Changing Investment Managers: Should I Stay or Should I Go?

A fact of life in active asset management is that management changes take place on a regular basis. Two reminders of this fact include fixed-income manager Jeffery Gundlach’s departure from Trust Company of the West (TCW) and more recently, Richard Glass’ departure from Morgan Stanley Investment Management. Given the unpredictable nature of some manager changes, this disruption can’t be avoided altogether. However, certain aspects of a comprehensive due diligence process can anticipate personnel stability in the roster of managers that advisors rely upon. Indeed, there are even some firms that keep their managers and strategies intact for years, even decades.

The goals for any due diligence process are to identify quality management teams or individual managers who display an investment edge and deliver consistently positive alpha performance. The keys to this process are to attempt to differentiate between luck and management skill, and to select those managers whose past performance is both repeatable and sustainable in the future. For these reasons, the initial and ongoing due diligence on any separately managed account (SMA) product or mutual fund should include an understanding of the firm’s structure, compensation and incentive programs, the investment professionals’ commitment to the organization and the organization’s management succession plan.

Organizational Changes

Before we address manager changes, let’s first consider organizational changes, such as corporate mergers or acquisitions. In this event, ownership changes must be understood in detail, though the detail needed may not be made available to the public. In particular, the removal of equity ownership from the investment professionals is rarely a positive development. Equity ownership, stock appreciation rights and related profit sharing are clearly large incentives for any management or investment team. Part of the assessment should also proactively assess how the firm evaluates the next generation of management, develops the career paths of these professionals, assigns increasing levels or responsibility, utilizes peer-to-peer employee performance reviews, and what the impact on corporate culture and investors may likely be.

Following a manager change, the decision to allow client capital to remain with the asset management firm is based on many factors. Importantly, advisors should assess how the portfolio structure may change, how the buy side and sell side discipline may change, whether risk controls on the portfolio may be modified, and how those prospective changes would disrupt the client’s asset allocation. While understanding the resum? of a new portfolio manager is important, often the new manager will be well qualified and have significant experience (except in very rare cases).

Of immediate concern, however, is the near-term impact that the new manager or management team will have on the portfolio. Are there any anticipated increases or decreases to the number of securities in the portfolio or the annual rate of turnover going forward? Does the new portfolio manager intend to stress one or more of the previous manager’s key investment themes or criteria, and if so, will it change the dynamics of the portfolio as a whole? Will there be new security valuation, portfolio characteristic or risk measurement models or filters employed as part of the process?