The following excerpt is from Gregory Curtis' latest book, "Family Capital: Working with Wealthy Families to Manage Their Money Across Generations" (Wiley).
Many investors are more fascinated with money managers than is appropriate given the limited -- and likely negative -- impact of managers on their portfolios.
One way for advisers to mitigate this issue is to underplay the manager selection process.
Although some advisers like to encourage their clients to have input into the manager selection process, that blurs the ultimate responsibility for how the managers perform, allowing the adviser to duck culpability.
This is wrong in two ways.
First, it assumes that the client actually knows something about manager selection, which is unlikely. Second, it allows the advisor to transfer some of the responsibility for poor manager performance to the client.
WALKING A FINE LINE
Advisers need to use managers who they are willing to stand behind, but just because a manager is good in an absolute sense doesn’t mean that every client is going to be happy with the choice. If there is a good reason why a client is uncomfortable with a particular manager, that firm has no place in the portfolio.
And what about managers the client brings up?
Unfortunately, an adviser needs to take a look at client-recommended managers even though it is time-consuming and expensive. In most cases, the defects in the manager will become quickly apparent, but in some cases an adviser might find that he or she has stumbled onto a very interesting manager.
THINK DAMAGE CONTROL
At the end of the day, manager selection is all about damage control.
Randomly selected managers will detract a great deal from a client’s returns. But even very carefully selected managers are unlikely to add much to the returns.
All that work checking a manager out 12 ways from Sunday won’t ensure that the manager will outperform, but it should go a long way toward ensuring that the choice won’t sink the ship.
Here is an example of how difficult manager selection is: There is a very high-quality, hardworking fund of funds manager on the West Coast who has been in business for more than two decades. A few years ago, looking back over the first 20 years of the fund -- which, by the way, had produced excellent performance -- the manager decided to look at how many of the hedge funds he had picked had worked out and how many hadn’t.
Over those 20 years, the fund had been invested with 51 managers; 26 worked out and 25 were terminated for cause.
'PRETTY MUCH CHANCE'
That is pretty much chance.
Granted, even the hedge funds that were terminated for cause were head-and-shoulders above the run-of-the-mill hedge fund.
I only bring up this experience because it shows, first, that manager selection is very hard work.
And it shows, second, that portfolios can perform quite well in spite of the fact that a lot of the managers will disappoint.
This story is part of a 30-30 series on ways to build a better portfolio. It was originally published on April 5.