whose investment approaches complement each other. Therefore, you may want to include one or two managers who try to anticipate changes in style and market conditions to attempt to enhance returns.

Changing a private asset manager usually comes about through a two-stage process. After a specified period of under-performance, a manager can be placed under review. The amount of time for which under-performance is tolerated before a manager is placed under review will probably vary. It may depend on how aggressive the manager's approach is, what proportion of your portfolio is allocated to the manager, whether his investment process lends itself to periods of under-performance, whether he is managing significantly more money than when he established his track record and how long the track record is.

When a private asset manager is placed under review, the monitoring process should become more frequent and comprehensive. Ideally, there should be communication with the manager to understand why he feels he has under-performed. Another useful action is to analyse changes in the portfolio's holdings, as well as to evaluate the historical stock selection. This is designed to confirm whether the manager has remained true to his investment process and level of risk in his mandate.

If the manager produces a satisfactory explanation for his performance, is sticking with his investment process and is not taking excessive risk, then you should probably remain invested, but keep the manager under review. If the under-performance continues, however, for another three months or a period you decide, then it is advisable to place him on your watch list. Of course, if you are not happy with the response or the analysis shows style drift, you may want to place the manager immediately on your watch list.

Continued under-performance will require you to replace the private asset manager. You and your wealth adviser may want to have other managers on a reserve list to replace any within your portfolio when they under-perform. In deciding whether to replace a manager, you need to consider whether his performance is likely to improve in the future. This largely depends, of course, on what has led to the under-performance in the first place. In the case of a fund manager, if the manager is under-performing because his fund has grown significantly in size, for example, then performance may not improve in the immediate future. If the manager has changed his investment style, there may not be any improvement either. Trading in and out of managers is best avoided if possible, however, because of the cost of doing so and the potential capital gains tax liabilities in the UK.

There are other reasons why you may consider changing managers. These include if the fund manager leaves the asset manager and thus gives up management of the assets. This may not lead to an immediate change. That will depend on which manager takes over the fund, whether the investment process will change and whether the new manager will take a greater degree of risk.

Another concern is when one asset manager acquires another. This raises questions over whether the fund managers will feel comfortable in their new environment, will they be able to pursue the same investment approach with similar freedom, will a list of stocks be imposed on them, will their mandate be changed, will they have the same level of resources as before and could the size of their fund grow substantially and thus affect performance.

Another reason for a fund manager to be changed within a portfolio is if there is an alteration in your asset allocation. If you decide to reduce your allocation to US equities, for example, then you will either want to cut exposure to US funds within your portfolio or sell out of some funds completely.

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