Investment Manager Selection – Winning the losers game

“When prospective new investment managers made presentations to the Fund, it was often proved that GraySwan had more knowledge of their history than the presenters. Consistent evaluation of investment managers was done and acted upon even when changes in teams dealing with our mandates were not reported by the relevant investment manager to the Fund. GraySwan ensured that Trustees were educated regarding investment terms and products as they created a database where Trustees could log into to broaden their knowledge.

I honestly believe that GraySwan has set a new necessary standard for investment consulting in South Africa. This has not only enabled our Fund to take informed decisions regarding investments, but also ensured that we remained in the top quartile since your appointment.”

Reference : GraySwan Retirement Fund Client > R15 billion in assets.

Investing is a world where every investment manager claims to be terrific and where they can typically back it up with some or other performance analytics. However, most investment managers actually underperform the market, making active management a losers’ game unless you have the skill to select superior investment managers and furthermore blend them in an optimal manner to provide superior risk adjusted returns.

We offer our clients a highly experienced and stable team, an established pedigree and a proven investment manager research and selection process. Our unique investment manager research and selection advisory offering centres around a deep understanding of the investment manager industry, which we have gained over the past two decades. We have gained our competitive edge not only from our wealth of investment consulting experience where we advised to most of the largest institutional investors in South Africa but also from our offshore investment management backgrounds. Clients require advice that is based not on a theoretical and academic basis but on proven investment management principles. Investment advisors that have institutional investment management backgrounds such as us have an advantage to meet more sophisticated client demands.

We spend our time and resources on detailed global investment manager research in order to pro-actively empower our clients to make informed and high conviction investment decisions. Our world travels helps us to think broader than the local best practice and helps us to challenge the status quo. For example, we have conducted various investment manager research trips to London, Edinburgh Beijing, Shanghai, Hong Kong) and India (Mumbai) to explore investment opportunities for our clients and met with many investment managers there. We have also attended various global investment conferences in Chicago and Singapore.

We have an internal Investment Committee, Wealth Management Committee and a Responsible Investment Committee at which our proprietary research is discussed and where we formulate our investment recommendations to our clients.

Our proprietary investment manager database encapsulates more than 1000 institutional mandates. Further, we also have access to the South African Unit Trust database of more than 1000 unit trusts and another offshore database comprising of more than 5000 investment products. We monitor retail unit trust funds as we believe only monitoring the institutional investment manager database is not optimal. There are many retail unit trust products which are very suitable for institutional funds.

We offer the widest and most comprehensive investment manager Peer Group Surveys (we call the “ScoreCards”) in the industry. Our investment manager ScoreCarss are detailed versus the industry standard of two to three pages and we cover track records typically as far back as 8 years whereas our competitors only show the past 3 years in their Surveys. Our risk statistics are based on long term statistics whereas our competitors use the last 3 years. We do not believe that a 3 year period is adequate because the analyses then excludes the credit crisis of 2008 and also that is not possible to separate luck from skill when assessing investment managers over such a short period of time. Therefore we base all our analyses on longer term results. We publish a summary ScoreCard every month which encapsulates a summary of 8 of the more than 32 ScoreCards that we produce on a monthly basis.

We incorporate advanced technology into our investment manager research process. In addition to the proprietary technology that we have built have we recently automated our approach even further. We have acquired a world-class portfolio construction, optimization and manager selection system from a global provider and are further incorporating a second off the shelf solution to further strengthen our approach.

Active versus Passive Mandates

We believe that there is a place for both passive and active management in portfolio construction. It’s not about one or the other. Academic research suggests that 85% of investment managers have and will continue to underperform the overall market. The problem is not that investment management is not done well, the problem is it is done well and by many and the active investment management universe thereby becomes the market. The issue is simply that selecting superior active investment managers in certain asset classes is a low probability and low conviction decision.

Our various local Equity ScoreCards (we conduct 5 different local Equity ScoreCards) as well as our offshore Equity ScoreCards shows that the average local and offshore active equity investment manager has underperformed the respective local and offshore equity markets on an after fee basis.

Our proprietary optimisation and portfolio construction investment manager research proves that the more active investment managers are selected the larger the role of a passive investment manager in the total portfolio construction. We have conducted a detailed research study which incorporated more than 70 investment manager’s local equity track records over the long term and have found that as soon as more than 3 active investment managers are selected then a passive mandate becomes relevant.

