Guidance on selecting the right institutional investment manager from recent experience
Kevin Foley is a Managing Director at YTM Capital, a Canadian asset manager focused on Credit and Mortgage investments. Kevin is a veteran of the capital markets and a long-standing member of three Canadian Foundation Boards and associated Investment Committees.
Finding the right institutional investment manager is a rewarding process that probably won’t unfold as you expect. It requires advance preparation and a willingness to learn as you realize that great partners are available, yet it may not be the panacea that you imagined.
Clarifying your own priorities and requirements ahead of time is essential. This feeds your selection of manager types and managers to invite, and it informs the information that you share with them and the information that you require from them. I know because our preparation was effective this time, and the lack of it caused a similar process to fail previously.
In our Foundation’s recent investment manager search, we defined investment manager as the fiduciary provider who designs, executes, and oversees the total portfolio. We made this distinction from the asset managers who make the actual investments, recognizing that those are one in the same in some instances.
What we did right.
We largely knew what we required before we started the process and sent out a detailed RFP document and schedule. We were considerate about which and which types of investment managers we invited. We stuck to our timeline, and we provided reasonably timely feedback to the respondents. We committed the requisite time, and we did not hesitate to ask for more information.
What we could have done better.
If we had delivered more insight into our goals and parameters the managers could have responded more specifically, which would have refined their initial asset allocation suggestion. In the RFP document, we should have explicitly asked for an itemized fee breakdown for each proposed asset allocation. We would have benefitted from a well-designed scorecard to aid our deliberation and decision-making.
What would be nice to do better, but unfortunately, I can’t tell you how.
Create a true apples-to-apples comparison of each manager’s proposal.
Find a better way to assess each manager’s track record for similar Foundations. Have an independent third-party assessment of an appropriate strategic asset allocation and associated risk and return metrics, for comparison purposes without respondent firm bias. Do it all in a shorter amount of time, wasting as little committee and respondent time as possible.
We found that it takes work to choose the best manager for you, because they are all meaningfully different and perfect is probably not available. This may cause you to reprioritize along the way, adding in the essential new elements that resonate with your group. The use of alternative investments to optimize a portfolio, now and in the future, might be a good example of something that resonated as essential to us.
Access to top-performing funds, with access to the essential asset classes, importantly including alternative investments, felt like a priority for us as we developed the RFP and throughout our process. Our challenge was trying to compare the totality of the fund offerings from the various managers, with an eye on future expected returns and not relying solely on track records. Some managers did not have certain important asset classes on their shelf, nor did they resolve how we might gain access to them in their model. Important exposures like private equity, a selective property mortgage fund, a distinct credit fund offering, and access to appropriate hedge funds were surprisingly missing on some platforms. We did experience some frustration related to this topic, wondering if the investment management firms were profiling the best of what they had versus the best of what we needed.
Do not decide on fees alone. Lowest fees do not equal best long-term performance. Do consider fees and try to determine best after-fee total portfolio return but only treat fees as one of the many deciding factors. Our detailed fee breakdown request helped us assess the total fees, including investment management fees, management fees, performance/carried interest fees, fees and expenses imbedded into funds, and custody fees.
The challenging themes for us included how to assess the value of customer service and reporting and the additional services like risk modelling and white papers, and how, as fiduciaries of the fund, we were supposed to choose between the large, proven household-name providers versus the smaller, lesser-known ones that might offer a fresher investment management process with the opportunity for higher risk-adjusted returns. My only conclusions here are to be open-minded and willing to do the extra due diligence work, noting that these themes were the only reason that we considered two managers, or at least a manager for a specific sleeve.
The most compelling theme for me might have been some of these refreshed approaches to asset allocation and risk management, notably from some of the smaller and growing providers. Their use of alternatives, ETFs, gaining distinct credit exposure, differentiating among private debt styles and a seemingly evolved approach to risk budgeting and risk management was a draw.
Other recurring themes for our group included the debate between investment managers with open or closed architecture, and the merits of a tactical asset allocation option. It seems that there are benefits to both open and closed, with fees and rebalancing merits potentially offsetting bespoke funds and a complete selection of asset classes. It feels like the right open architecture offering should offer a full suite of options, and that fees could be similar or only marginally higher, which may be an ongoing opportunity for managers to differentiate themselves within the Canadian investment management space. Our group agreed that a strategic asset allocation is the most important investment decision and that i) only a few managers have the skill to add worthwhile benefits from tactical shifts and ii) that the allowance within the tactical shifts shouldn’t be capable of swamping the overarching strategic choice. We chose to include TAA as an important factor.
What we were left wondering.
How to effectively assess future expected returns. What we should be thinking about investing for tomorrow differently than what we have experienced in the past. Do private asset valuations (real estate, infrastructure, private debt) reflect reasonable valuations after an historic move in interest rates and which ones of those private funds are currently investible. The mindset of meeting a target annual return on average over 10 years versus the mindset to setup to reach for the target each year. How does our new partner help us refrain from meddling too much.
We are not quite finished our process, but we are close. I am convinced that the process was entirely worth the effort, despite the enormous time spent. We learned about new approaches, ideas, and concepts. We tested individual and group beliefs. We unintentionally tested and reviewed our own governance policies. We learned that there is no panacea in investment management and that judging the future based upon the past is an important but difficult thing to do. We were reminded that investment management business models are influenced by their structure and their profit motive. We confirmed that we need a great investment management partner now as much as we ever did.
