Before I became a wealth strategist serving individuals and families as their dedicated fiduciary, I consulted leading financial advisors around the country on how to use absolute return managers for their clients. Certain absolute return strategies have historically underperformed the stock market during bull markets, which can be frustrating; however, they have historically outperformed the stock market during bear markets, which can help buffer downside risk. This reminds us of why we diversify.
The absolute return landscape is quite large. To assist with your due diligence on managers, I’m providing the 10 questions that have helped me navigate the space over the years.
- What fundamental and technical analyses does your lead portfolio manager (“PM”)/team use to make portfolio management decisions?
- What is the actual track record of your mutual fund? If your mutual fund is new but you have a private placement offering, what is the track record of the private placement? Is the trading in your mutual fund precisely the same as in your private placement?
- What is the correlation between your strategy and the a) S&P 500 & b) Barclay’s Agg over rolling 3-, 5-, & 10-year periods, as well as since inception?
- During periods of economic duress — most recently the selloff earlier this year, the correction in early 2016, and larger systemic events like 2008 — what are the correlation numbers (asked in question #3) during those periods?
- I prefer to minimize the correlation of my absolute return managers; therefore, what is the correlation between your strategy and the other managers I use over rolling 3-, 5-, & 10-year periods?
- Does your firm have an independent auditor, custodian, and Due Diligence Questionnaire (“DDQ”)?
- In the interest of tax efficiency for nonqualified (“non-retirement” account) portfolios, what is your portfolio turnover?
- If your lead PM was hit by the proverbial bus, what is your current succession plan and how would you minimize redemptions?
- On the personal front: What is your PM’s age, health status and family situation? Are there any qualitative issues that may pull the PM away from the primary objective of managing the portfolio?
- If I was in your seat, what due diligence question(s) would you not want me to ask and why?
While no amount of due diligence can prevent loss, hopefully these questions help you research absolute return managers you are considering. Enjoy the current party — but keep in mind, it may not last forever.
Vance Barse is a wealth strategist for high-net-worth individuals, families and business owners. Previously, for nearly a decade, he was an investment consultant to leading private wealth and retail financial advisors around the country. In that role, he managed relationships with advisors, RIAs, and family offices. Sign up for Vance’s blog updates at vancebarse.com.
Absolute returns strategies are not intended to outperform stocks and bonds in strong markets, and there is no guarantee of positive return or the strategies will be achieved. Alternative strategies often engage in leverage and other investment practices that are speculative and involve a high degree of risk. Such practices may increase the volatility of performance and the risk of investment loss, including the entire amount that is invested. Satellite investments tend to include more specialized investments that are not highly correlated with the stock market. Investments are subject to risk, including the loss of principal. Some investments are not suitable for all investors, and there is no guarantee that any investing goal will be met. Past performance is no guarantee of future results. Talk to your financial advisor before making any investing decisions.