Outperforming equity benchmarks after fees consistently is not an easy task but it is possible and has been achieved by a select few. It is therefore crucial for investors to identify the handful of truly exceptional investment managers for potential inclusion in their investment strategy.

Incubation

We recognize that our local equity market is extremely concentrated with a small number of shares making up the bulk of the market. The top 20 shares make up more than 65% of our market. If some large investment managers want to invest 5% of their assets in a smaller company listed on the JSE would they own the entire companies’ share capital. An investment manager that manages about R50 billion of equity assets only have approximately 40 shares in which to invest as much as 5% without owning more than 10% of the issued shares. An investment manager with more than R200 billion of equity assets has a universe of approximately 10 shares he can invest into without owning more that 10% of the issued shares. The risk is therefore not only a potential missed opportunity for investors but also the illiquidity or difficulty of the investment manager to trade out of a share in which they have a material allocation which could be detrimental to your performance.

We also recognize that smaller investment managers are more flexible to exploit opportunities across the smaller shares in the investable universe and thus the need to potentially incubate smaller investment managers. Our research however shows that even the smaller investment managers, despite being able to invest into the smaller shares, still invests a large portion of their assets to the Top 20 shares which is in contradiction to what the various smaller investment managers “markets” to their clients. The question remains whether incubation is the answer to access opportunities in the mid and small cap sectors rather than to invest in a mid and small cap fund managed by a larger investment manager.

Transformation of the asset management industry

The South African investment industry is currently highly concentrated with the largest 5 investment managers accounting for more than 60% of the total market share. Fortunately some of the many young firms that won mandates from the PIC in 2008 have started to build a footprint in the industry. Albeit that transformation has happened very slowly do we believe that the revised Regulation 28 now requires Trustees to formally apply their minds to consider transformation when appointing service providers. The market share of smaller investment managers should therefore grow from its current low base.

Responsible Investing

Trustees do not have one single ‘fiduciary duty’ but rather a number of distinct duties including to act in the best interest of all members, to treat all beneficiaries impartially and to avoid (rather than to manage) conflicts of interest. Yet conventional understanding view ‘fiduciary duty’ as a single “duty to maximise returns”. Responsible investment (RI) offers the opportunity to rethink fiduciary duty in light of long-term, sustainable returns, although this may challenge conventional thinking.

GraySwan is one of only 3 investment consultants in South Africa that are United Nations backed Principles for Responsible Investment (UNPRI) signatories. We have recently been awarded as the Responsible Investment Consultant of the Year by BATSETA (our industry body).

Our investment manager research and selection process formally incorporates ESG into our screening of the universe of investment managers. We have conducted material work in this regard. For example, we conduct monthly BEE and RI Peer Group investment manager ScoreCards, we have implemented Qualitative Investment Manager Questionnaire Templates, which focus on BEE and RI and we have conducted a “proxy voting” study in conjunction with one of the largest Universities in South Africa.

Further, we have an internal Responsible Investment Committee, supported by two external specialists, which meets on a monthly basis to unpack issues relating to Responsible Investment and as such to inform our clients accordingly.

Summary

We always count. We test, we test and we test again. We don’t trust, we verify and then we conduct extensive investment and operational due diligence and then only do we advise our clients to potentially invest. Our clients are the ambassadors of our proven investment manager selection approach. Herewith two of our largest retirement fund’s testimonies to our approach.

“Since their appointment, GraySwan’s investment advice has resulted in a marked improvement in our investment results. We have furthermore been impressed by their work ethic and attention to detail when investigating opportunities or scrutinising investment manager performance. We are particularly pleased by GraySwan’s uncompromising attitude towards staying independent, since it is important to us that our investment consultant does not have conflicting interests that could impact on the absolute objectivity of their advice.”

“Through GraySwan’s high standard of ethics and being independent vis-a-vis all asset managers, the Fund has always had the benefit of receiving unbiased advice regarding its investments and undivided loyalty towards the Fund. Insofar as prospective new asset managers are concerned, this unbiased view has uncovered matters not mentioned by these managers during presentations to the Fund, which can then be raised with them. Regarding existing asset managers, regular independent evaluation is very important as they are consistently undergoing changes or need to explain why they acted in a certain manner regarding an investment.”

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