We’re aware that when some financial advisors hear the term “manager due diligence,” a nice tidy checklist comes to mind. We’re aware—and we understand—but it’s hard not to be a little disappointed. The thought that such a robust process—the classic combination of art and science—is ever reduced to something on the order of an eHow query always gives us pause. We’re pretty sure that selecting serious money managers for serious assets goes way beyond filling in a few blanks and checking off a few boxes.
Let’s face it…it’s not that hard to quantify a few ‘Hows’ and ‘Whats.’ The real trick comes in qualifying the ‘Whys.’
Looking Behind the Decisions
Without question, inquiries that get to what a manager does and how he or she does it are an essential element of the evaluation process. An investment manager’s responses to these factual questions provide plenty of background.
But the more revealing and meaningful insight is likely to be found in answers to the ‘Why?’ questions. Why has a manager chosen to do things in a particular way? Why does the manager think he has an unassailable alpha thesis? Why does he think he has an edge in exploiting inefficiencies? There are more and less effective ways to do things in the investment industry, of course, but there’s not likely to be one ‘right’ way. That is why assessing the quality of the thinking behind a decision is often more important than the decision itself.
That can be said of business decisions that affect the investment process as well as the investment decisions themselves. Take an investment firm’s compensation plan. There are myriad ways to construct compensation plans for investment professionals so we’d be interested in looking past the factual elements of a plan to the logic behind it. What was the thinking that went into constructing a particular compensation plan and why was it executed? Which behaviors were being elicited and why are they considered important? Who is responsible for determining if the plan is achieving its intended effect and why does that matter to the investment process?
Imagine the insight you would gain if you discovered decisions were being made with no evaluation of the results. You’d surely be inclined to question the rigor with which that manager approached the entire business.